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Item 6. Selected Financial Data Information responding to Item 6 is included in the 1993 Annual Report to Shareholders, in the section entitled "Financial Information" under the caption "Statistical Review from 1989 to 1993" on Page 36, filed herein by the Registrant with the Commission pursuant to Regulation 14A and is incorporated herein by reference pursuant to General Instruction G(2). Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation Information responding to Item 7 is included in the 1993 Annual Report to Shareholders, under the caption "Management's Discussion and Analysis" on Pages 17 through 23, filed herein by the Registrant with the Commission pursuant to Regulation 14A and is incorporated herein by reference pursuant to General Instruction G(2). Item 8.

92116

1993

Item 6. SELECTED FINANCIAL DATA - - - ------- ----------------------- The following table sets forth selected consolidated financial information of the Company for the fiscal years ended December 31, 1993, 1992, 1991, 1990 and 1989. 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. - - - --------------- (1) Includes the results from January 1, 1993 of the Roederstein acquisition. (2) Includes the results from January 1, 1992 of the businesses acquired from STI. Item 7.

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - - - ------- CONDITION AND RESULTS OF OPERATIONS ------------------------------------------------- Introduction and Background The 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. Since mid-1990, sales of most of the Company's products have been adversely affected by the worldwide slowdown in the electronic components industry. In addition, sales to defense-related industries have declined since the first quarter of 1991. These trends are continuing. Year ended December 31, 1993 compared to Year ended December 31, 1992 Results of Operations - - - --------------------- Net sales for the year ended December 31, 1993 increased by $192,046,000 over the comparable period of the prior year. The increase resulted from the acquisition of Roederstein, effective January 1, 1993. Net sales of Roederstein were $212,124,000 for the year ended December 31, 1993. Net sales, exclusive of Roederstein, decreased by $20,078,000, compared to the same period of the prior year. This decrease in net sales is attributable to the strengthening of the U.S. dollar against foreign currencies, which resulted in a decrease in reported Vishay sales of $15,671,000 for the year ended December 31, 1993, and recessionary pressures in Europe. Costs of products sold for the year ended December 31, 1993 were 77.5% of net sales as compared to 76.5% for the comparable period of the prior year. The reason for this increase is that the costs of products sold for Roederstein (prior to the full implementation of synergistic cost reductions) are approx- imately 80% of net sales, while Vishay's business, exclusive of Roederstein, has been operating in the 76% to 78% range. In 1993, grants of $3,424,000 received from the government of Israel, which were utilized to offset start-up costs of new facilities, were recognized as a reduction of costs of products sold. Selling, general, and administrative expenses for the year ended December 31, 1993 were 13.9% of net sales as compared to 15.3% for the comparable period of the prior year. The current year's lower rates reflect the effect of the acquisition of Roederstein and the ongoing cost savings programs implemented with the acquisition of certain businesses of STI during 1992. Restructuring 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. Income 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. Interest costs increased by $1,514,000 for the year ended December 31, 1993 as a result of increased debt incurred for the acquisition of Roederstein. Other income for the year ended December 31, 1993 decreased by $4,410,000 over the comparable period of the prior year because other income for the year ended December 31, 1992 included consulting fees of $2,307,000 from Roederstein. These fees to Vishay were for time and expenses of Vishay personnel utilized by Roederstein in its attempt to restructure itself. Also, other income for the year ended December 31, 1992 included fees of approximately $3,325,000 from STI under one-year sales and distribution agreements. Foreign currency losses for the year ended December 31, 1993 were $1,382,000, as compared to foreign currency losses of $1,594,000 for the year ended December 31, 1992. The effective tax rate of 16.2% for the year ended December 31, 1993 reflects the non-taxability of certain insurance recoveries. The 1993 rate was also affected by increased manufacturing in Israel, where the Company's average income tax rate was approximately 4% in 1993. The effective tax rate for the year ended December 31, 1993, exclusive of the effect of the non- taxable insurance proceeds, was 18.6%. The effective tax rate for the year ended December 31, 1992 was 19.8%. Accounting Changes - - - ------------------ Effective 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 pretax amounts. The 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 $0.04 per share. Prior-year financial statements have not been restated to apply the new standard. Year ended December 31, 1992 compared to Year ended December 31, 1991 Net sales for the year ended December 31, 1992 increased $221,943,000 over the comparable period of the prior year. The increase was the result of the inclusion of the businesses acquired from STI effective as of January 1, 1992. Net sales of the acquired businesses were $230,492,000 for the year ended December 31, 1992. For the year ended December 31, 1992, net sales, exclusive of the acquired businesses, decreased by $8,549,000 compared to the same period of the prior year when recessionary pressures affecting sales were not as great. The weakening of the U.S. dollar against foreign currencies resulted in an increase in reported Vishay sales of $10,418,000 for the year ended December 31, 1992. Costs of products sold for the year ended December 31, 1992 were 76.5% of net sales as compared to 71.9% for the comparable period of the prior year. The reason for this increase is that the costs of products sold for the newly purchased businesses from STI (prior to any synergistic cost reductions) are 80% of net sales, while Vishay's resistor businesses traditionally operate at levels of 70% to 75%. Selling, general, and administrative expenses for the year ended December 31, 1992 were 15.3% of net sales compared to 17.2% for the comparable period of the prior year. The 15.3% rate reflects the effect of the businesses acquired from STI. The rate applicable to the businesses acquired from STI (approximately 11%) includes the effects of initial cost saving programs installed subsequent to the acquisition. For the year ended December 31, 1992, selling, general and administrative expenses of the Vishay resistor business (approximately 17%) were comparable to the levels experienced in the prior year. Interest costs increased by $3,903,000 for the year ended December 31, 1992 as a result of the increased debt incurred for the purchase of the businesses from STI. Other income for the year ended December 31, 1992 includes consulting fees of $2,307,000 from Roederstein. Other income for the year ended December 31, 1992 also includes fees of approxi- mately $3,325,000 from STI under one-year sales and distribution agreements expiring February 14, 1993, which were entered into in connection with the acquisition of the businesses from STI. The effective tax rate was 19.8% for the year ended December 31, 1992. The effective rate is comparable to the rate of 23.3% for 1991. The 1992 rate was in part affected by increased manufacturing in Israel where the Company's average income tax rate was 7% for 1992. Year ended December 31, 1991 compared to Year ended December 31, 1990 Net sales decreased by $3,313,000 or approximately 1% to $442,283,000 for the year ended December 31, 1991 from $445,596,000 for the year ended December 31, 1990. Sales increased in the United States by 2.7% as a result of acquisitions, which partially offset the effect of the worldwide recession. Sales in Western Europe declined 4.9% compared to the year ended December 31, 1990 as a result of the recession and the strengthening of the dollar against foreign currencies. Price increases did not materially affect sales. Costs of products sold increased to $318,166,000 or 71.9% of sales for the year ended December 31, 1991 from $312,925,000 or 70.2% of sales for the year ended December 31, 1990. The increase in costs of products sold as a percentage of sales reflects increased production costs of relatively flat sales in addition to certain manufacturing inefficiencies during the latter part of 1991. Selling, general, and administrative expenses decreased to $75,973,000 or 17.2% of sales for the year ended December 31, 1991 from $77,740,000 or 17.4% of sales for the year ended December 31, 1990 primarily because of the continuation of cost reduction programs introduced during 1990. Expenses of approximately $3,700,000 for layoff costs at the Company's European subsidiaries were incurred during the latter half of 1991. This correction to the work force was made to strengthen the subsidiaries' ability to attain earnings goals and to respond to the current recession. Interest expense decreased by $4,219,000 to $15,207,000 for the year ended December 31, 1991 from $19,426,000 for the year ended December 31, 1990 primarily as a result of payments made on long-term debt and lower interest rates. Other expenses for the year ended December 31, 1991 were $289,000 compared to income of $2,344,000 for the year ended December 31, 1990, primarily due to decreases in investment grants from Israel and interest income. Investment grants and interest income for the year ended December 31, 1991 were $106,000 and $797,000, respectively, compared to $980,000 and $2,257,000, respectively, for the year ended December 31, 1990. The effective tax rate for the year ended December 31, 1991 was 23.3% versus 31.5% for the year ended December 31, 1990. The decrease in the effective tax rate resulted from a reduced tax rate for certain Israeli operations and an increase in the propor- tion of earnings taxable in Israel. The lower rate was primarily due to tax advantages of doing business in Israel where the Company's effective average tax rate was approximately 10% at that time. Financial Condition Cash flows from operations were $50,114,000 for the year ended December 31, 1993 compared to $54,357,000 for the prior year and were used primarily to finance capital expenditures. Purchases of property and equipment were $76,813,000 for the year ended December 31, 1993 compared to $49,801,000 for the prior year primarily due to additions of manufacturing equipment for surface mount products and expansion of manufacturing facilities in Israel. The Company's financial condition at December 31, 1993 is strong with the Company's current ratio of 2.1 to 1. The Company's ratio of long-term debt to stockholders' equity was .7 to 1 at December 31, 1993 as compared to .4 to 1 at December 31, 1992. The increase in this ratio resulted from additional borrowings in connection with the acquisition of Roederstein. In connection with the Roederstein acquisition, Vishay entered into a DM 104,316,000 term loan agreement with its lending banks in January 1993. In addition, an Israeli subsidiary of Vishay borrowed $20 million pursuant to an unsecured credit agreement. The funds from the credit facilities were used in connection with the Roederstein acquisition and the refinancing of Roederstein's debt. Vishay and the Banks also amended certain terms of the outstanding $170,000,000 Revolving Credit and Term Loan Agreement dated as of January 10, 1992 among Vishay and the Banks and the Amended and Restated DM 42,375,000 Revolving Credit and DM 57,036,000 Term Loan Agreement dated as of January 10, 1992 among Vishay, Draloric and the lending banks in order to, among other things, allow Vishay to draw upon its revolving credit facilities to refinance a portion of Roederstein's debt. See Note 6 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. Management believes that 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. Inflation Normally, 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 extent permitted by competition, can be adjusted to reflect cost increases caused by inflation. Item 8.

103730

1993

ITEM 6. SELECTED FINANCIAL DATA A summary of selected financial data for the Company for the five years ended December 31, 1993 is included under the caption entitled "Selected Financial Data" on page 28 of the 1993 Annual Report to Shareholders and is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company reported consolidated revenue of approximately $1.9 billion for the year ended December 31, 1993, a 9% increase over the same period last year. Operating profit, defined as income before interest expense, interest income, income taxes, extraordinary items, and the cumulative effect of a change in accounting principle, rose 4% over 1992 to $302 million. The Company incurred a net loss of $244 million, which included a nonrecurring charge of $306 million for the cumulative effect of a change in accounting for income taxes, and $11 million in extraordinary charges, net of tax benefits, for the early termination of certain of the Company's bank credit facilities and the redemption of its convertible debt due 2004. Income before these charges and the provision for income taxes was $121 million, or a 21% increase over 1992. The consolidated financial statements and all related information included in the 1993 Annual Report to Shareholders incorporated herein by reference should be read in conjunction with the following review. See the financial statements set forth on pages 29 through 51 of the 1993 Annual Report to Shareholders, incorporated herein by reference. For a discussion of regulatory and legislative matters affecting the Company, refer to Part I -- Item 1, "Business -- Regulation." OVERVIEW The Company's present operations and future prospects are influenced by many factors, primarily the growth of the cable television industry and the economic climate both in the United States and abroad, as well as the availability of programming for its entertainment and news networks. Additionally, governmental regulation and information technology changes relating to the cable television industry also influence domestic and international prospects. Because of the Company's recent acquisition of Castle Rock and New Line, future prospects will also be influenced by the profitability of the motion picture industry. U.S. CABLE TELEVISION INDUSTRY The growth of the Company's Entertainment and News Segments is influenced by the growth of the U.S. cable industry since that medium represents the principal distribution system for TBS SuperStation, TNT, the Cartoon Network, CNN and Headline News. At the end of 1993, homes subscribing to cable television service in the United States reached approximately 63 million, which represented 67% of all U. S. television households and a 1% increase over 1992. Homes served by cable television are expected to grow through 1996 and are expected to represent approximately 72% of all U.S. television households by the end of that year. The growth of the Company's Entertainment and News Segments is also influenced by the channel capacity of individual cable system operators. ECONOMIC CLIMATE The state of the U.S. economy influences the results of the Entertainment and News Segments as those segments derive a significant portion of their revenues from advertising, which is sold largely within three to nine months of airing and which, under certain conditions, can be cancelled by the buyers. Overall, domestic advertising revenues totaled $828 million in 1993, $750 million in 1992 and $662 million in 1991, representing 43%, 42% and 45%, respectively, of total revenues in those years. The impact of changes in the economy is mitigated by the fact that the Company derives a portion of its revenues from subscription fees, which are relatively resistant to short-term domestic economic factors. Domestic subscription fees from cable system operators, which totaled $502 million in 1993, $429 million in 1992 and $386 million in 1991, representing 26%, 24% and 26% of total revenues in those respective years, are generally received under contracts with three to five year terms. PROGRAMMING The Company continues to make significant investments in original, sports and licensed entertainment programming and in newsgathering capabilities to increase the viewership of its Entertainment and News Networks. The Entertainment Networks use high-profile original movies, specials and sporting events to define identity and provide a base of highly promotable programming from which to attract viewers to their entire slate of offerings. The Company has acquired programming rights to two of the most promotable sporting franchises available. Under a contract entered into in 1990, TNT telecast three pre-season and nine regular season National Football League ("NFL") games in 1993 and 1992. The Company has reached an agreement with the NFL to telecast a similar number of pre-season and regular season games each year over a four-year period beginning in 1994. Since 1989, TNT has also telecast NBA regular season and playoff games. The Company has entered into a new contract with the NBA covering the 1994-1995 through 1997-1998 seasons. Under the new contract, TNT and TBS SuperStation will telecast NBA regular season and playoff games. In addition, affiliations with sporting events such as the 1992 and 1994 Winter Olympics, telecast on TNT, and the Company's own Goodwill Games, telecast on TBS SuperStation, provide exposure on an international level. In 1990, the Company negotiated a long-term television license agreement with MGM-Pathe Communications Co. (now Metro-Goldwyn-Mayer Inc. ("MGM")) for approximately 1,000 feature films, over 300 cartoon shorts and selected television series. In December 1991, the Company acquired a 50% interest in HB Holding Co., a newly-formed joint venture. The joint venture, through a merger, acquired Hanna-Barbera, Inc. and the HB Library, which provided the Company access to a library of over 3,000 half-hours of animated programming and afforded exposure to a new facet of entertainment programming. Coupled with the 1,850 cartoon episodes in the TEC Film Library, the Company now has access to a vast source of animated programming. In October 1992, the Company used access to this programming to launch the Cartoon Network, a 24-hour per day cable program service which has revenue streams from both advertising and subscription fees. On December 22, 1993, the Company acquired all of the equity interests in Castle Rock, a motion picture and television production company, and on December 29, 1993, the Company acquired the remaining 50% interest in HB Holding Co. In addition, on January 28, 1994, the Company completed the acquisition of New Line, an independent producer and distributor of motion pictures. See Note 2 and Note 16 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders incorporated herein by reference. When combined with existing arrangements for programming and the extensive library of feature films, cartoons and televisions series, these new acquisitions continue to build core programming for the Entertainment Networks and allow for control of programming from production through various stages of distribution. The Company will continue to use this programming for new networks, such as the launch of a 24-hour satellite and cable distributed family entertainment network -- Turner Classic Movies -- during 1994. Programming costs in the News Segment primarily relate to personnel, travel costs and satellite and communications access. CNN presently operates nine news bureaus in the United States and 19 bureaus in countries outside the United States. In the near future, the Company anticipates expanding staff and facilities internationally, increasing staff working on breaking news stories, and modifying its daily programming mix as necessary, all with the objective of increasing viewership. INTERNATIONAL While most of the Company's revenues are derived from domestic distribution of its products and services, the Company views the international market as an important source for future revenue growth. Historically, the Company has derived the majority of its international revenues from syndication and licensing to television stations, the sale of home videos of feature films from the TEC Film Library and, to a lesser degree, from theatrical release of original productions made for TNT. These operations continue to contribute an important revenue stream to the Company; in 1993 international syndication and licensing revenues (defined as broadcast fees, syndication, home video and licensing and merchandising revenues), were $149 million, representing approximately 62% of total international revenue. This is an increase of 2% over 1992. The Company believes the greatest potential for growth internationally is in the area of satellite delivered programming. Currently, CNN International is the Company's predominant programming vehicle outside the United States. CNN International is distributed via satellite primarily to cable systems, broadcasters, hotels and private satellite dish owners. Subscription levels in Europe grew from 12 million households at the end of 1991 to 45 million households by the end of 1993. CNN International's programming is generally either CNN product as viewed in the United States or in a reformatted version which conforms to retransmission restrictions imposed by certain agreements under which CNN collects international news stories from certain overseas suppliers. It also includes segments specifically produced for the international markets. Revenues, which are derived from subscriber fees, broadcast fees, and advertising sales, are principally generated from Europe. Total revenues from CNN International increased from $74 million in 1992 to $93 million in 1993. It is anticipated that these revenues will continue to increase as the Company capitalizes on the growing international reputation of CNN and the increased international opportunities to market the service, both in terms of increases in international advertising and in terms of overall growth in international television media and markets. In January 1991, the Company launched TNT Latin America, a 24-hour per day trilingual entertainment program service serving Latin America and the Caribbean via satellite. Relying largely on existing programming from the TEC Library, this service allows the user to customize the service using Spanish, Portuguese and English audio tracks and subtitles. Contracts for carriage of this service are offered by the Company's sales and marketing organizations to operators of cable systems and similar technologies. Revenues from this service, which in many areas is being marketed together with CNN's news programming, are almost entirely from subscription fees based on contracts with cable operators which specify minimum subscription levels. Revenues for TNT Latin America continue to increase with a 50% growth over 1992. In March 1993, the Company acquired a 27.5% limited partnership interest in n-tv, a 24-hour German language news channel. The partnership provides for cooperation in newsgathering, exchange of news footage and cooperative access to facilities. In April 1993, the Company launched Cartoon Network Latin America, a 24-hour per day programming service in Latin America utilizing animated programming from both the HB Library and TEC Library. In September 1993, the Company also launched TNT & Cartoon Network Europe, which consists of European versions of the Cartoon Network and TNT, originating in the United Kingdom, and distributed throughout Europe. Both of these new networks have revenue streams from advertising and subscription fees. The Company is also committed to a 50% joint venture interest in an over-the-air television station in Moscow. Programming for this joint venture will primarily be in the Russian language and will include classic films from the TEC Library, sports and children's programming and CNN International programming. The Company is planning the launch in 1994 of a 24-hour movie and cartoon network in Asia (TNT & Cartoon Asia). Programming for this new international network will come primarily from the TEC Library and the HB Library. The Company believes international markets provide substantial opportunities for revenue growth in the future. Such growth will be significantly influenced by, among other things, competition, governmental regulation, access to satellite transmission facilities, improvements in encryption technologies, the continued growth of distribution system alternatives to over-the-air broadcast technology, the availability of effective intellectual property protection and local market economic conditions in the countries served. LIQUIDITY AND CAPITAL RESOURCES SOURCES AND USES OF CASH As part of its ongoing strategic plan, the Company has invested, and will continue to invest, significant amounts of capital for network and television programming development, filmed entertainment and programming acquisition. Historically, the Company has relied primarily on debt to finance these initiatives and as a result has maintained a high degree of financial leverage. This approach continued in 1993 enabling the Company to implement its growth plans. See Note 2, Note 5 and Note 16 of the Notes to Consolidated Financial Statements included in the 1993 Annual Report to Shareholders incorporated herein by reference. Additionally, see "Liquidity and Capital Resources -- Credit Facilities and Financing Activities." The Company expects that internally generated funds supplemented by existing credit facilities and debt that may be issued pursuant to its shelf registration filed in May 1993 will be sufficient to meet operating needs and scheduled debt maturities through the end of 1994 and beyond. Cash provided by operations for the year ended December 31, 1993, aggregated $136 million, net of cash interest payments of $138 million, payments of $75 million for accreted amounts upon redemption of the zero coupon notes due 2004 (the "Convertible Notes due 2004") completed in August 1993, and payment of debt issue costs of $16 million related to the issuance of 8 3/8% Senior Notes and the execution of the 1993 Credit Agreement, both of which occurred in July 1993. Other primary sources of cash included borrowings under the 1993 Credit Agreement of $1.225 billion and approximately $297 million of gross proceeds from the 8 3/8% Senior Notes. Cash was primarily utilized for the retirement of indebtedness, including the Convertible Notes due 2004 ($216 million, net of payments of accreted amounts) and amounts outstanding under the 1989 Credit Agreement ($710 million) and the CNN Center Ventures Credit Agreement ($40 million). In addition, the Company acquired an equity interest in and advanced funds to the German limited partnership, n-tv ($35 million), purchased the remaining 50% interest in HB Holding Co. and its subsidiaries ($243 million, net of cash) and acquired Castle Rock Entertainment ($314 million, net of cash). Cash was also used during the period for additions to property and equipment ($51 million) and payments of cash dividends ($18 million). See the Consolidated Statements of Cash Flows for details regarding sources and uses of cash, Note 2 of Notes to Consolidated Financial Statements for a detailed discussion of the acquisitions, and Note 5 of Notes to Consolidated Financial Statements for a detailed discussion of definitions, terms and restrictive covenants associated with the Company's indebtedness, all of which are included in the 1993 Annual Report to Shareholders incorporated herein by reference. CREDIT FACILITIES AND FINANCING ACTIVITIES The Company had approximately $2.3 billion of outstanding indebtedness at December 31, 1993, of which $1.2 billion was outstanding under an unsecured revolving credit facility with banks. On July 1, 1993, the Company entered into a credit agreement (the "1993 Credit Agreement") with a group of banks pursuant to which such banks extended a $750 million unsecured revolving credit facility. On December 15, 1993, the 1993 Credit Agreement was amended, among other things, to increase the amount available for borrowing to $1.5 billion. Amounts available for borrowing or reborrowing under this revolving facility will automatically decrease by $75 million as of the last business day of the calendar quarters ending March 31, 1998, June 30, 1998, September 30, 1998, and December 31, 1998, and by $150 million as of the last business day of each quarter thereafter until December 31, 2000, at which time the revolving credit facility will terminate. Under the 1993 Credit Agreement, amounts repaid under the revolving credit facility may be reborrowed subject to borrowing availability. The amount of borrowing availability is subject to other provisions of the 1993 Credit Agreement, including requirements that (a) minimum ratios, as from time to time are in effect, of funded debt to cash flow, cash flow to interest expense and cash flow to fixed charges be maintained; and (b) there does not exist, and that such borrowing would not create, a default or event of default, as defined. Those covenants are similar to, though generally less restrictive than, those provided in the credit agreement entered into by the Company in 1989, as amended (the "1989 Credit Agreement"). Approximately $1.2 billion of the Company's indebtedness bears interest on a floating basis tied to short-term market indices. The Company has interest rate swap agreements having a total notional principal amount of $780 million with commercial banks to mitigate possible rising interest rates. The contracts have expiration dates ranging from March 1994 to March 1995. The weighted average receipt and payment rates associated with the swap agreements were 4.16% and 9.07%, respectively, at December 31, 1993 and were 4.44% and 9.80%, respectively, at December 31, 1992. The Company designates these interest rate swaps as hedges of interest rates and the differential paid or received on interest rate swaps is accrued as an adjustment to interest expense as interest rates change. The Company has exposure to credit risk, but does not anticipate nonperformance by the counterparties to these agreements. On May 6, 1993, the Company filed a registration statement with the Securities and Exchange Commission to allow the Company to offer for sale, from time to time, up to $1.1 billion of unsecured senior debt securities or unsecured senior subordinated debt securities (together, the "Debt Securities") consisting of notes, debentures or other evidence of indebtedness. The Debt Securities may be offered as a single series or as two or more separate series in amounts, at prices and on terms to be determined at the time of the offering. The Debt Securities may be sold to or through one or more agents designated from time to time. On July 8, 1993, the Company sold $300 million of 8 3/8% Senior Notes due July 1, 2013 (the "Notes") under the registration statement. The net proceeds to the Company were approximately $291 million after market and underwriting discounts. The Notes bear interest at the rate of 8 3/8% per annum payable semi- annually on January 1 and July 1 of each year, commencing January 1, 1994. The Notes are not redeemable at the option of the Company. Each holder has the right to require the Company to repurchase such holder's Notes in whole, but not in part, upon the occurrence of certain triggering events, including, without limitation, a change of control, certain restricted payments or certain consolidations, mergers, conveyances or transfers of assets, each as defined in the indenture relating to the Debt Securities. The covenants governing the Notes limit the Company's ability to incur additional funded debt by requiring the maintenance of a minimum consolidated interest coverage ratio, as defined. On July 9, 1993, the Company called for redemption of all of its Convertible Notes due 2004, of which $291 million, net of unamortized discount of $409 million, was outstanding at August 9, 1993, to be funded by the issuance of the Notes. The Convertible Notes due 2004 could have been converted into shares of Class B Common Stock, par value $0.0625 per share, at any time before the close of business on August 9, 1993, at the rate of 15 shares of Class B Common Stock for each $1,000 principal amount at maturity. All Convertible Notes due 2004 which were not converted into shares of Class B Common Stock were redeemed on August 9, 1993, at a redemption price of $415.01 in cash for each $1,000 principal amount at maturity. The price reflects accrued original issue discount at the rate of 8% compounded semiannually to the redemption date. On December 21, 1993, the Company cancelled a $125 million revolving credit agreement governed by the CNN Center Ventures Credit Agreement that was guaranteed by the Company and secured by a first mortgage lien on the CNN Center and adjacent parking deck facility. The redemption of the Convertible Notes due 2004 and cancellation of the 1989 Credit Agreement and the CNN Center Ventures Credit Agreement resulted in an extraordinary charge of $11 million, net of approximately $6 million of tax benefits, representing the write-off of unamortized debt issue costs. Scheduled principal payments for all outstanding debt for 1994 total approximately $2 million, the majority of which relates to capital leases and other debt. On February 3, 1994, the Company sold $250 million of 7.4% Senior Notes due 2004 (the "Senior Notes") and $200 million of 8.4% Senior Debentures due 2024 (the "Senior Debentures") under the shelf registration dated May 6, 1993. The Company used substantially all of the net proceeds to repay amounts outstanding under the 1993 Credit Agreement incurred in connection with the acquisitions of Castle Rock and the remaining 50% interest in HB Holding Co. See Note 2 and Note 16 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders incorporated herein by reference. CAPITAL RESOURCES AND COMMITMENTS During 1994, the Company anticipates making cash expenditures of approximately $320 million for sports programming, primarily rights fees, approximately $640 million for original entertainment programming (excluding promotional and advertising costs) and approximately $85 million for licensed programming. Also, during 1994, the Company expects to make total expenditures of approximately $105 million for additional or replacement property and equipment. Of the anticipated programming and capital expenditures described above, firm commitments exist for approximately $520 million. Other capital resource commitments consist primarily of lease obligations, some of which are contingent on revenues derived from usage. Management expects to continue to lease satellite facilities, sports facilities and office facilities not already owned by the Company. Management expects to finance these commitments from working capital provided by operations and financing arrangements with lessors, vendors, film suppliers and additional borrowings. RESULTS OF OPERATIONS 1993 VS. 1992 ENTERTAINMENT SEGMENT Entertainment Segment revenue increased 8%, or $84 million. Advertising revenue contributed $56 million to the advance, which reflected an increase in the amount charged per thousand viewing homes on TBS SuperStation and TNT. Subscription revenue increased $49 million, through an increase in the monthly amount charged and a higher number of subscribers for TNT. These advances were offset somewhat by a $26 million decrease in 1993 in domestic and international home video revenue. This decrease was due to a refinement of previously recorded estimates resulting from the resolution of several uncertainties. Operating profit (defined as income before interest expense, interest income, income taxes, extraordinary items and the cumulative effect of changes in accounting for income taxes) for the Entertainment Segment decreased 6%, or $9 million, to $143 million, despite significant revenue advances in the core networks. Operating losses of $25 million in 1993 associated with new networks contributed to the operating profit decrease. New networks consist of the Cartoon Network, which was launched in 1992, and Cartoon Network Latin America and TNT & Cartoon Network Europe, which were launched in 1993. Also contributing to the operating profit decrease were a $21 million increase in original programming and related promotion and advertising costs, $15 million in costs related to the theatrical release of "Gettysburg," and increased selling, general and administrative costs. These higher costs were offset somewhat by a $34 million decrease in home video costs, reflecting the related cost effects of the refinement of previously recorded estimates and generally lower 1993 cost of sales. NEWS SEGMENT News Segment revenue increased 13%, or $68 million, to $599 million. Advertising revenue contributed $29 million to the increase, up 11% from 1992, primarily from an increase in the amount charged per thousand viewing homes domestically. Subscription revenue contributed $31 million, up 16% from 1992, due to an increase in the monthly amount charged for CNN and a higher number of subscribers. CNN International contributed $93 million, or 16%, to total 1993 News Segment revenue due primarily to continued global expansion. Operating profit for the News Segment increased 19% to $212 million. This increase was due to the advances in revenue, offset by an increase in total costs of $34 million. The total cost increase arose from higher production costs, expenses associated with covering events in Somalia and Bosnia and higher international sales costs. OTHER Other Segment revenues remained constant at $182 million. Increased Braves home game and broadcasting revenue in 1993 offset the non-recurring effects of $12 million in Major League Baseball expansion fees received in 1992, as well as a decline in WCW revenue. Operating losses for this Segment declined to $33 million, a net decrease of $4 million, primarily due to a $16 million charge related to discontinuance of the Checkout Channel in 1992, offset somewhat by higher Braves team expenses and other increases in general and administrative costs. EQUITY (LOSS) IN UNCONSOLIDATED ENTITIES/OTHER CONSOLIDATED INFORMATION Equity in the losses of unconsolidated entities increased $16 million over 1992 results to $20 million. This increase arose primarily from the Company's investments in new international ventures. In March 1993, the Company acquired a 27.5% interest in n-tv, a 24-hour German news channel. The Company's share of 1993 losses was approximately $19 million. The Company is also committed to a 50% joint venture interest in an over-the-air television station in Moscow. See Note 2 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders incorporated herein by reference. Extraordinary items represent $11 million, net of tax benefits, associated with the early termination of certain of the Company's bank credit facilities and the redemption of the Convertible Notes due 2004. The 1992 extraordinary item of $44 million represents the utilization of operating loss carryforwards. See Note 5 and Note 7 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Shareholders incorporated herein by reference. The Company also reflected a $306 million non-recurring charge for the cumulative effect of adopting Statement of Financial Accounting Standards No. 109. This charge was primarily related to the TEC Library and, to a lesser degree, the Company's 50% interest in the HB Holding Co. As a result of the information discussed, the Company reported a net loss of $244 million in 1993 ($0.92 net loss per common share and common share equivalent). This compares to net income of $78 million in 1992 ($0.30 net income per common share and common share equivalent). RESULTS OF OPERATIONS 1992 VS. 1991 ENTERTAINMENT SEGMENT Entertainment Segment revenue increased 24%, or $210 million. Advertising revenue contributed $73 million to the increase, which reflected higher rates charged per thousand viewing homes, the amount of national inventory sold and the size of the viewing audience. Subscription revenue rose $35 million due to an increase in the size of TNT's subscriber base and a rate increase effective January 1, 1992. Businesses launched in late 1991, TNT Latin America, Hanna-Barbera, Inc. and Turner Publishing, contributed $10 million, $15 million and $12 million, respectively, to the increase in total revenue for 1992. In addition, home video revenues grew by $72 million, primarily related to the refinement of previously recorded estimates resulting from the resolution of several uncertainties and increases in international revenues. Operating profit for the Entertainment Segment increased 4%, or $5 million, to $152 million, despite much greater revenue advances in the core networks. TNT Latin America, Hanna-Barbera, Inc. and Turner Publishing reflected an entire year of operating expense in 1992 operating profit, or an additional $37 million over 1991. Also contributing to the modest operating profit increase were $50 million in increased home video costs commensurate with revenue increases, additional rights fees and production costs of $23 million associated with TNT's telecast of the 1992 Winter Olympics and $21 million for the NFL games telecast and increased selling, general and administrative costs. NEWS SEGMENT News Segment revenue increased 11%, or $53 million, to $531 million. Advertising revenue rose $24 million and subscription revenues grew $26 million, reflecting an increase in the number of subscribers and a rate increase as well as overall growth experienced by CNN International. CNN International contributed $23 million to the News Segment's total increase in revenues. Operating profit for the News Segment increased 8%, to $178 million. Revenue increases were offset by CNN International expansion and the related increases in satellite and production costs. Higher domestic newsgathering costs associated with political and election coverage were mitigated somewhat by reduced international newsgathering costs due to the 1991 coverage of the Persian Gulf crisis. OTHER Other Segment revenues increased 26%, or $37 million. The continued strong performance of the Braves resulted in higher stadium attendance and concession revenues. In addition, expansion fees from Major League Baseball contributed $12 million to the increase in revenues for the year. Operating losses for these companies increased to $37 million, a net change of $22 million, due to increased Braves' player salaries, the development of the Airport Channel and $16 million of costs accrued in conjunction with the termination of the Checkout Channel. EQUITY (LOSS) IN UNCONSOLIDATED ENTITIES/OTHER CONSOLIDATED INFORMATION Equity in the losses of unconsolidated entities increased $4 million. This increase arose primarily from the Company's investment in HB Holding Co. Extraordinary items represent the utilization of $44 million of net operating loss carryforwards, compared to operating loss carryforwards reflected in 1991 of $43 million. As a result of the information discussed above, the Company reported net income of $78 million in 1992 ($0.30 net income per common share and common share equivalent). This compares to 1991 net income of $86 million ($0.24 net income per common share and common share equivalent). NEW ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Post-Employment Benefits." This standard requires companies to recognize the obligation to provide post-employment benefits (benefits provided to former or inactive employees after employment but before retirement) if the obligation is attributable to employees' services already rendered, employees' rights to these benefits vest or accumulate and the payment of the benefits is probable and can be estimated. The new standard, which the Company will adopt January 1, 1994, is not anticipated to have a material impact on its financial position. ITEM 8.

100240

1993

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS OVERVIEW Lennar's earnings increased in 1993 to $52.5 million ($2.27 per share) from 1992 earnings of $29.1 million ($1.42 per share) on total revenues in 1993 of $666.9 million compared to $429.4 million of revenues in 1992. Fiscal 1992 earnings had increased from 1991 earnings of $21.1 million ($1.05 per share), and revenues in 1992 had increased from 1991 revenues of $325.7 million. REAL ESTATE OPERATIONS Homebuilding The Homebuilding Division constructs and sells single family attached and detached and multi-family homes. These activities accounted for 87%, 86% and 84% of total real estate operations revenues for the fiscal years ended November 30, 1993, 1992 and 1991, respectively. Revenues from the sale of homes increased 71% in 1993 and 37% in 1992, due primarily to the number of homes delivered (4,634, 3,039 and 2,480 in 1993, 1992 and 1991, respectively). Additionally, the average price of a home delivered in 1993 increased 9% to $111,100 from $101,700 in 1992, having increased 9% during 1992 from $93,100 in 1991. The higher average sales prices were due to price increases for existing products, as well as a proportionately greater number of sales of higher-priced homes. In fiscal 1993, new sales orders increased by 31% when compared to 1992, which had increased by 40% over 1991. The 1993 increase resulted in an increase of 18% in the Company's backlog of home sales contracts to 2,105 at November 30, 1993, as compared to a backlog of 1,788 contracts a year earlier. The dollar value of contracts in backlog increased 39% to $264.3 million at November 30, 1993 from $190.7 million a year earlier. Gross profits from the sales of homes, as a percentage of total homebuilding revenues, averaged 12.3% in 1993, 12.1% in 1992 and 10.2% in 1991. The increases in the gross profit percentages were mainly attributable to the higher volume of homes delivered in both years as construction and selling overhead were absorbed by a greater number of home deliveries. Start-up costs, construction overhead and selling costs are expensed as incurred and included in cost of homes sold. The increase in 1993 gross profits was achieved despite start-up costs in the Company's new homebuilding operations in Houston, Texas and Port St. Lucie, Florida and increases in lumber prices on homes which were under contract for sale at the time of the price increases. Gross profit percentages are not significantly different for the various types of homes which the Company builds. During 1993, 1992 and 1991, interest costs of $19.7 million, $16.8 million and $14.2 million, respectively, were incurred, and $17.1 million, $15.0 million and $14.2 million, respectively, were capitalized by the Company's real estate operations. Previously capitalized interest charged to cost of sales was $13.1 million in 1993, $9.5 million in 1992 and $9.3 million in 1991. Interest amounts incurred in 1993 were higher than those incurred in 1992 and 1991 due to higher debt levels in both the real estate and financial services operations. The higher debt at November 30, 1993 is a reflection of the expansion of both the real estate and financial services operations along with the assumption of debt related to the Company's acquisition of partners' interests in various joint ventures. The higher amount of interest charged to cost of sales in 1993, when compared to 1992 and 1991, is a result of the higher volume of homes delivered. This increase was partially offset by lower interest rates and the increase in land and construction inventories as the Company's business volume increased. The amount of interest capitalized by the Company's real estate operations in any one year is a function of the assets under development, outstanding debt levels and interest rates. In August 1992, Hurricane Andrew, which had winds believed to be substantially in excess of those contemplated by the South Florida Building Code, severely damaged a wide range of homes, commercial structures and schools, and substantially destroyed a United States Air Force base in south Dade County, Florida. Damage was incurred at several communities which were in the process of being built by the Company and at several of the Company's commercial properties. In the third quarter of fiscal 1992, the Company made an unusual charge against pre-tax earnings of $7.6 million ($4.9 million after taxes or $.24 per share) to provide for the damage to Company properties and other associated costs, net of insurance recoveries, due to the storm. During 1993, the Company was involved in the repairing or rebuilding of homes in south Dade County communities that were damaged by Hurricane Andrew. Revenues and costs related to this activity are included in other sales and revenues and cost of other sales and revenues. These activities did not have a significant impact on the Company's net earnings during 1993 and were substantially completed by November 30, 1993. Investment The Investment Division (formerly referred to as Asset Management), is involved in the development, management and leasing, as well as the acquisition and sale, of commercial and residential rental properties and land. During 1992 and 1993, the Company became a participant in two partnerships which manage portfolios of mortgage loans, real properties and business loans. The Company shares in the profits or losses of the partnerships and also receives fees for the management and disposition of the partnerships' assets. These partnerships are capitalized primarily by long-term debt of which none is guaranteed by the Company. Other sales and revenues which include, for the most part, the activities of the Investment Division increased in 1993 to $79.8 million from $50.8 million in 1992. The higher revenues were partially the result of additional management fees and earnings from the Company's two Investment Division partnerships. Additionally, rental income on operating properties owned directly by the Company increased during 1993 due to the addition of operating properties, increased occupancy rates and rent increases. As previously discussed, 1993 amounts also include revenues from the repair or rebuilding of homes damaged by Hurricane Andrew in the amount of $13.7 million. Other sales and revenues increased from $42.9 million in 1991 to $50.8 million in 1992 primarily as a result of increases in rental income, revenues from the Company's hotel operation and management fees. Gross profits from other sales and revenues increased to $33.9 million in 1993 from $23.2 million in 1992 and $14.4 million in 1991. These increases were due primarily to increases in earnings and management fees from the Company's partnerships as well as increases in rental income. These increases were partially offset by lower sales of real estate in 1993 when compared to the prior two periods. General and administrative expenses increased during 1993 to $28.1 million from $20.4 million in 1992. In 1991, these expenses totaled $17.3 million. The increase in general and administrative expenses in 1993, as compared to 1992, was due primarily to increases in personnel and other costs resulting from the expansion of the Company's operations. However, as a percentage of real estate revenues, these expenses decreased in 1993 to 4.7%, compared to 5.8% in 1992 and 6.6% in 1991. FINANCIAL SERVICES Financial services activities are conducted primarily through five subsidiaries of Lennar Financial Services, Inc. ("LFS"). LFS subsidiaries perform mortgage servicing activities, and arrange mortgage financing, title insurance and closing services for a wide variety of borrowers and homebuyers. Financial services' earnings before income taxes decreased to $12.9 million in 1993, from $14.0 million and $13.2 million in 1992 and 1991, respectively. The decrease in 1993 earnings was the result of fewer sales of packages of home mortgage loans. Gains recorded on these dispositions contributed $0.7 million, $2.0 million, and $4.1 million to earnings in 1993, 1992 and 1991, respectively. Also contributing to the decrease in earnings in financial services were lower earnings from servicing and origination activities. Earnings from these activities have decreased due to higher costs associated with the expansion of loan origination activities and increased mortgage payoffs. The aforementioned decreases in earnings were partially offset by increases in interest income and gains on bulk sales of mortgage loan servicing rights which contributed $3.3 million to earnings in 1993. There were no bulk sales of mortgage servicing rights in 1992 or 1991. INCOME TAXES The provision for income taxes was 36.0% of pre-tax income in 1993, 35.7% in 1992 and 36.0% in 1991. The 1993 provision was higher than that of 1992 due to the increase in the federal tax rate from 34% to 35% during the Company's fiscal year. This increase was partially offset by additional differences between book and tax basis deductions during 1993. Fiscal 1991 had fewer book and tax basis deductions when compared to the other two periods. IMPACT OF ECONOMIC CONDITIONS Real estate development during 1993, both nationally and in Florida, continued to be affected by the reduced number of thrift institutions and more restrictive credit criteria of commercial banks. The Company does not, however, borrow from thrift institutions to finance any of its activities. Instead, the Company finances its land acquisition and development activities, construction activities, mortgage banking activities and general operating needs primarily from its own base of $467.5 million of equity at November 30, 1993, as well as from commercial bank borrowings. The Company has maintained excellent relationships with the commercial banks participating in its financing arrangements, and has no reason to believe that such relationships will not continue in the future. The availability of financing based on corporate banking relationships may provide a competitive advantage to the Company. The Company anticipates that there will be adequate mortgage financing available for the purchasers of its homes during 1994 through the Company's own financial services subsidiaries as well as external sources. Low interest rates during 1993 increased demand for the Company's homes. In addition, the Company's financial services subsidiaries originated a larger volume of new mortgage loans and benefited from reduced borrowing costs. The Company's mortgage servicing operations were adversely affected by lower interest rates as an increased number of borrowers prepaid their mortgage loan. The prepayment of a loan results in the termination of the future stream of servicing revenue from such loans and reduces the value of the Company's servicing portfolio. The Company expects the refinancing trend to slow during 1994 and believes that the lower interest rate loans originated during 1993 will be less susceptible to refinancing and will therefore increase the stability and value of its servicing portfolio. Total revenues and earnings in 1994 will be affected by both the new sales order rate during the year and the backlog of home sales contracts at the beginning of the year. The Company is entering fiscal 1994 with a backlog of $264.3 million, which is 39% higher than at the beginning of the prior fiscal year. Revenues and earnings will also be positively affected by the increased activities of the Company's Investment Division partnerships as 1994 will be the first year in which both partnerships will contribute a full fiscal year of earnings. Inflation can have a long-term impact on the Company because increasing costs of land, materials and labor result in a need to increase the sales prices of homes. In addition, inflation is often accompanied by higher interest rates, which can have a negative impact on housing demand and the costs of financing land development activities and housing construction. In general, in recent years the increases in these costs have followed the general rate of inflation and hence have not had a significant adverse impact on the Company. GOVERNMENT REGULATIONS Governmental bodies in the areas where the Company conducts its business have at times imposed laws and other regulations that affect the development of real estate. These laws and regulations are often subject to change. The State of Florida has adopted a law which requires that commitments to provide roads and other offsite infrastructure be in place prior to the commencement of new construction. This law is being administered by individual counties and municipalities throughout the State and may result in additional fees and assessments, or building moratoriums. It is difficult to predict the impact of this law on future operations, or what changes may take place in the law in the future. The Company may have a competitive advantage in that it believes that most of its Florida land presently meets the criteria under the law, and it has the financial resources to provide for development of the balance of its land in compliance with the law. As a result of Hurricane Andrew, there have been changes to the various building codes within Florida. These changes have resulted in higher construction costs. The Company believes these additional costs have been recoverable through increased selling prices without any significant, adverse effect on sales volume. FINANCIAL CONDITION AND CAPITAL RESOURCES Lennar meets its short-term financing needs for its real estate activities with cash generated from operations and funds available under its unsecured revolving credit agreement. During 1993, the Company entered into a new $175 million unsecured revolving credit agreement with nine banks. The agreement currently extends until July 29, 1996, however, on each annual anniversary date of the agreement each bank has the option to participate in a one year extension. On December 3, 1993, this agreement was expanded to $190 million by admitting an additional bank. At November 30, 1993, there was $129.7 million outstanding under this agreement as compared to $44.9 million outstanding under a similar agreement as of the same date in the prior year. During 1993, a net of $68.5 million of cash was used in the Company's operations, compared to a net of $72.3 million used by operations in 1992. Cash of $87.4 million was used in 1993 to increase inventories through construction of homes, land purchases and land development. This compares to $54.5 million of cash used in 1992 to increase inventories. Additionally, $49.7 million in cash was used in 1993 to increase loans held for sale or disposition by the financial services subsidiaries, compared to $65.3 million used to increase the balance of these loans in 1992. Partially offsetting these uses of cash in 1993 was $27.2 million of cash provided by an increase in accounts payable and accrued liabilities in 1993, compared to an increase of $15.3 million in 1992. This resulted from a significant increase in real estate accounts payable due to the increased volume of homebuilding activities, and a large increase in mortgage fundings payable due to a higher volume of loan originations in the last few days of the year. Net cash used in investing activities increased during 1993 to $58.3 million from $48.7 million in 1992. In 1993, investing activities included a $21.4 million use of cash for the acquisition of additional operating properties. In addition, $20.2 million of cash was used to increase investments in and advances to partnerships and joint ventures. This increase includes $28.8 million of cash used for the acquisition of a 9.9% equity interest in a new Investment Division partnership. The increase in investments in and advances to partnerships and joint ventures was partially offset by capital distributions from the Investment Division partnership entered into in 1992. During 1993, the Company further strengthened its financial position with a successful public offering of 3,450,000 additional shares of common stock which generated net proceeds to the Company of approximately $97 million. The proceeds were used for the expansion of the Company's operations as well as the investing activities discussed above. REAL ESTATE OPERATIONS The Company finances its land acquisitions with its revolving lines of credit or purchase money mortgages or buys land under option agreements, which permit the Company to acquire portions of properties when it is ready to build homes on them. The financial risk of adverse market conditions associated with longer term land holdings is managed by strategic purchasing in areas that the Company has identified as desirable growth markets along with careful management of the land development process. The Company believes that its land inventories give it a competitive advantage, especially in Florida, where developers face government constraints and regulations which will limit the number of available homesites in future years. Based on its current financing capabilities, the Company does not believe that its land holdings have any adverse effect on its liquidity. The Company has also borrowed on a secured term loan basis in order to supplement its short-term borrowings. These term loans, which are collateralized principally by certain real estate held for future use and operating properties, amounted to $50 million at November 30, 1993 and are due in 1996. Total secured borrowings, which include the term loan debt, as well as mortgage notes payable on certain operating properties and land, were $108.4 million at fiscal year-end 1993 and $132.8 million at November 30, 1992. A significant portion of inventories, land held for investment, model homes and operating properties remained unencumbered at the end of the current fiscal year. Total real estate operations borrowings increased to $242.2 million at November 30, 1993 from $177.7 million at November 30, 1992. However, due to increased equity, the real estate debt-to-equity ratio improved to 51.8% at the end of fiscal 1993, compared to 55.6% one year earlier. The increase in real estate debt is attributable to increases in construction in progress, land inventories, partnership investments, and the assumption of liabilities upon the purchase of three former real estate joint ventures. FINANCIAL SERVICES Lennar Financial Services subsidiaries finance their mortgage loans held for sale on a short-term basis by either pledging them as collateral for borrowings under two lines of credit totaling $200 million or borrowing funds from Lennar in instances where, on a consolidated basis, the overall cost of funds is minimized. Total borrowings under the two lines of credit were $167.6 million and $144.4 million at November 30, 1993 and 1992, respectively. This increase is due mainly to the $52.7 million increase in loans held for sale or disposition described below. LFS subsidiaries dispose of the mortgage loans they originate or purchase and convert the majority of such mortgage loans to cash within thirty to sixty days of origination or purchase. At November 30, 1993, the balance of loans held for sale or disposition was $243.1 million, compared with $190.4 million one year earlier. The increase represents greater mortgage production by LFS' mortgage banking subsidiaries. LIMITED-PURPOSE FINANCE SUBSIDIARIES Limited-purpose finance subsidiaries of LFS have placed mortgage loans and other receivables as collateral for various long-term financings. These subsidiaries pay the debt service on the long-term borrowings primarily from the cash flows generated by the related pledged collateral; and therefore, the related interest income and interest expense, for the most part, offset one another in each of the three years ended November 30, 1993. The Company believes that the cash flows generated by these subsidiaries will be adequate to meet the required debt payment schedules. Based on the Company's current financial condition and credit relationships, Lennar believes that its operations and borrowing resources will provide for its current and long-term capital requirements at the Company's anticipated levels of growth. NEW ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", becomes effective for fiscal years beginning after December 15, 1992, and SFAS No. 112, "Employers' Accounting for Postemployment Benefits", becomes effective for fiscal years beginning after December 15, 1993. Neither SFAS No. 106 nor SFAS No. 112 will have a material impact on the Company's financial statements. SFAS No. 109, "Accounting for Income Taxes", must be adopted by the Company in fiscal 1994. SFAS No. 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 SFAS No. 109, deferred income taxes are recognized for future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates 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 taxes of a change in tax rates is recognized in the period that includes the enactment date. Upon adoption of SFAS No. 109, the Company plans to apply the provisions of the Statement without restating prior years' financial statements. It is estimated that the adoption of SFAS No. 109 will result in a reduction of the net deferred tax liability by approximately $5.0 million and that this amount will be reported separately as the cumulative effect of a change in the method of accounting for income taxes in the consolidated statement of earnings for the year ending November 30, 1994. KPMG PEAT MARWICK CERTIFIED PUBLIC ACCOUNTANTS ONE BISCAYNE TOWER TELEPHONE 305 358-2300 TELEFAX 305 577 0544 SUITE 2900 2 SOUTH BISCAYNE BOULEVARD MIAMI, FL 33131 INDEPENDENT AUDITORS' REPORT The Board of Directors Lennar Corporation: We have audited the accompanying consolidated balance sheets of Lennar Corporation and subsidiaries as of November 30, 1993 and 1992, and the related consolidated statements of earnings, cash flows and stockholders' equity for each of the years in the three-year period ended November 30, 1993. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in Item 14(a)2. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. 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 Lennar Corporation and subsidiaries as of November 30, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended November 30, 1993, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK January 18, 1994 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------- Lennar Corporation and Subsidiaries November 30, 1993, 1992 and 1991 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of Lennar Corporation and all wholly-owned subsidiaries (the "Company"). The Company's investments in partnerships and joint ventures are accounted for by the equity method. All significant intercompany transactions and balances have been eliminated. REVENUE RECOGNITION Revenues from sales of homes are recognized when the sales are closed and title passes to the new homeowners. Revenues from sales of other real estate (including the sales of land and operating properties) are recognized when a significant down payment is received, the earnings process is complete, and the collection of any remaining receivables is reasonably assured. INVENTORIES Inventories are stated at the lower of accumulated costs or market. Market value is evaluated at the community level and is defined as the estimated proceeds upon disposition less all future costs to complete and sell. Inventory adjustments to market value in 1993, 1992 and 1991 were not material to the Company. Start-up costs, construction overhead and selling expenses are expensed as incurred and are included in cost of homes sold. Homes held for sale are classified as construction in progress until delivered. Land, land development, amenities and other costs are accumulated by specific area and allocated proportionately to homes within the respective area. CAPITALIZATION OF INTEREST AND REAL ESTATE TAXES Interest and real estate taxes attributable to land, homes and operating properties are capitalized and added to the cost of those properties as long as the properties are being actively developed. During 1993, 1992 and 1991 interest costs of $19.7 million, $16.8 million and $14.2 million, respectively, were incurred, and $17.1 million, $15.0 million and $14.2 million, respectively, were capitalized by the Company's real estate operations. Previously capitalized interest charged to cost of sales was $13.1 million in 1993, $9.5 million in 1992 and $9.3 million in 1991. OPERATING PROPERTIES AND EQUIPMENT Operating properties and equipment are recorded at cost. Depreciation is calculated to amortize the cost of depreciable assets over their estimated useful lives using the straight-line method. The range of estimated useful lives for operating properties is 15 to 40 years and for equipment is 2 to 10 years. WARRANTIES Warranty liabilities are not significant as the Company subcontracts virtually all segments of construction to others and its contracts call for the subcontractors to repair or replace any deficient items related to their trade. Extended warranties are offered in some communities through independent homeowner warranty insurance companies. The costs of these warranties are expensed in the period the homes are delivered. - --------------------------------------------------------------------------- INCOME TAXES The Company and its subsidiaries file a consolidated federal income tax return. Income taxes are accounted for under the Accounting Principles Board Opinion ("APB") No. 11, however, the Company will be required to adopt Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which supersedes APB No. 11 effective December 1, 1993. NET EARNINGS PER SHARE Net earnings per share is calculated by dividing net earnings by the weighted average number of the total of common shares and Class B common shares outstanding during the year. The weighted average number of shares outstanding was 23,139,000, 20,495,000 and 20,114,000 in 1993, 1992 and 1991, respectively. FINANCIAL SERVICES Mortgage loans held for sale or disposition by Lennar Financial Services Inc. ("LFS") are recorded at the lower of cost or market, as determined on an aggregate basis. Discounts recorded on these loans are presented as a reduction of the carrying amount of the loans and are not amortized. LFS enters into forward sales and option contracts to protect the value of loans held for sale or disposition from increases in market interest rates. Adjustments are made to these loans based on changes in the market value of these hedging contracts. When LFS sells loans or mortgage-backed securities in the secondary market, a gain or loss is recognized to the extent that the sales proceeds exceed, or are less than, the book value of the loans or the securities. Loan origination fees, net of direct origination costs, are deferred and recognized as a component of the gain or loss when loans are sold. LFS generally retains the servicing on the loans and mortgage-backed securities it sells. LFS recognizes servicing fee income as those services are performed. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments", requires companies to disclose the estimated fair value of their financial instrument assets and liabilities. The estimated fair values have been determined by the Company using available market information and appropriate valuation methodologies. The fair values are significantly affected by the assumptions used including the discount rate and estimates of cash flow. Accordingly, the use of different assumptions may have a material effect on the estimated fair values. The estimated fair values presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. RECLASSIFICATION Certain prior year amounts in the consolidated financial statements have been reclassified to conform with the 1993 presentation. - --------------------------------------------------------------------------- 2. LINES OF BUSINESS The Company operates principally in two lines of business: (1) real estate, which includes the activities of the parent company (Lennar Corporation), the Homebuilding Division and the Investment Division (formerly referred to as Asset Management); and (2) financial services, which includes certain activities of LFS, but excludes the limited-purpose finance subsidiaries. The Homebuilding Division constructs and sells single-family (attached and detached) and multi-family homes. The Investment Division is involved in the development, management and leasing, as well as the acquisition and sale, of commercial and residential properties and land. This division also manages and participates in partnerships with financial institutions. Financial services activities are conducted primarily through five LFS Subsidiaries: Universal American Mortgage Company ("UAMC"), AmeriStar Financial Services, Inc., Universal Title Insurors, Inc., Lennar Funding Corporation and Loan Funding, Inc. These subsidiaries arrange mortgage financing, title insurance, and closing services for Lennar homebuyers and others, acquire, package and resell home mortgage loans, and perform mortgage loan servicing activities. The limited-purpose finance subsidiaries of LFS have placed mortgages and other receivables as collateral for various long-term financings. These limited-purpose finance subsidiaries are not considered a part of the financial services operations for lines of business purposes and, as such, are reported separately. - --------------------------------------------------------------------------- 3. UNUSUAL ITEM - HURRICANE DAMAGE On August 24, 1992, the South Florida area was hit by a severe hurricane which affected a portion of the Company's Dade County real estate operations. The results of operations for the year ended November 30, 1992 include an unusual charge of $7.6 million, before income taxes, representing the cost of the damage to the Company's inventories, properties and similar costs associated with the destruction caused by Hurricane Andrew. - --------------------------------------------------------------------------- 4. RESTRICTED CASH Cash includes restricted deposits of $4,154,000 and $2,041,000 as of November 30, 1993 and 1992, respectively. These balances are comprised primarily of escrow deposits held related to condominium purchases and security deposits from tenants of commercial and apartment properties. - --------------------------------------------------------------------------- 5. SUMMARY OF NONCASH INVESTING AND FINANCING ACTIVITIES During the first quarter of 1993, the Company acquired a portfolio of loans from the Resolution Trust Corporation for $24.8 million. Of this amount, $5.0 million was paid in cash, and the Company issued a non-recourse note in the amount of $19.8 million for the remainder. Also, during 1993, the Company purchased the other partners' interests in three of its joint ventures. As a result, the operations of these ventures were consolidated into the accounts of the Company as of the respective dates of acquisition. The net result of these transactions was to decrease investments in and advances to partnerships and joint ventures by $34.9 million, increase all other assets by $73.7 million and increase liabilities by $38.8 million. - --------------------------------------------------------------------------- 7. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS AND JOINT VENTURES (CONTINUED) During 1993, the Company acquired a 9.9% equity interest in LW Real Estate Investments L.P., a partnership between Westinghouse Electric Corporation and an affiliate of Lehman Brothers. This partnership has selected the Company to manage its portfolio of commercial real estate assets. During 1992, Lennar Florida Partners, a partnership between a subsidiary of the Company and The Morgan Stanley Real Estate Fund, L.P., was formed to acquire and manage a portfolio of mortgage loans, business loans and real property. The Company's initial contribution to this partnership amounted to 25% of the partnership's total equity. After the partners have recovered their investment, plus a return, the Company will be entitled to 50% of the partnership's cash flows. The Company shares in the profits or losses of both partnerships, and also receives fees for the management and disposition of the assets. The outstanding debt of the partnerships is not guaranteed by the Company. The Company acquired the other partners interest in three of its joint ventures during 1993. As a result, the operations of the ventures have been consolidated into the accounts of the Company as of the respective dates of acquisition. - --------------------------------------------------------------------------- 9. MORTGAGE NOTES AND OTHER DEBTS PAYABLE (CONTINUED) On July 29, 1993, the Company entered into a new $175 million unsecured revolving credit agreement with nine banks. The agreement was expanded to $190 million on December 3, 1993 by admitting an additional bank. The term of the agreement is three years. On every anniversary date of the agreement each bank has the option to participate in a one year extension. The interest rate under this agreement fluctuates with market rates and was 4.8% at November 30, 1993. At November 30, 1993, the Company was party to interest rate swap agreements which replaced the floating interest rates on $45 million of debt, with fixed rates ranging from 8.7% to 10.2%. These agreements expire in 1994 and 1996. The minimum aggregate principal maturities of mortgage notes and other debts payable required during the five years subsequent to November 30, 1993, assuming that the revolving credit agreement is not extended, are as follows (in thousands): 1994-$23,027; 1995-$5,551; 1996-$180,284; 1997- $8,439 and 1998-$12,419. All of the notes secured by land contain collateral release provisions for accelerated payment which may be made as necessary to maintain construction schedules. The fair value of interest rate swaps at November 30, 1993 was $3.5 million. The estimated fair values represent a net unrealized loss. The value is based on dealer quotes and generally represents an estimate of the amount the Company would pay to terminate the agreement at the reporting date, taking into account current interest rates and the credit worthiness of the counterparties. The fair values of the Company's fixed rate borrowings are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates of similar type of borrowing arrangements. The fair values of these borrowings at November 30, 1993 approximated their carrying value. The interest rates on variable rate borrowings are tied to market indices. Accordingly, fair value approximates their carrying value. - ---------------------------------------------------------------------------- The Financial Services Division finances its activities through its two bank lines of credit, which amount to $200 million, or borrowings from Lennar Corporation, when on a consolidated basis the Company can minimize its cost of funds. The two lines of credit expire in March and July 1994, unless otherwise extended. Borrowings under these agreements were $167.6 million and $144.4 million at November 30, 1993 and 1992, respectively, and were collateralized by mortgage loans with outstanding principal balances of $155.9 million and $137.4 million, respectively, and by servicing rights to approximately $2.2 billion and $1.8 billion, respectively, of loans serviced by LFS. There are several interest rate pricing options which fluctuate with market rates. The borrowing rate has been reduced to the extent that custodial escrow balances exceeded required compensating balance levels. The effective interest rate on these agreements at November 30, 1993 was 2.4%. The Financial Services Division is party to financial instruments in the management of its exposure to interest rate fluctuations. Forward sales contracts and options are used by the division to hedge mortgage loans held for sale and in its pipeline of loan applications in process. By hedging in the instruments that the division will create, market interest rate risk is reduced. Gains and losses on these hedging transactions have not been material to the Company. Exposure to credit risk is managed through evaluation of trading partners, limits of exposure, and monitoring procedures. At November 30, 1993 and 1992, the Financial Services Division was a party to approximately $212 million and $183 million, respectively, of forward sales contracts and options. Certain of the division's servicing agreements require it to pass through payments on loans even though it is unable to collect such payments and, in certain instances, be responsible for losses incurred through foreclosure. Exposure to this credit risk is minimized through geographic diversification and review of the mortgage loan servicing created or purchased. Management believes that it has provided adequate reserves for expected losses based on the net realizable value of the underlying collateral. Provisions for these losses have not been material to the Company. The division is also subject to prepayment risk on the servicing portfolio. Exposure to prepayment risk is managed by the division's ongoing evaluation of prepayment possibilities, and by the Company's active involvement in the refinancing business. The fair value of loans held for sale at November 30, 1993 approximated carrying value. The fair value was based on quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics, net of the difference between the settlement value and the quoted market values of forward commitments and options to buy and sell mortgage-backed securities. - --------------------------------------------------------------------------- 12. LIMITED-PURPOSE FINANCE SUBSIDIARIES In prior years, limited-purpose finance subsidiaries of LFS placed mortgages and other receivables as collateral for various long-term financings. These limited-purpose finance subsidiaries pay the principal of, and interest on, these financings primarily from the cash flows generated by the related pledged collateral which includes a combination of mortgage notes, mortgage- backed securities and funds held by trustee. The fair value of the collateral for the bonds and notes payable at November 30, 1993 was $135.5 million and was based on quoted market prices for similar securities. BONDS AND NOTES PAYABLE At November 30, 1993 and 1992, the balances outstanding for the bonds and notes payable were $121.4 million and $174.2 million, respectively. The borrowings mature in years 2013 through 2018 and carry interest rates ranging from 5.1% to 14.3%. The annual principal repayments are dependent upon collections on the underlying mortgages, including prepayments, and cannot be reasonably determined. The fair value of the bonds and notes payable at November 30, 1993 was $128.0 million and was based on quoted market prices for similar securities. - --------------------------------------------------------------------------- 14. CAPITAL STOCK COMMON STOCK The Company has two classes of common stock. The common stockholders have one vote for each share owned, in matters requiring stockholder approval, and during 1993 received quarterly dividends of $.03 per share. Class B common stockholders have ten votes for each share of stock owned and during 1993 received quarterly dividends of $.025 per share. As of November 30, 1993, Mr. Leonard Miller, Chairman of the Board and President of the Company, owned 6.6 million shares of Class B common stock, which represents approximately 79% voting control of the Company. STOCK OPTION PLANS The Lennar Corporation 1980 Stock Option Plan ("1980 Plan") expired on December 8, 1990. However, under the terms of the 1980 Plan, certain options granted prior to the plan termination date are still outstanding. Unless exercised or cancelled, the last options granted under the 1980 Plan will expire in December 1995. - --------------------------------------------------------------------------- The Lennar Corporation 1991 Stock Option Plan ("1991 Plan") provides for the granting of options to certain key employees of the Company to purchase shares at prices not less than market value as of the date of the grant. No options granted under the 1991 Plan may be exercisable until at least six months after the date of the grant. Thereafter, exercises are permitted in varying installments, on a cumulative basis. Each stock option granted will expire on a date determined at the time of the grant, but not more than 10 years after the date of the grant. - --------------------------------------------------------------------------- EMPLOYEE STOCK OWNERSHIP/401(K) PLAN The Employee Stock Ownership / 401(k) Plan ("Plan") provides shares of stock to employees who have completed one year of continuous service with the Company. All contributions for employees with five years or more of service are fully vested. The Plan was amended in 1989 to add a cash or deferred program under Section 401(k) of the Internal Revenue Code. Under the 401(k) portion of the Plan, employees may make contributions which are invested on their behalf, and the Company may also make contributions for the benefit of employees. The Company records as compensation expense an amount which approximates the vesting of the contributions to the Employee Stock Ownership portion of the Plan, as well as the Company's contribution to the 401(k) portion of the Plan. This amount was (in thousands): $361 in 1993, $366 in 1992 and $356 in 1991. In 1993, 1992 and 1991, 9,200, 39 and 5,968 shares, respectively, were contributed to participants' accounts. Additionally, in 1992 and 1991, 8,716 and 5,340 shares, respectively, were credited to participants' accounts from previously forfeited shares. RESTRICTIONS ON PAYMENT OF DIVIDENDS Other than as required to maintain the financial ratios and net worth requirements under the revolving credit and term loan agreements, there are no restrictions on the payment of common stock dividends by the Company. The cash dividends paid with regard to a share of Class B common stock in a calendar year may not be more than 90% of the cash dividends paid with regard to a share of common stock in that calendar year. Furthermore, there are no agreements which restrict the payment of dividends by subsidiaries to the Company. As of November 30, 1993, the Company's share of undistributed earnings from partnerships was not significant. 15. COMMITMENTS AND CONTINGENT LIABILITIES The Company and certain subsidiaries are parties to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, the disposition of these matters will not have a material adverse effect on the financial condition of the Company. During 1993, the Company settled two lawsuits and a number of claims in which owners of approximately 550 homes built by the Company sought damages as a result of Hurricane Andrew. There still remain approximately 125 additional homeowners who have asserted claims. Other homeowners or homeowners' insurers are not precluded from making similar claims against the Company. Four insurance companies have contacted the Company seeking reimbursement for sums paid by them with regard to homes built by the Company and damaged by the storm. Other claims of this type may be asserted. The Company's insurers have asserted that their policies cover some, but not all, aspects of these claims. However, to date, the Company's insurers have made all payments required under settlements. Even if the Company were required to make any payments with regard to Hurricane Andrew related claims, the Company believes that the amount it would pay would not be material. 15. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) The Company is subject to the usual obligations associated with entering into contracts for the purchase, development and sale of real estate in the routine conduct of its business. The Company is committed, under various letters of credit, to perform certain development and construction activities in the normal course of business. Outstanding letters of credit under these arrangements totaled approximately $41.0 million at November 30, 1993. Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with per share amounts for the year. - --------------------------------------------------------------------------- Item 9. Disagreements on Accounting and Financial Disclosure. Not applicable. *************************************************************************** PART III Item 10. Directors and Executive Officers of the Registrant. Information about the Company's directors is incorporated by reference to the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission not later than March 30, 1994 (120 days after the end of the Company's fiscal year). Information about the Company's executive officers is contained in Part I of this Report under the caption "Executive Officers of the Registrant". Item 11. Executive Compensation. The information called for by this item is incorporated by reference to the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission not later than March 30, 1994 (120 days after the end of the Company's fiscal year). Item 12. Security Holdings of Certain Beneficial Owners and Management. The information called for by this item is incorporated by reference to the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission not later than March 30, 1994 (120 days after the end of the Company's fiscal year). Item 13. Certain Relationships and Related Transactions. The information called for by this item is incorporated by reference to the Company's definitive proxy statement, which will be filed with the Securities and Exchange Commission not later than March 30, 1994 (120 days after the end of the Company's fiscal year). PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Documents filed as part of this Report. 1. The following financial statements are included in Item 8:

58696

1993

ITEM 6. SELECTED FINANCIAL DATA HEI: The information required by this item is incorporated herein by reference to page 27 of HEI's 1993 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13(a). HECO: The information required by this item is incorporated herein by reference to page 2 of HECO's 1993 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13(b). ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS HEI: The information required by this item is incorporated herein by reference to pages 29 to 39 of HEI's 1993 Annual Report to Stockholders, portions of which are filed herein as HEI Exhibit 13(a). HECO: The information required by this item is incorporated herein by reference to pages 3 to 9 of HECO's 1993 Annual Report to Stockholder, portions of which are filed herein as HECO Exhibit 13(b). ITEM 8.

46207

1993

ITEM 6. SELECTED FINANCIAL DATA The following table summarizes information with respect to the operations of the Company. TEN-YEAR FINANCIAL REVIEW (dollars in millions, except per share amounts and as noted) SELECTED FINANCIAL DATA RESTATED TO A CALENDAR YEAR BASIS Financial statements for 1992, 1991, and 1990 have been restated for the adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATIONS YEAR ENDED DECEMBER 31, 1993 VERSUS YEAR ENDED DECEMBER 31, 1992 For the year ended December 31, 1993, net sales were $612.6 million, an increase of $4.6 million or 1% over the prior year. Loctite management measures the results of the Company based on individual business units. Units are consolidated into businesses or regions. Trade sales between regions are reflected as sales of the region servicing the customer. A summary of sales activity (in millions) is as follows: Price changes contributed to the growth in sales for the Company. Average net prices changed as a result of changes in list price, changes in product mix, and changes in customers. Such factors are not quantifiable individually due to the wide variety of markets, product formulations, and product packages. North American sales increased by 7% in both local currency and U.S. dollars when compared to 1992. The North American Industrial business grew 10% on a local currency basis and 9% on a dollar basis as a result of a focus on the maintenance market, as well as a general upturn in industrial output in the U.S. economy. U.S. Automotive Aftermarket (AAM) sales were flat while the Retail (Consumer) business reported an 8% sales gain, for a combined growth of 4%. Volume increases contributed to the growth. Poor economic conditions in Europe held sales growth in local currency to 2% over the prior year. This figure translated to a decline of 10% when converted to dollars because of the impact of the relatively stronger dollar compared to last year. There was a wide range of local currency sales growth reported within the region as each country is affected by different economic conditions. Of the five major countries in Europe (in terms of Loctite sales), France's local currency sales were flat with the prior year, Italy was up 11%, the U.K. was up 6%, Germany was down 9% and Spain had local currency growth of 1%. With respect to products, volume decreases in major industrial products were offset by growth in other products and channel mix. Latin American sales growth in 1993 was 4%. Although Costa Rica, Colombia, and Chile experienced double digit percentage sales growth, Brazil's sales were down slightly. In Brazil, prices are changed monthly to keep up with the effects of inflation (see paragraph under Inflation and Changing Prices). Excluding the effects of inflation, Brazil reported a 5% decrease in sales vs. 1992. Unstable economic conditions were a contributing factor. Local currency sales in the Asia/Pacific region increased by 20% vs. the prior year. This translated into a 27% increase when converted to dollars. All countries except Japan reported strong local currency growth. Although Japan's local currency sales decreased by 7% when compared to 1992, in dollars the growth was 6% due to the strength of the yen relative to the U.S. dollar. Included in this year's results are those of new subsidiaries operating in Malaysia, Singapore, China, and India which resulted in $7.9 million of additional sales. Luminescent Systems sales decreased by 19% in local currency and 20% in U.S. dollars when compared to 1992. Sales continued to suffer in response to the decline in the defense and airline industries. Gross margin decreased from 62% of sales in 1992 to 61% of sales in 1993. The decrease was caused by lower margins in Europe and North America as well as geographic mix. As a percentage of sales, operating expenses were 45% in 1993 and 44% in 1992. In total, expenses increased $8.8 million or 3% over the prior year. Expenses in the Company's new subsidiaries operating in Malaysia, Singapore, India, China, Czech Republic, Slovakia, Hungary, Poland, Slovenia, and Norway accounted for $5.8 million of the increase. Included in administrative expenses is a $1.2 million charge related to the closing of a manufacturing facility of Loctite Luminescent Systems, a small subsidiary which has seen its market shrink. The closing of this Rocky Hill, Connecticut, facility will allow all manufacturing for this business to be concentrated in New Hampshire, adjacent to its management function. Additional monies were spent in the Asia/Pacific area to strengthen our industrial and automotive aftermarket selling skills and in Brazil where we are upgrading our manufacturing, technical, and selling skills to take advantage of an underpenetrated industrial market. North America reported expense increases of 8% primarily to support higher sales levels. In local currencies, European expenses increased by 6% vs. the prior year, but when translated into dollars, current year expenses decreased by 7% when compared to the prior year. Investment income was $0.9 million lower in 1993 than in 1992 primarily as a result of lower average interest rates on deposits in foreign locations translated into dollars at comparatively weaker average exchange rates. Interest expense decreased by $0.2 million year-to-year as the effects of significant increases in average short-term debt levels in the U.S. were offset by benefits derived from the refinancing of maturing long-term debt, the capitalization of certain interest costs associated with the financing of construction-in-progress, and lower average short-term debt levels in Brazil. Net foreign exchange losses decreased by $0.8 million for the 12 month period over the comparable 1992 period due primarily to favorable transaction related exchange results in Ireland. Income taxes, as a percentage of earnings before taxes, were 25% for the year ended December 31, 1993. For further discussion of income taxes, see Notes to Consolidated Financial Statements, Note 6, Income Taxes. YEAR ENDED DECEMBER 31, 1992 VERSUS YEAR ENDED DECEMBER 31, 1991 For the year ended December 31, 1992, net sales were $608.0 million, an increase of $46.8 million or 8% over the prior year. A summary of sales activity (in millions) is as follows: Price changes contributed to the growth in sales for the Company. Average net prices changed as a result of changes in list price, changes in product mix, and changes in customers. Such factors are not quantifiable individually due to the wide variety of markets, product formulations, and product packages. Our North American Industrial business reported strong growth considering the sluggish economic environment in the United States. Major product lines (anaerobics, cyanoacrylates, silicones, and hand cleaners) had both volume increases and price changes which contributed to the positive results. In the U.S. Automotive Aftermarket (AAM) and Retail (Consumer) business, hand cleaner sales increased by double digits with silicones and cyanoacrylates reporting modest growth over the prior year. Both volume and price increases were factors. In Europe, the impact of a comparatively weaker dollar increased European sales by approximately four percentage points when compared to the prior year. On a local currency basis, sales of most products increased with volume increases being a larger factor than price changes. Hand cleaners were introduced to the European product line in 1992 and resulted in 10% of the dollar sales growth over the prior year. It is anticipated that hand cleaners will contribute to additional sales growth in the future. Latin America reported a sales increase of 10%. Much of the increase was due to price increases in the region. In Brazil, prices are changed monthly to keep up with the effects of inflation (see paragraph under Inflation and Changing Prices). Most volumes in the region declined from year to year. Sales in the Asia/Pacific region were flat in dollars vs. the prior year. On a local currency basis, the region's sales decreased 2% with Japan the primary factor. The Japanese original equipment manufacturing industries to which we sell are in a recession, which has affected our sales volume. Current year sales of electroluminescent lamps were disappointing and decreased primarily due to the sluggishness of the U.S. economy. Gross margin increased from 61% of sales in 1991 to 62% of sales in 1992. As a percentage of sales, operating expenses (excluding restructuring charges) were 44% in both 1992 and 1991. The Company has invested in research and development and sales and marketing expenses. Expense growth in these categories was 16% and 12%, respectively, vs. the prior year. Administrative expenses were down 2%. In total, expenses increased 9% over 1991. In the second quarter of 1992, the Company recorded a pretax charge of $12.7 million for restructuring its North American operations. The restructuring charge is the result of a strategic decision to combine the Company's two major businesses in the U.S., the Industrial Group and the Automotive and Consumer Group, to accelerate market penetration and reduce operating expenses, along with the provision of new, centralized research and development facilities. The restructuring charge includes provisions for employee relocations and redundancies of $7.4 million and facilities disposal costs of $5.3 million. Investment income for 1992 was $4.2 million lower than 1991. Lower average deposit levels in foreign locations (due to the acquisition of FRAMET (now Loctite France) in the fourth quarter of 1991) was a significant contributing factor in the year to year decline. The foreign exchange loss for the year was $2.4 million greater than in 1991 primarily due to the translation effects of higher average rates of Cruzeiro devaluation on the Company's Brazilian operations. Income taxes, as a percentage of earnings before taxes, were 24% for the year ended December 31, 1992. YEAR ENDED DECEMBER 31, 1991 VERSUS YEAR ENDED DECEMBER 31, 1990 For the calendar year ended December 31, 1991, net sales were $561.2 million, an increase of $6.0 million or 1% over the prior calendar year. Sales growth in the Automotive and Consumer Group was $5.8 million or 6%, while the Asia/Pacific Region also had a strong growth of $5.3 million or 13%. Sales in the North American Industrial markets were up slightly, while Europe and Latin America experienced declines of $2.7 million and $2.8 million, respectively. The impact of the comparatively stronger dollar decreased sales by approximately one percentage point when compared to the prior year. Volume growth, sales mix and price changes all contributed to the sales growth over the prior year. Gross margin was 61% of sales for the twelve month periods ended December 31, 1991 and 1990. As a percentage of sales, operating expenses were 44% in both 1991 and 1990. In dollars, there was no change year to year as continued expense management throughout the year kept expenses level. In the first quarter of 1991, the Company recorded a charge of $4.4 million for the restructuring of certain activities in a number of countries to reduce ongoing costs and expenses. Pretax investment income for 1991 was $2.4 million higher than 1990. Higher average deposit levels and gains from limited partnership activity contributed to the increase. Pretax interest expense decreased by $1.3 million year to year due to the capitalization of certain interest costs associated with the financing of construction-in-progress and due to lower interest rates, on average, on borrowings in the United States and Brazil. Decreased translation losses in Brazil, the result of reduced rates of currency devaluation, was the primary factor in the $1.2 million decrease in net foreign exchange losses. Income taxes, as a percentage of earnings before taxes, were 27.5% for the calendar year ended December 31, 1991. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1993, the Company had $44.6 million in cash and cash equivalents, an increase of $14.7 million from the previous year's balance. The increase was due primarily to cash provided by operating activities plus the increase in short-term debt partially offset by the cash outflow for the stock repurchase mentioned below, additions to property, plant and equipment, dividends paid, increased trade receivables, and acquisitions. The Company has significant financial resources available for future growth. Capital expenditures and dividend payments are expected to increase in the next few years. Time and certificates of deposit of $51.5 million, cash from operations, and existing unused credit lines at December 31, 1993 will provide additional financing flexibility. During the first quarter of 1993, the Company purchased 1,000,000 shares of its common stock. The cost of this repurchase, $42.6 million, was funded through U.S. short-term borrowings. The stock repurchase reduced retained earnings by $41.4 million and common stock by $1.2 million. The increase in accounts and notes receivable from $111.6 million at December 31, 1992, to $119.3 million at December 31, 1993, was due to an increase in trade receivables in the Company's U.S. Industrial, Automotive and Retail (Consumer) businesses, as well as receivables recorded by the new subsidiaries operating in 1993. The U.S. businesses reported fourth quarter sales that were $5.5 million higher than the comparable 1992 fourth quarter, which resulted in higher receivables at year end. Net property, plant and equipment increased $25.5 million from 1992 to 1993 with a large part resulting from construction-in-progress recorded for the Company's new facility in Rocky Hill, Connecticut. Through December 31, 1993, $25.2 million had been spent on land and buildings, $17.6 million of which was spent in 1993. The 200,000 square foot facility is being built on 57 acres and will house consolidated North American sales, marketing, administrative, and research and development functions. The facility is expected to cost approximately $40.0 million and is expected to be completed in the second half of 1994. Approximately $4.0 million was spent in 1993 to expand our Solon, Ohio warehouse facility. This project is also expected to be completed in 1994. Property recorded by the Company's new subsidiaries operating in 1993 also contributed to the increase in net property, plant and equipment. While not a capital intensive business, the Company's practice is to ensure that sufficient operating capacity is available to meet its customers' needs. In the year ended December 31, 1993, capital expenditures were $44.5 million. The level of capital expenditures for calendar 1994 and the next two years is expected to be approximately $40-$50 million per year. Except for the $14.8 million which will be spent to complete the Rocky Hill facility, the projected capital expenditures are not firm commitments but are subject to final management approval depending on the needs of the individual businesses and the business conditions at the time of the expenditure. Approximately 55% of the expected capital expenditures will be to support increased product sales and product maintenance. Approximately 30% will be for new product developments and research and development, with the remaining expenditures for building improvements, computer equipment and office furniture. There are no planned projects that represent a material commitment for the Company. Short-term debt increased from $23.5 million at December 31, 1992 to $103.0 million at December 31, 1993, primarily due to the funding of the stock repurchase noted above. Other contributory factors were construction-in-progress on the Rocky Hill facility, additional investments in subsidiaries, and the refinancing of the current portion of long-term debt. In 1992, the Company recorded a pretax charge of $12.7 million for restructuring its North American operations. At December 31, 1992, approximately $1.4 million had been spent. During 1993, an additional $3.5 million was spent resulting in $7.8 million remaining as liabilities. $5.4 million is recorded as a long-term liability and $2.4 million is recorded in short-term liabilities. Projects to be completed include the relocation of research and development employees to Rocky Hill and the closing of the Company's plants in Aurora, Illinois and Newington, Connecticut. The $5.0 million decrease in accrued salaries, wages, and other compensation resulted from reduced bonus accruals and payments made against the restructuring accruals mentioned above. Long-term debt declined by $11.1 million due to the reclassification of this debt to current debt because scheduled long-term promissory note payments will be made during 1994 (see Note 9 of the Notes to Consolidated Financial Statements). The unrealized foreign currency translation adjustment included in stockholders' equity changed from a loss of $3.4 million at December 31, 1992 to a loss of $21.9 million at December 31, 1993 due to the impact of a comparatively stronger U.S. dollar on the Company's net asset position at December 31 in its foreign subsidiaries. Since a substantial portion of our business is transacted in foreign locations and currencies, the Company's financial statements are affected by fluctuations in foreign exchange rates. A stronger U.S. dollar decreases the translated results of foreign subsidiaries, while a weaker U.S. dollar increases the translated results. For the year ended December 31, 1993, the effect of a comparatively stronger dollar decreased sales by approximately five percentage points when compared to the prior year. For the year ended December 31, 1992, the effects of a comparatively weaker dollar increased sales by approximately one percentage point when compared to the prior year. For the year ended December 31, 1991, the effect of a comparatively stronger dollar decreased sales by approximately one percentage point when compared to the prior year. ACQUISITIONS During the first quarter of 1993, the Company acquired certain assets from its distributor in Malaysia and Singapore and now operates wholly owned subsidiaries in those countries. Loctite acquired a majority interest in its joint ventures in China and India in the second quarter of 1993 and in Norway in the third quarter of 1993. The cost of these acquisitions was approximately $6.5 million and is not considered material to the Company. During the first quarter of 1994, the Company announced the acquisition of Plastic Padding Holdings Limited, a market leader in automotive aftermarket chemical products with strong brand presence and established distribution networks in the U.K., Ireland, and Scandinavia. The cost of this acquisition was not material to the Company. INFLATION AND CHANGING PRICES The Company prices its products according to value in each of its markets. The Company attempts to offset the effects of inflation in its pricing. Due to the wide variety of pricing situations, currency factors, and inflation rates in the numerous countries in which the Company does business, a meaningful estimate of the effect of price increases is not practical. However, in management's judgment, except for the reasons indicated in the paragraph below, such increases have not been significant to the Company's reported results. The Company's Brazilian subsidiary was subject to a rate of inflation in excess of two thousand percent in 1993, in excess of one thousand percent in 1992, and in excess of four hundred percent in 1991. If the Company excluded the effects of inflation from the Brazilian sales value, Brazilian sales would have been reduced by $8.1 million (1993), $7.0 million (1992), and $4.8 million (1991) from the net sales amounts reported for Latin America. Similarly, Brazilian operating profit would have been reduced by $7.1 million (1993), $5.6 million (1992), and $3.9 million (1991) from the operating profit amounts reported for Latin America. ACCOUNTING CHANGES INCOME TAXES During the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). The statement requires that deferred taxes be recorded under the liability method rather than the income statement approach previously used by the Company under Accounting Principles Board Opinion No. 11 (APB No. 11). The Company has adopted SFAS No. 109 by restating the financial statements of 1992, 1991, and 1990. For further discussion, see Note 6 of the Notes to Consolidated Financial Statements. POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS During the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions" (SFAS No. 106). The statement requires that annual postretirement benefit costs be accrued during an employee's years of active service. In prior years, the Company expensed the cost of such benefits when paid. For further discussion, see Note 12 of the Notes to Consolidated Financial Statements. PROSPECTIVE ACCOUNTING CHANGE POSTEMPLOYMENT BENEFITS In November 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" (SFAS No. 112). This statement must be adopted by the Company no later than calendar year 1994 but earlier adoption is permitted. The statement requires the recognition of the cost of postemployment benefits (after employment but before retirement) on an accrual basis. The Company will adopt SFAS No. 112 in 1994. The new standard is not expected to have a significant effect on the Company's annual benefits expense or liabilities. ITEM 8.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Kentucky Utilities Company (Kentucky Utilities), an electric utility, is a wholly owned subsidiary of KU Energy Corporation (KU Energy). RESULTS OF OPERATIONS Net Income Applicable to Common Stock Net income applicable to common stock was $78.7 million in 1993 compared to $73.8 million in 1992 and $81.7 million in 1991. The increase in 1993 was primarily due to weather-related growth in sales and lower interest charges attributable to debt refinancings and redemptions. Earnings in 1993 were negatively impacted by an increase in other operating expenses and a decline in interest and dividend income. The decline in 1992 earnings was due to unusually mild weather, increases in operating and maintenance costs, and an increase in interest charges attributed to a $35 million increase in long-term debt. Sales increased 6% to 15.8 billion kilowatt-hours (kWh) in 1993. The increase resulted primarily from increases in sales to residential and industrial customers. The rise in residential sales reflects cooler weather in the first and fourth quarters of 1993 and warmer weather during the second and third quarters of 1993 as compared to the corresponding periods of 1992. Due to the exceptionally warm weather in the third quarter of 1993, Kentucky Utilities set an all-time peak demand for electricity on July 28, 1993, of 3,176 megawatts. The increase in industrial sales reflects the general strength of the service area economy as well as an increase in the number of industrial customers. As a result of the increase in sales, revenues rose 5% in 1993 to $606.6 million. Revenues in 1993 were reduced approximately $3.3 million as a result of refunds to customers of amounts recovered from a litigation settlement with a former coal supplier. The $3.3 million, which was charged against revenue, represents $4.1 million of fuel savings less $.8 million for incurred litigation costs. See Note 2 of the Notes to Financial Statements. Despite declines in residential and commercial sales in 1992, total sales increased due to greater sales to industrial customers. The decline in residential and commercial sales was the result of cooler than normal weather in the second and third quarters of 1992, compared to warmer than normal weather in the corresponding periods of 1991. The decline in 1992 revenues was due primarily to lower average fuel costs passed on to customers. 1993 Kilowatt-Hour Sales by Classification Year Ended December 31, 1993 Residential 30% Commercial 20% Industrial 22% Mine Power 6% Public Authorities 8% Other Electric Utilities 14% Total 100% Fuel and Purchased Power Expense Fuel expense in 1993 totaled $178.9 million, a 6% increase over 1992. The increase was largely attributable to greater coal consumption. Fuel expense for 1993 reflects a $4.1 million reduction associated with the refunding to customers of fuel cost savings resulting from the litigation settlement with a former coal supplier. See Note 2 of the Notes to Financial Statements. Purchased power expense increased $2.0 million (6%) in 1993. The increase reflects greater demand charges associated with a new short-term capacity contract with a neighboring utility, partially offset by a 5% decline in power purchases. The decline in power purchases was due to a reduction in the availability of Owensboro Municipal Utilities' (OMU) generating units during scheduled maintenance of those units in the second quarter of 1993. A contract between Kentucky Utilities and OMU allows Kentucky Utilities to purchase, on an economic basis, surplus power from a 400-megawatt generating station owned by OMU. Fuel expense in 1992 declined $14.7 million (8%) to $168.5 million. The reduction was due to a lower average price per ton of coal consumed (6%) and to a decline in coal consumption (2%). The decline in the average price per ton was due to lower cost coal and to the completion in May 1992 of the amortization of buyout costs associated with a terminated coal contract. Coal consumption in 1992 was reduced as a result of increases in power purchases. Purchased power expense rose $6.0 million (22%) in 1992 due to increased power purchases (39%), primarily under the OMU contract. The increase in purchased power costs resulting from greater kWh purchases in 1992 was partially offset by a reduction in the average price per kWh purchased. Other Operating Expenses Other operating expenses for 1993 increased $11.0 million (12%), $6.3 million of which resulted from the adoption of a new accounting standard. See Note 4 (Other Postretirement Benefits) of the Notes to Financial Statements. Other Income and Deductions Other income and deductions in 1993 declined $2.6 million. A reduction in interest and dividend income resulted from lower levels of cash investments. Other income and deductions in 1992 were comparable to 1991. Additional interest and dividend income associated with an increase in the average amounts available for investment and bond proceeds deposited pending retirement of existing debt issues were offset by lower available short- term investment returns. Interest Charges Interest charges decreased $8.2 million (20%) in 1993. The decrease was the result of the redemption of two debt issues near the beginning of the second quarter of 1993 and the refinancing of several debt issues during the second half of 1992 and early in the third quarter of 1993 at significantly lower interest rates. See Note 5 of the Notes to Financial Statements for information pertaining to Kentucky Utilities' refinancing and redemption activities in 1993. Interest charges in 1992 increased $2.8 million (7%). The interest expense associated with the issuance of additional debt was partially offset by the refinancing of higher cost existing debt. The effects of the increase in interest expense were partially offset by the above mentioned interest income on bond proceeds deposited. LIQUIDITY & RESOURCES Capital Structure Kentucky Utilities continues to maintain a strong capital structure. At the end of 1993, common stock equity represented 53.4% of total capitalization while long-term debt stood at 42.7%, and preferred stock was 3.9%. Cash Flow In 1993, cash provided by operating activities accounted for 67% of total cash requirements as compared to 68% in 1992 and 105% for 1991. Cash requirements included in the above percentages exclude optional debt refinancings and redemptions. At the end of 1993, cash and cash equivalents totaled $8.8 million. Cash and cash equivalents were $94.3 million at the end of 1992 and $125.6 million at year-end 1991. Cash and cash equivalents were utilized to redeem $55 million of first mortgage bonds and to help meet expenditures for compliance with the 1990 Clean Air Act Amendments and peaking unit construction, thus lowering cash levels at the end of 1993. Financing During 1993, Kentucky Utilities continued to take advantage of opportunities to reduce its embedded cost of long-term debt through refinancings. A total of $120 million of first mortgage bonds was refinanced in 1993 at significantly lower interest rates. Kentucky Utilities has refinanced over $300 million of long-term debt over the past year and a half. The reduction of interest expense on an annual basis from these refinancings will total about $5.4 million. In 1992, Kentucky Utilities refinanced $53 million of first mortgage bonds (including a $3 million redemption premium) and $133.9 million of pollution control bonds at significantly lower interest rates. As a result of the foregoing activities, Kentucky Utilities' embedded cost of long-term debt declined to 7.23% in 1993 as compared to 8.00% in 1992 and 8.94% in 1991. In December 1993, $50 million of 5 3/4% Collateralized Solid Waste Disposal Facility Revenue Bonds was issued to finance a portion of the costs of environmental compliance facilities currently under construction. Kentucky Utilities also issued $20 million of 6.53% preferred stock in December 1993. Proceeds from the sale of this issue were used to redeem the utility's 7.84% Preferred Stock on February 1, 1994. See Note 5 of the Notes to Financial Statements for additional information on 1993 financing activities. Construction Construction expenditures totaled $177.1 million in 1993 as compared to $86.1 million in 1992 and $65.6 million in 1991. The 1993 increase was largely attributable to $48.7 million expended for compliance with the 1990 Clean Air Act Amendments and $55.5 million expended for construction of peaking units. Projected construction requirements for the 1994-1998 period are $631.6 million. Included in this amount are $152.3 million for environmental compliance measures of which $128.6 million is for compliance with the 1990 Clean Air Act Amendments. Also included in the 1994-1998 construction total is $137.8 million for peaking units. Kentucky Utilities expects to provide about 79% of its 1994-1998 construction requirements through internal sources of funds with the balance primarily from long-term debt. Providing for Customer Growth Kentucky Utilities utilizes a least cost planning strategy to ensure that growth in customer demand is provided for in the most efficient and cost- effective manner. The Kentucky Public Service Commission (PSC) requires filing of an Integrated Resource Plan every two years. Kentucky Utilities filed its 1993 Integrated Resource Plan in October 1993. This plan includes a 15-year load forecast and description of existing and planned conservation programs, load management programs and generation facilities to meet forecasted requirements in a reliable manner at the lowest reasonable costs. The PSC has initiated an informal review of the plan according to existing regulations. As outlined in Kentucky Utilities' 1993 Integrated Resource Plan, annual growth in sales and customer peak demand is forecast at 1.8% and 1.9%, respectively, over the next 15 years. The utility plans to provide for customer growth in the '90s through purchased power and the addition of combustion turbine peaking units. Three 110-megawatt peaking units are currently under construction. Two of the units will be installed in 1994 and the other in 1995. An additional peaking unit may be required in each year from 1996-1998. There are no plans for additional baseload capacity before 2010. ENVIRONMENTAL MATTERS Clean Air Act Compliance Kentucky Utilities' compliance strategy for the 1990 Clean Air Act Amendments includes installing flue gas desulfurization systems (scrubbers), low nitrogen oxide burners and continuous emission monitoring devices as well as fuel switching to lower sulfur coal. The key component of the utility's compliance plan for Phase I requirements, which are effective January 1, 1995, is a scrubber under construction at Ghent Unit 1. The flexible design of the Ghent Unit 1 scrubber provides the option of installing equipment to scrub flue gas from Ghent Unit 2 at an economical cost. Anticipated costs of implementing this option are included in the total estimated 1994-1998 construction expenditures shown above. In 1993, Kentucky Utilities revised its previous cost estimates for compliance to reflect lower than expected costs for construction of the Ghent Unit 1 scrubber. Kentucky Utilities also deferred, until the 2005 time frame, an additional scrubber originally planned at Brown Unit 3 for compliance with Phase II requirements, which are effective January 1, 2000. The utility had anticipated capital spending of about $359 million through 2000 for the 1990 Clean Air Act Amendments ($166 million for Phase I and $193 million for Phase II). With the above mentioned revisions and the anticipated additional equipment to scrub Ghent Unit 2, current estimates of the capital costs for compliance through the year 2000 are about $200 million (over two-thirds of which should be incurred by January 1, 1995). Through December 31, 1993, about $70 million had been spent for compliance. Kentucky Utilities has purchased 12,900 Phase I emission allowances and has been awarded about 114,000 additional allowances through participation in the Environmental Protection Agency's Phase I Extension Plan Program. The allowances give the utility additional flexibility in implementing its compliance plans and will be incorporated into its strategy to achieve the most economical means of compliance. Kentucky Utilities will continue to review and revise its compliance plans to ensure that its obligations are most effectively met. Environmental Surcharge In January 1994, Kentucky Utilities filed plans with the PSC to implement an environmental surcharge. The surcharge will permit the utility to recover certain ongoing operating and capital costs of compliance with any federal, state or local environmental requirements associated with the production of energy from coal, including the 1990 Clean Air Act Amendments. Upon PSC approval, the proposed environmental surcharge would begin August 1, 1994. Kentucky Utilities estimates that under the proposed surcharge, it would recover about $15.5 million in environmental costs during the first twelve months and about $23 million during the second twelve months. Other In 1990, Kentucky Utilities received a letter from the Environmental Protection Agency (EPA) identifying Kentucky Utilities and others as potentially responsible parties under the Comprehensive Environmental Response Compensation and Liability Act of 1980 for a disposal site in Daviess County, Kentucky. The EPA has turned over responsibility for investigation of the site and development of a remediation plan to a group (not including Kentucky Utilities) originally named as potentially responsible parties. Kentucky Utilities has entered into an agreement with the group as to the portion of the investigation and development costs to be borne by Kentucky Utilities in connection with the site. Any remediation plan would be subject to approval of the EPA. Although a final, approved plan has yet to be developed, Kentucky Utilities does not believe that any liability with respect to the site will have a material impact on its financial position or results of operations. NATIONAL ENERGY POLICY ACT The National Energy Policy Act of 1992 (Energy Act) promotes energy efficiency, environmental protection and increased competition. Provisions of the Energy Act of most importance to electric utilities are those that promote competition in the generation and transmission of electricity. The Energy Act removes long-standing constraints on the development of wholesale power generation by establishing a new class of independent power producers which are exempt from traditional utility regulation. The Energy Act also makes it easier for nonutility power producers to gain access to utility-owned transmission networks by allowing the Federal Energy Regulatory Commission to order wholesale "wheeling" by public utilities. While the final impact of the Energy Act is yet to be determined, Kentucky Utilities believes that it will increase competition and may affect the traditional business strategies of the utility industry. Kentucky Utilities further believes it is well positioned for increased competition because Kentucky Utilities' rates continue to be among the lowest in the nation. IMPACT OF ACCOUNTING STANDARDS Refer to Note 8 of the Notes to Financial Statements for information concerning a new standard for accounting for investments in debt and equity securities. INFLATION Kentucky Utilities' rates are designed to recover operating and historical plant costs. Financial statements, which are prepared in accordance with generally accepted accounting principles, report operating results in terms of historic costs and do not evaluate the impact of inflation. Inflation affects Kentucky Utilities' construction costs, operating expenses and interest charges. Inflation can also impact Kentucky Utilities' financial performance if rate relief is not granted on a timely basis for increased operating costs. Item 8.

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Item 6. Selected Financial Data Reference is made to the Registrant's Annual Report to Shareholders, page 32, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Reference is made to the Registrant's Annual Report to Shareholders, pages 27 to 31, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13. Item 8.

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ITEM 6. Selected Financial Data Five Year Summary of Operations Year ended July 31, --------------------------------- The numerical note referred to above is included in the Notes to Financial Statements. Registrant has not conducted any business operations during its last five (5) fiscal years, except that during the above fiscal years it has incurred expenses necessary to keep its good standing in its state of residence. ITEM 7.

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Refer to notes and financial statements. ITEM 8.

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ITEM 6. SELECTED FINANCIAL DATA. The following selected consolidated financial information for each of the five years in the period ended December 31, 1993 is derived from the Company's Consolidated Financial Statements, which have been audited by Arthur Andersen & Co., independent public accountants, whose report thereon is incorporated by reference in this report. The information below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements, and the related Notes, and the other financial information which are filed as exhibits to this report and incorporated herein by reference. Chemical Waste Management, Inc. and Subsidiaries Selected Consolidated Financial Data for the Years Ended December 31 (000's omitted except per share amounts) /1/ Results for 1993 reflect the consolidation of Rust. See Note 1 to the Company's Consolidated Financial Statements filed as an exhibit to this report and incorporated herein by reference. /2/ Includes special charges of $36 million in 1991, $111.2 million in 1992, and $550 million in 1993. See Note 17 to the Company's Consolidated Financial Statements filed as an exhibit to this report and incorporated herein by reference. /3/ Includes non-taxable gains of $10.7 million in 1991, $47 million in 1992, and $10.5 million in 1993 resulting from issuance of stock by subsidiary and equity investee. See Note 2 to the Company's Consolidated Financial Statements filed as an exhibit to this report and incorporated herein by reference. /4/ In August 1993, the Board of Directors suspended indefinitely the payment of quarterly cash dividends on the Company's common stock. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations set forth on pages 7 to 14 of the Company's 1993 Annual Report to Stockholders (the "Annual Report"), which discussion is filed as an exhibit to this report and incorporated herein by reference. ITEM 8.

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1993

50178

1993

ITEM 6. SELECTED FINANCIAL DATA. The following selected financial information for the years ended December 31, 1989 through 1993, is derived from the consolidated financial statements of the Company for such years. The information should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere herein. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. LIQUIDITY AND CAPITAL RESOURCES REORGANIZATION. On June 4, 1993, the Debtors filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code. On September 29, 1993, the Bankruptcy Court issued an order confirming the Debtor's First Amended Joint Plan of Reorganization. On November 2, 1993, the following transactions resulted from the consummation of the Plan: (1) The Debtors paid approximately $2.1 million in cash and transferred their Mississippi Fuel, Ada, Chalybeate Springs and Leaf River gathering and pipeline systems along with certain contractual rights owned by the Debtors to the holders (the "Noteholders") of the Debtor's 9% Senior Notes, 11.7% Senior Notes and 11.5% Subordinated Convertible Debentures. The cash payments and transfer of assets was in full satisfaction of all allowed claims of the Noteholders (approximately $44.1 million of debt and accrued interest on the financial records of the Debtors). The Company paid in full all other creditors. (2) The Debtors paid approximately $4.6 million in cash and issued promissory notes in the aggregate of $2.5 million (the "Note") to the holders (the "Preferred Stockholders") of the Company's $9.50 Series A Cumulative Convertible Exchangeable Preferred Stock (the "Preferred Stock") in satisfaction of all allowed claims (approximately $27.0 million on the financial records of the Debtors, which includes the liquidation value of the Preferred Stock and all accrued and unpaid dividends thereon). The Note is secured by a lien on the stock of all the subsidiaries of Cornerstone and is guaranteed by its subsidiary, Cornerstone Pipeline Company (formerly known as Endevco Pipeline Company), which holds an interest in the Mountain Creek Joint Venture and also owns the Excelsior gathering system. Pursuant to the terms of the Note, the Company is prohibited from paying dividends or repurchasing shares of its capital stock. (3) All outstanding common stock, par value $.10 per share (the "Former Common Stock"), of Endevco, Inc. was canceled and each holder thereof was issued one share of the common stock of Cornerstone (the "New Common Stock") for each share of Former Common Stock held. Holders of the Former Common Stock constitute approximately 63% of the shares of New Common Stock. All outstanding stock options were canceled. (4) Pursuant to the First Amended Stock Purchase Agreement by and between Ray Davis, Trustee (the "Purchaser") and Cornerstone dated May 28, 1993, Ray Davis and his assigns acquired 4,576,659 shares of New Common Stock and warrants to acquire an additional 2,564,103 shares of New Common Stock with an exercise price of $.78 per share. The aggregate purchase price of such shares of New Common Stock and warrants was $3.0 million. The purchased shares constitute approximately 37% of the Company's issued and outstanding shares of New Common Stock. The purchased shares and the warrants, if exercised, would constitute approximately 47% of the fully diluted capital stock of the Company. (5) The Company entered into a term loan and revolving credit facility (the "Senior Loan") with a financial institution. The term portion of the Senior Loan was for $5.8 million and provides for monthly principal and interest payments. The interest is to be calculated at the applicable prime rate plus two percent. The revolving credit facility allows for working capital loans and standby letters of credit up to an aggregate of $6.0 million. A portion of the proceeds from the new Senior Loan were used to retire the remaining debt associated with the purchase of the original assets of Dubach Gas Company ("Dubach") as well as the debt incurred when the assets of Claiborne Gasoline Company were acquired. (6) The Company amended its Certificate of Incorporation to (1) change the Company's name to Cornerstone Natural Gas, Inc. from Endevco, Inc. and (2) provide for certain restrictions on the transfer of New Common Stock. One of the goals of the Company from the reorganization was to restructure the Company's debt obligations so they could be met from continuing operations. As part of the Plan, the Company is moving two of its cryogenic plants from Brazoria County, Texas to Lincoln Parish, Louisiana. The cost to move and install these plants is estimated to be $2.5 million. The cryogenic plants are expected to be operational early in the second quarter of 1994. The cryogenic plants are more fuel efficient, achieve greater recoveries of NGLs, are less labor intensive, and have lower operating costs than the Company's current gas processing operations. Management expects these plants to significantly improve cash flows from operations by the second half of 1994. CAPITAL EXPENDITURES. The Company made capital expenditures of approximately $3.7 million in 1993. Approximately $1.6 million of these related to the building of a five mile pipeline to service a paper mill in East Baton Rouge Parish, Louisiana (the "Port Hudson Pipeline"). Approximately $1.2 million has been spent towards the moving of the two cryogenic plants to Lincoln Parish, Louisiana. The Company anticipates spending another approximately $1.3 million in 1994 to complete the project. The Company is continuing to evaluate its remaining assets in regard to its current strategic direction. As such, the Company is actively attempting to redeploy existing idle assets into new projects and is evaluating potential sales of nonperforming assets. The Company's Senior Loan requires lender approval to pursue major projects. The Company's capital budget for 1994 is limited under the the Senior Loan to $500,000 (excluding the moving of the two cryogenic gas processing plants). However, the Company continues to pursue projects that would require long-term borrowing. These funds and the approvals necessary under existing loan agreements will be secured prior to committing to any new projects. The Company believes that its current relationships with existing lenders will allow borrowing capacity for future capital requirements. However, each project will be separately evaluated, and must meet its own cash flow requirements. There can be no assurance regarding the Company's ability to obtain additional capital when needed on acceptable terms or that all necessary consents or waivers will be obtained from its lenders. LINE OF CREDIT. On July 1, 1993, Dubach discontinued operations at one of its two condensate refineries. As a result, the Company is buying less condensate and crude oil reducing the amount of standby letters of credit needed. Dubach reduced its line of credit to $10.0 million under which standby letters of credit can be issued. This line of credit expires March 31, 1994. Dubach has replaced this line of credit with a $2.6 million line of credit from a different financial institution. The maturity date of the new line is April 30, 1994. The current line of credit covers Dubach's requirements for buying condensate and crude oil for the refinery through March business. Dubach will need an extension of this line or must reduce its purchases of crude oil for April business. See Note 4 of "Notes to Consolidated Financial Statements." NOL CARRYFORWARDS. The Company has NOL carryforwards for income tax purposes of approximately $28.9 million which, if not previously utilized, will expire at various times from 2001 until 2008. In addition, the Company has unused investment tax credits of approximately $1.6 million available to offset future federal income tax liability. The Company considers such carryforwards and tax credits to be potentially valuable assets which may be used to shelter future taxable earnings from income taxes. If a change of ownership as defined in Internal Revenue Code Section 382 occurs, utilization of the NOL carryforwards could be severely limited. WORKING CAPITAL. The Company's working capital deficit was $5.2 million at December 31, 1993. The Company expects to maintain a working capital deficit throughout 1994 in order to effectively manage cash. Management believes that its improved cash flows from operations combined with amounts available under its $6.0 million line of credit will be sufficient to meet its cash requirements in 1994. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992 GENERAL. The Company's operations were negatively impacted in 1993 by the reorganization. The uncertainty related to the Company's financial condition limited the Company's ability to purchase natural gas. Many suppliers required prepayments or put restrictions on purchases which ultimately resulted in an increase in the cost of natural gas to the Company. Management believes that the negative influences of the reorganization will begin to dissipate in 1994. In addition, average margins on refined products decreased in 1993 from 1992. This combined with a decrease in emphasis on refining is expected to allow the Company to return to profitability. NATURAL GAS PIPELINE OPERATIONS. Sales volumes for natural gas declined in 1993 as the financial condition of the Company required curtailment of certain business activities. The following table provides pertinent information relating to the Company's natural gas pipeline operations. The Company's natural gas pipeline operations contributed 44% of total consolidated gross margin in 1993 compared to 49% in the prior year. Earnings from operations before depreciation declined $3.9 million (47%) primarily as a result of a decrease in throughput of natural gas. As a result of the Company's reorganization, it became increasingly difficult to acquire supplies of natural gas. The Company utilized its supplies to ensure that it fulfilled its commitments on all its term sales contracts. From the limited supply, the Company was forced to curtail certain other marketing activities. This particularly impacted the assets transferred as part of the reorganization. Throughput on the transferred assets declined 63 MMCFD. The Company also experienced a decline in throughput of approximately 7 MMCFD on its Mountain Creek System. This was the result of maintenance performed on the power plant which is supplied by the Mountain Creek System. The maintenance required the plant to be taken off-line for three months. Additionally, this plant will have lower utilization in the future as the utility has replaced some of its needs with nuclear power. These declines in throughput were partially offset by the addition of the Company's Port Hudson System which began operations in April 1993. The Company's Off-system sales throughput declined 5 MMCFD (7%) in 1993. Gross margin on these sales decreased approximately $378,000. This was caused in part by an increase in the cost of supply relative to sales. Additionally, higher natural gas prices during most of 1993 limited the Company's ability to compete with utility tariffs in the northeast market areas. NATURAL GAS PROCESSING OPERATIONS. The following table provides pertinent information relating to the Company's gas processing operations. Gross margin from gas processing operations contributed 56% of consolidated margin compared to 51% in the prior year. Earnings from operations declined $1.4 million (63%) in 1993. The decreased earnings was primarily the result of a decline in margin per barrel sold. The Company discontinued operations at one of its two condensate refineries in July 1993. The Company also consolidated the usage of its North Louisiana facilities and was able to discontinue operations at one of its two fractionating units in September 1993. The Company expects the installation of cryogenic facilities in North Louisiana to significantly increase cash flow in 1994 from its gas processing operations. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses have declined $823,000 (20%) in 1993. This reflects specific management efforts to reduce overhead costs through consolidation and eliminations of functions and staff reductions. The Company significantly reduced its office space and has reduced its use of outside professional services. OTHER INCOME (EXPENSE). Interest expense decreased $2.4 million (47%) primarily as a result of the debt that was retired as part of the reorganization. The Company sold its interest in Three Rivers Pipeline Company and Allegheny Energy Marketing Company (collectively referred to as "Three Rivers") in January 1993. The Company's share of losses from its interest in Three Rivers was $555,000 in 1992. The Company recorded a gain from the sale of its interest in Three Rivers of $611,000 in 1993. REORGANIZATION ITEMS. The Company recorded a loss on the disposition and write downs of property, plant and equipment of $20.3 million in 1993. This included the assets transferred to the Noteholders and other assets that were considered impaired to the reorganized Company. The professional fees of $4.5 million incurred for the reorganization included primarily legal fees, consultant fees and bankruptcy costs. EXTRAORDINARY ITEM. The Company recorded a $9.1 million gain from the extinguishment of debt in conjunction with the reorganization. YEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991 GENERAL. The Company experienced a net loss applicable to common stockholders of $7.5 million in 1992 compared to a net loss of $3.5 million in 1991. The increase in net loss was primarily a result of decreased natural gas volumes on the Company's facilities, decreased unit margins from gas processing and refining, increased operating expenses (primarily repairs, maintenance and treating chemicals) and increased costs related to the negotiations of debt restructuring. NATURAL GAS PIPELINE OPERATIONS. The natural gas operations segment contributed 49% of total revenues and 48% of total gross margin during 1992, as compared to 56% and 57% respectively in 1991. Earnings before depreciation declined $2.0 million (20%) in 1992. This was primarily the result of reduced gross margin on the Company's Mississippi System and the disposition of its Hattiesburg Gas Storage facilities. The Company recorded $1.8 million of gross margin and $1.5 million of operating earnings before depreciation from the Hattiesburg facilities in 1991 before the disposition. The Company moved an average of 208 MMCFD through its facilities during 1992 compared to 241 MMCFD in 1991. The decrease in volume was primarily attributable to a 31 MMCFD decline on the Company's Mississippi System. Third party transportation on the Mississippi System declined 11 MMCFD as reserves were depleting without new drilling. The Company's volumes, bought for resale, declined 20 MMCFD. This was partially a result of the Company's financial difficulties which limited the supply of natural gas. Gross margin decreased $1.4 million (10%) in 1992. The Company's unit margin increased to $.16 per MCF from $.15 per MCF. The gross margin decline was primarily a result of the decreased throughput on the Mississippi System. Decreased third party gas transportation volumes resulted in a decline in gross margin of $964,000 while the decreased volumes, bought for resale, resulted in a decline of $1.1 million. These declines were partially offset by an increase in gross margin on the Company's Ada System of $731,000. The Ada System increase resulted from a greater average gross margin per unit in 1992. The Company's Off-system volumes increased 15% to 68 MMCFD in 1992. The gross margin increased 24% to $1.3 million in 1992. NATURAL GAS PROCESSING OPERATIONS. Gross margin increased $2.4 million (20%) in 1992, primarily as a result of a full year of operations from the Claiborne facilities compared to only five months in the previous year. Earnings from operations declined $2.2 million (46%) primarily from the Company's Dubach and Claiborne facilities. The decreased earnings reflect increased operating expenses and a decline in margin per barrel sold. Operating expenses increased due to (i) several major overhauls of compressors, (ii) repair of lightning damage, (iii) repair of natural gas lines in order to return them to service and (iv) repairs needed to meet environmental and safety standards. GENERAL AND ADMINISTRATIVE. General and administrative costs decreased $1.3 million in 1992. This difference is primarily attributable to project development costs that were written off in 1991 related to projects that did not fit the Company's current strategic direction. OTHER INCOME (EXPENSE). Interest expense decreased $1.4 million in 1991. This was primarily a result of $10.2 million of principal payments made in 1991 and the sale of the Hattiesburg facilities. The $643,000 decrease in equity earnings (losses) of unconsolidated affiliates was largely the result of a $454,000 decrease in earnings from the Company's interest in Three Rivers. The Company sold its interest in Three Rivers in January 1993. In 1991, there was a $3.7 million gain recorded on the sale of the Hattiesburg facilities. Also in 1991, there was a loss of $1.6 million recorded in relation to a sale and leaseback on three of the Company's Texas pipeline systems. There were no sales of significant assets in 1992. OTHER MATTERS ACCOUNTING FOR INCOME TAXES. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes," ("FAS 109"). The adoption of FAS 109 changed the Company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. Under APB 11, the Company has deferred the tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequence of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Adoption of FAS 109 had no material impact on the Company's financial position at January 1, 1993, or the results of its operations for the year ended December 31, 1993. The Omnibus Budget Reconciliation Act of 1993 signed into law by President Clinton on August 10, 1993, contains several provisions affecting corporations. The most notable to the Company is an increase in the top corporate income tax rate from 34% to 35%. Although most provisions of the new law were effective January 1, 1993, it had no impact in 1993 and it is not anticipated to have any significant impact in 1994 due to the net operating loss position of the Company. EFFECTS OF CHANGING PRICES. Natural gas, NGLs and petroleum product prices have fluctuated significantly over the last three years. The Company, however, earns a margin which is the difference between the revenues from sales of products over the purchase costs of such. The change in margin, although it has declined over the three year period, is much less volatile than the change in product prices. Inflation has not had a significant impact on operating expenses in the last three years. ITEM 8.

725625

1993

Item 6. Selected Financial Data. The information called for by this item is set forth under the caption "Millipore Corporation Eleven Year Summary of Operations" on pages 48 and 49 of Millipore's Annual Report to Shareholders for the year ended December 31, 1993, which information is hereby incorporated herein by reference. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information called for by this item is set forth under the caption "Management's Discussion and Analysis" on pages 33 and 34 of Millipore's Annual Report to Shareholders for the year ended December 31, 1993, which information is hereby incorporated herein by reference. Item 8.

66479

1993

Item 6. Selected Financial Data ----------------------- NYFS03...:\16\12316\0001\7120\FRM32894.P9B Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations ------------------------- Liquidity and Capital Resources ------------------------------- In January, 1993, the Company issued and sold $74.8 million of 6% Convertible Subordinated Debentures (the "Debentures") due 2003 and received $72.5 million, after commissions and expenses, from the sale of the Debentures. The net proceeds were initially used to repay $5.0 million of outstanding revolving credit balances and for general corporate purposes, including acquisitions of other companies in the same or related businesses. On July 1, 1993, the Company acquired the Votainer group of Companies for a cash purchase price of $11.3 million plus the assumption and payment of certain indebtedness of approximately $3.3 million to the seller. Capital expenditures in 1993, which were largely for the acquisition of data processing equipment and facility improvements totaled $4.9 million. Capital expenditures for 1992 totaled $15.2 million, which included the purchase of a warehouse and office facility in Sydney, Australia for $7.5 million and the construction of a warehouse and distribution facility in Venlo, Holland for $3.0 million. Depreciation and amortization expense totaled $6.3 million in 1993 and $7.0 million in 1992. Capital expenditures for 1994 are anticipated to be approximately $17.0 million. Cash, cash equivalents and short-term investments at December 31, 1993 totaled $65.2 million compared to $14.1 million at December 31, 1992. The increase was largely attributable to the proceeds remaining from the sale of the $74.8 million of Debentures. The Company maintains a revolving credit facility which permits borrowing in amounts up to a maximum of $20.0 million at any time outstanding until maturity in September, 1995. Interest on outstanding borrowings is payable at a variable rate equal, at the Company's election, to (i) the prime commercial rate in effect from time-to-time or (ii) LIBOR in effect from time-to-time plus 2.0%. At December 31, 1993, there were no borrowings under this facility. Management believes that the Company's available cash and sources of credit, together with expected future cash generated from operations, will be sufficient to satisfy its anticipated needs for working capital, capital expenditures and fixed charges. NYFS03...:\16\12316\0001\7120\FRM32894.P9B Results of Operations --------------------- 1993 Compared to 1992 --------------------- Included in the consolidated results of operations for 1993 are the ocean freight activities of Votainer for the last six months of 1993. Votainer was acquired by the Company on July 1, 1993. The consolidated results of airfreight and ocean freight activities for 1993 compared to 1992 (airfreight only) are as follows: Consolidated revenues increased $53.4 million (7.9%) to $725.7 million in 1993 compared with 1992. The increase in revenues was attributable to the inclusion of $51.4 million of revenues from the ocean freight operations from Votainer for the last six months of 1993. Revenues from airfreight operations for 1993 were $674.3 million, largely unchanged from 1992 revenues. Airfreight revenues for 1993 were impacted by the positive effects of a 4.4% increase in the number of shipments and a 11.2% increase in the total weight of cargo shipped, which was offset by the negative effects of lower customer selling rates and the effect of weaker foreign currencies when converting foreign currency revenues into United States dollars for financial reporting purposes. Gross profit (revenue less transportation expense) increased $7.0 million (3.1%) to $229.3 million in 1993 compared with 1992. The increase in gross profit is attributable to the inclusion of $12.2 million of gross profit of Votainer for the last six months of 1993, which was partially offset by a $5.2 million (2.3%) decrease in airfreight gross profit to $217.1 million. The decrease in airfreight gross profit was due to lower gross profit in European airfreight operations and competitive pricing pressures, which reduced gross margin (gross profit as a percentage of revenues) from 33.1% in 1992 to 32.1% in 1993. NYFS03...:\16\12316\0001\7120\FRM32894.P9B The Company's internal operating expenses (terminal and selling, general and administrative) increased $6.9 million (3.6%) to $197.9 million in 1993 compared to 1992. The increase was due entirely to the inclusion of Votainer's internal operating expenses of $13.0 million for the last six months of 1993, which more than offset a $6.1 million (2.3%) reduction in the internal operating expense attributable to the Company's airfreight operations. The latter category of expenses benefitted from the effects of weaker foreign currencies when converting foreign currency expenses into United States dollars for financial reporting purposes as well as lower employee incentive compensation expense. Operating income for 1993 was $31.4 million, unchanged from 1992 operating income, with the $.9 million loss from Votainer's operations being offset by a $1.0 million improvement in airfreight operating income. Net interest expense increased $1.5 million (45%) to $3.7 million in 1993 compared with 1992. The increase was attributable to the interest cost associated with the Company's 6% Convertible Subordinated Debentures issued in January 1993. The effective tax rate for 1993 was 38.0% compared to 37.6% for 1992. The Company's effective tax rates fluctuate due to changes in tax rates and regulations in the countries in which it operates and the level of pre-tax profit earned in each of those countries. United States Operations ------------------------ United States revenues increased $37.8 million (14%) to $308.5 million in 1993 compared to 1992. The increase in United States revenues was comprised of a $6.2 million (21.6%) increase in domestic airfreight revenues, an $11.9 million (4.9%) increase in international airfreight revenues, and the inclusion of $19.7 million of Votainer revenues for the last six months of 1993. The increase in United States airfreight revenues was attributable to a 5.5% increase in the number of shipments (18.1% increase in domestic shipments and 1% increase in international shipments) and a 14% increase in the total weight of cargo shipped (30% increase in domestic cargo and 9% increase in international cargo). The increased domestic and international airfreight shipping volumes resulted in an increase in airfreight profit of $1.8 million (19.4%), which was partially offset by a $1.2 million operating loss in Votainer, resulting in an overall increase in United States operating profit of $.6 million (6.0%) to $9.6 million in 1993. Foreign Operations ------------------ Foreign revenues increased $15.6 million (3.9%) to $417.3 million in 1993 compared with 1992. The increase in revenues was attributable to the inclusion of $31.7 million of Votainer revenues for the last six months of 1993, which was offset by a $16.1 million (4.0%) decrease in foreign airfreight revenues. The decrease in foreign airfreight revenues was attributable to the Company's European operations, where weaker foreign currencies, particularly the NYFS03...:\16\12316\0001\7120\FRM32894.P9B British Pound, accounted for a reduction of $20.7 million (8.6%) in European airfreight revenues when European revenues were converted to United States dollars for financial reporting purposes. The number of shipments and total weight of cargo shipped by the Company's European airfreight operations increased 3.2% and 15.4%, respectively. In the Company's Asia and Others segment, revenues increased $19.4 million (12.1%) to $180.0 million in 1993 compared to 1992. This increase was attributable to the inclusion of $14.8 million of Votainer revenues for the last six months of 1993 and a $4.6 million increase in airfreight revenues. The number of airfreight shipments handled by the Company's Asia and Others operation increased 3.0%, while the total weight of cargo shipped by these operations was unchanged from 1992. Operating profit from foreign operations decreased $.4 million (2.1%) to $21.8 million for 1993 compared with 1992. The decline in foreign operating profit was due entirely to a $1.7 million decrease in European airfreight operating profit, which was partially offset by a $.9 million increase in Asia and Others airfreight operating profit and a $.4 million operating profit in Votainer's foreign operations. In Europe, five of the Company's seven wholly-owned subsidiaries reported lower operating results in 1993 when compared with 1992, including an operating loss incurred by the Company's German subsidiary. These declines are directly attributable to the continuing economic recession in most European countries, particularly Germany, and resulting competitive pricing pressures. The operating results in the Company's United Kingdom and Holland airfreight operations, which comprised 54% of 1993 European revenues and 90% of 1993 European operating profit, were largely unchanged from 1992. 1992 Compared to 1991 Worldwide Operations: -------------------- Consolidated revenues increased $70.3 million (11.7%) to $672.3 million in 1992 compared with 1991. The increased revenues were largely attributable to a 5.7% increase in the number of shipments and a 16.7% increase in the total weight of cargo shipped. Additionally, when converting foreign currency revenues into U.S. dollars for financial reporting purposes, the effect of a weaker U.S. dollar accounted for approximately $9.3 million of the increase in revenues. Gross profit (revenues less transportation expense) increased $24.5 million (12.4%) to $222.3 million in 1992 compared with 1991 due to the increase in the number of shipments and the total weight of cargo shipped. Gross margin (gross profit as a percentage of revenues) for 1992 was 33.1%, compared to 32.8% for 1991. Of the Company's internal operating expenses (terminal and selling, general and administrative expenses), terminal expense increased $8.6 million (8.2%) to $113.2 million while selling, general and administrative expense increased $9.3 million (13.6%) to $77.8 million. The higher internal operating expense was due to increases in shipping volumes, higher advertising and promotional expense and increased employee compensation. NYFS03...:\16\12316\0001\7120\FRM32894.P9B Operating income increased $6.6 million (26.8%) to $31.3 million in 1992 compared with 1991. This increase was attributable to the increased number of shipments and weight of cargo shipped and a decline in internal operating expense as a percentage of revenues to 28.4% in 1992 from 28.8% in 1991. Net interest expense for the year ended December 31, 1992 declined $0.4 million (14.9%) to $2.2 million compared with 1991. The decrease reflected the conversion in April 1992 of the Company's 11.15% Convertible Subordinated Notes due 1999 in the principal amount of $20.0 million into 2,045,407 shares of Common Stock, which shares were then repurchased by the Company. The effective tax rate for 1992 was 37.6% compared to 39.9% for 1991. The lower tax rate was due to higher levels of pre-tax income in 1992, which reduced the impact of nondeductible expenses on the effective tax rate and lower statutory tax rates in four countries where the Company operates. United States Operations: ------------------------ United States revenues increased $23.2 million (9.4%) to $270.6 million in 1992 compared with 1991. The increase in United States revenues was attributable to a 4.0% increase in the number of shipments and a 14.3% increase in the total weight of cargo shipped. The increases in the number and total weight of shipments resulted in an increase in operating income of $1.0 million (11.9%) to $9.0 million in 1992 compared with 1991. Foreign Operations: ------------------ Foreign revenues increased $47.1 million (13.3%) to $401.7 million in 1992 compared with 1991. European revenues for 1992 increased $25.5 million (11.9%) to $241.0 million and Asia and other revenues increased $21.6 million (15.5%) to $160.6 million. A 7.4% increase in the number of shipments and a 18.1% increase in the total weight of cargo shipped accounted for approximately $18.9 million (40.0%) of the increase, while stronger European currencies accounted for approximately $6.6 million (14.0%) of the increase when the Company's European revenues were converted into U.S. dollars for financial reporting purposes. The increase in the Asia and other revenues was primarily due to a 6.4% increase in the number of shipments and a 20.4% increase in the total weight of cargo shipped. Foreign operating income increased $5.6 million (34.0%) to $22.2 million in 1992 compared with 1991. The increase was due to a $3.5 million (34.1%) increase in European operating income and a $2.2 million (33.9%) increase in the Asia and other sector. All six of the Company's wholly-owned subsidiaries in Europe (Belgium, France, Germany, Holland, Ireland and the United Kingdom) reported improved results for 1992. In particular, the Company's operations in the United Kingdom and Holland accounted for approximately 53.9% of its European revenue and 78.2% of its European operating income. NYFS03...:\16\12316\0001\7120\FRM32894.P9B Item 8.

700674

1993

Item 6. Selected Financial Data. The information set forth under the caption "Selected Ten-Year Financial Data" on page 29 of the Company's 1993 Annual Report To Shareholders is incorporated herein by reference. Item 7.

Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition. The information set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" beginning on page 11 of the Company's 1993 Annual Report To Shareholders is incorporated herein by reference. Item 8.

854094

1993

Item 6. Selected Consolidated Financial Data The selected consolidated financial statement data presented below for periods subsequent to June 30, 1993 give effect to the consummation of the Prepackaged Plan and to the application of fresh-start reporting by the Company as of that date 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." Accordingly, periods through June 30, 1993 have been designated "Pre-emergence," and periods subsequent to June 30, 1993 have been designated "Post-emergence." Selected financial consolidated balance sheet and income statement data of the pre-emergence periods are not comparable to those of the post-emergence periods and a line has been drawn in the tables to separate the post-emergence financial data from the pre-emergence financial data. The following table presents selected (i) historical consolidated financial data of the Company (pre-emergence) for each of the four fiscal years in the period ended December 31, 1992 and the six-month period ended June 30, 1993, (ii) historical consolidated financial data of the Company (post-emergence) for the six-month period ended December 31, 1993, and (iii) pro forma consolidated income statement data for the fiscal year ended December 31, 1993. The pro forma data (i) eliminate the effect of non-recurring transactions resulting from the Reorganization included in the results of the Company, (ii) adjust pre-emergence results of the Company to reflect the assumed implementation of fresh-start reporting as of January 1, 1993 for income statement purposes, and (iii) assume the exchange of $65,975,000 aggregate principal amount of Old Subordinated Notes for $48,628,625 aggregate principal amount of New Senior Secured Notes and the issuance of 10,000,000 shares of Common Stock pursuant to the Prepackaged Plan as of January 1, 1993. The information below should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," the Company's Consolidated Financial Statements, including the notes thereto, and other information contained elsewhere herein. The historical consolidated financial data presented below for each of the three fiscal years in the period ended December 31, 1991 have been derived from the Company's Consolidated Financial Statements, which were audited by Ernst & Young, independent accountants. Ernst & Young's report on the consolidated financial statements for the year ended December 31, 1991, which appears elsewhere herein, includes a description of uncertainties that might have led to the Company's inability to continue as a going concern. The historical consolidated financial data for the six months ended December 31 and June 30, 1993 and the fiscal year ended December 31, 1992 have been derived from the Company's Consolidated Financial Statements, which were audited by Price Waterhouse, independent accountants. The data should be read in conjunction with the consolidated financial statements, related notes and other financial data included elsewhere herein. (1) Adience's management believes the per share amounts are not meaningful prior to June 30, 1993 due to the Reorganization. (2) Pro forma balance sheet information is not presented since the historical balance sheet data as of December 31, 1993 includes the effects of the Prepackaged Plan and the implementation of fresh-start-reporting. (3) On February 10, 1989, Adience's Board of Directors authorized an amendment to Aidence's Certificate of Incorporation to increase the authorized number of shares of common stock from 200 shares, no par value, to 20,000,000 shares, par value $0.15 per share, and a 100,000-for-1 stock split. On September 30, 1990, Adience's Board of Directors declared a $.10 per share cash dividend. No dividends were declared on Adience's common stock for any other period covered. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Reorganization and Fresh-Start Reporting Adience, Inc. has experienced continued losses from continuing operations (before reorganization items) both pre- and post-emergence under Chapter 11. In addition, a write down of reorganization value in excess of amounts allocable to identifiable assets has been recorded at December 31, 1993, based on management's belief that a permanent impairment of this asset now exists. The Company is currently seeking to replace and improve the terms of its line of credit financing agreement with Congress Financial Corporation (Congress) which expires June 30, 1994. The continued viability of the Company is dependent upon, among other factors, the ability to generate sufficient cash from operations, financing, or other sources that will meet ongoing obligations over a sustained period. Management has prepared detailed operating and financial plans which combine multifunctional resources as teams to respond better to customer needs, make an investment in product and service opportunities expected to produce a significantly greater return on investment, continue a cost control program begun in 1993, and assume refinancing of the line of credit arrangement on improved terms. Management believes that the successful implementation of this plan will enable the Company to continue as a going concern for a reasonable period. There can be no assurance however, that such activities will achieve the intended improvement in results of operations or financial position. On February 22, 1993, Adience and the unofficial committee of noteholders of Adience filed a prepackaged plan of reorganization (the "Prepackaged Plan") under Chapter 11 of the United States Bankruptcy Code (the "Reorganization"). The Prepackaged Plan was confirmed by the United States Bankruptcy Court for the Western District of Pennsylvania on May 4, 1993 and consummated on June 30, 1993. The filing was precipitated by a combination of an overall decline in the demand for refractory products and service during 1991 and 1992 caused by a decrease in the production of refractory-using industries in the United States, particularly steel, and losses from discontinued operations. The primary purposes of the Prepackaged Plan were to reduce Adience's debt service requirements and overall indebtedness, to realign its capital structure and to provide Adience with greater liquidity. Neither IDT nor Adience Canada, Inc. filed a plan of reorganization. The Prepackaged Plan provided for a restructuring of Adience's capital structure and allowed the holders of $65,975,000 aggregate principal amount of Adience's Senior Subordinated Reset Notes ("Old Subordinated Notes") to exchange them for $48,628,625 aggregate principal amount of new 11% Senior Secured Notes ("New Senior Notes") due June 15, 2002, plus common stock representing 55% of the outstanding common stock of Adience. The Prepackaged Plan also included forgiveness of outstanding interest totaling approximately $8,800,000. The value of the cash and securities distributed was $17,480,000 less than the allowed claims; the resultant gain was recorded as an extraordinary gain. In connection with the Reorganization described above, Adience applied the provisions of the American Institute of Certified Public Accountants' Statement of Position No. 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code" ("SOP 90-7") as of June 30, 1993. The Company's basis of accounting for financial reporting purposes changed as a result of applying SOP 90-7. Specifically, SOP 90-7 required the adjustment of the Company's assets and liabilities to reflect a reorganization value generally approximating the fair value of the Company as a going concern on an unleveraged basis, the elimination of its accumulated deficit, and adjustments to its capital structure to reflect consummation of the Prepackaged Plan. Accordingly, the results of operations after June 30, 1993 are not comparable to the results of the operations prior to such date, and the results of operations for the six months ended June 30, 1993 and the six months ended December 31, 1993 have not been aggregated. Further, the financial position of the Company after June 30, 1993 is not comparable to its financial position at any date prior thereto. Results of Operations Fiscal Year ended December 31, 1993 Compared to Fiscal Year ended December 31, The following table summarizes the Company's consolidated results of operations for 1993 and 1992 and provides a consistent basis for further discussion and analysis of those results. (1) For further discussion, see Note 1 to Consolidated Financial Statements. Excluding the effects of reorganization items, the pre-emergence and post-emergence loss of $4.7 million and 13.6 million, respectively, decreased by $5.7 million from 1992, reflecting primarily a reduction in selling, general and administrative expenses of $2.8 million and a decrease in interest expense of $7.3 million, offset partially by a net increase in depreciation and amortization expense of $7.2 million. Included in the net increase in amortization expense for 1993 is the fourth quarter write down of the Company's reorganization value in excess of amounts allocable to identifiable assets. The amount written down was based on management's comparison of actual cash flows for the post-emergence period through December 31, 1993 with the projected cash flows used to arrive at the reorganization value at June 30, 1993. This charge increased the post-emergence loss by $8 million or $.80 per share. Additional losses from previously discontinued operations and disposals amounted to $400,000 and $84,000 for the pre-emergence and post-emergence periods, respectively, and $5.3 million in 1992. Management's decision to discontinue these operations was made after concluding that these businesses no longer fit Adience's long-term growth plans. Net revenues by industry segment for 1993 and 1992 were as follows: During the Reorganization period, which initially began in December 1992, Adience operated under strict payment terms with many of its suppliers, thereby experiencing higher costs. Increased competition in the refractory product sector prohibited the Company from passing along to customers increases in the costs of some important raw materials. As a result, sales opportunities were lost due to Adience's inability to compete on price and offer extended payment terms. In addition, the necessity of management's concentration of efforts on the Reorganization resulted in a loss of business in certain primary steel markets. During 1993, steel producers generally operated at levels close to capacity. However, Adience's restructuring under the supervision of the Bankruptcy Court did not enable the Heat Technology division to capitalize on these favorable economic conditions in the first half of 1993. The Company reacted to the sales decline during the first half of 1993 by taking several significant steps which, due to timing, only modestly impacted 1993 results. The primary steps included the election of a new Board of Directors and the appointment of a new Chief Executive Officer. The problems experienced in the past are being addressed by the new Board and executive management. As a result, new incentive plans are being implemented for the sales force and a realignment of duties is being accomplished within the internal operations of the Company. The Heat Technology division has also expanded its research and development programs through the hiring of seven new ceramic engineers during 1993. A management focus for 1994 is customer service and product quality. Teams of sales and service representatives have been established to respond to customer needs within the various industries that are supplied or serviced with refractory product. Net revenues for the Heat Technology division increased by 23% for the six month period ended December 31, 1993 compared to the six month period ended June 30, 1993. Net revenues for IDT remained consistent with prior year's net revenues. Included in 1993 and 1992 revenues is one large project with incremental revenues of $4.7 million and $2 million, respectively. Excluding this project, net revenues declined $3 million or 6.4% during 1993 within this segment. This decline is attributable to management's efforts to reduce the number of contracts which require the use of purchased rather than manufactured product because the former generate lower gross margins. The Heat Technology Division's cost of revenues amounted to 80.9% and 87.6% of net revenues for the pre-emergence and post-emergence periods respectively, compared with 83.5% for the year ended December 31, 1992. The increase in the Heat Technology Division's cost of revenues as a percentage of net revenues during the post-emergence period was primarily due to negative variances in the refractory production facilities due to a decline in volume (caused by a decrease in material shipments as opposed to construction activity) and the reduced ability to cover overhead costs. The decrease in direct material sales for the Heat Technology Division which caused these negative variances has been partially offset by the increase in construction revenues during the post-emergence period. Additional depreciation expense on buildings and machinery and equipment written up as a result of fresh start reporting (approximately $500,000) and the write-up of inventory values on June 30, 1993 (approximately $1,287,000) through the application of SOP 90-7, accounted for 3.7% of the increase in cost of revenues during the post-emergence period. Going forward, cost of revenues as a percentage of net revenues is expected to remain close to post-emergence levels due to the impact of additional depreciation expense on buildings and machinery and equipment written up as a result of fresh start reporting. (See Notes to Consolidated Financial Statements for further details). IDT's gross margins increased $300,000 to 18.1% of revenues during 1993. During the first quarter of 1993, IDT won a decision by the order of the Board of Finance and Revenue of Pennsylvania, relating to a reassessment of use tax on casework sold during the period February 1988 through September 1990. As a result, an adjustment to decrease cost of revenues by $438,000 was recorded during 1993 resulting from the reversal of the provision relating to this contingency. IDT's Kensington division, which was sold during the fourth quarter of 1993, contributed to the overall gross margin by $378,000 and $385,000 for the years ended December 31, 1993 and 1992, respectively. IDT's gross margin percentage excluding the Kensington division, the 1993 sales tax adjustment and the one large project, which recognized a loss of $290,000 during 1993, would have been 9% higher than 1992. The improvement in gross margin results principally from significant charges incurred in 1992 related to project cost overruns. The project cost overruns of approximately $600,000 were due to weaknesses in sales and project management in specific territories. Controls have been established during 1993 to minimize these types of overruns. For the pre and post-emergence periods in 1993, selling, general and administrative expenses of the Company amounted to 21.5% and 16.6% of net revenues respectively, compared with 21% for the year ended December 31, 1992. The increase in selling, general and administrative expenses during the pre-emergence period is attributable to the low level of sales during the same period. The major component in the overall decrease in 1993 over 1992 related to insurance expense. Adience was self-insured from November 1988 to June 1992 for workers' compensation and general liability. For this period, Adience is responsible for the first $250,000 of losses per occurrence. A loss calculation is performed at the end of each policy year summarizing incurred losses, paid losses and the outstanding reserve. Based upon this calculation and an estimate for potential changes in reserves and for new claims, Adience recorded an additional $2.3 million in insurance expense during the fourth quarter of 1992. In addition, the reduction in selling, general and administrative expenses is due to significant charges of approximately $1.1 million incurred in 1992 related to clean-up activities and other costs associated with the environmental issue at one of IDT's facilities. These activities were accounted for in 1992 and did not have a significant impact on operating costs in 1993. Other income (expense) for the pre-emergence period in 1993 includes retroactive health insurance premium refunds of approximately $215,000 for the Company's medical self-insurance program for the period September 1991 to February 1992. In addition, during June 1993, the Supreme Court of Pennsylvania held that the insurance policies covering these asbestosis and silicosis claims covered liabilities and defense costs up to the amounts of the limits of the respective policies, without regard to the period of time said policies were in effect. As a result of this judicial determination, the court awarded a refund to J.H. France for its pro rata share of the funds paid in these cases or $265,000. Also included in other income (expense) for the post-emergence period in 1993 is the $220,000 loss on the sale of the Heat Technology Division's Los Angeles operations and the $94,000 loss on the sale of IDT's Kensington division. Both sales were recorded during December 1993. Fiscal Year ended December 31, 1992 Compared to Fiscal Year ended December 31, The following table sets forth as a percentage of net revenues certain items appearing in the Company's consolidated financial statements. Percentage of Net Revenues During 1992, a decline in the demand for refractory products and services caused by a decrease in the production of refractory-using industries in the United States, particularly steel, precipitated the decline in revenues. Compounding the decline in demand for refractory products and services during 1992 was the effect of the Prepackaged Plan which increased customer apprehension. Net revenues for the Heat Technology Division's top ten customers declined by $3,500,000 in 1992. The contributing factors in this revenue decline were customer plant closings and major construction projects which were performed in 1991 and not repeated during 1992. IDT's revenues declined by $10,900,000 from 1991. IDT's primary market depends on the construction or refurbishing of educational buildings which, according to industry statistics, reported a 12% decline in capital expenditures in 1992. Industry reports attributed the decline to unusually conservative state and municipal budgets rather than a result of a permanent decline in demand. IDT's major market in the eastern portion of the United States declined, according to industry reports, by approximately 20%. IDT's revenues from this market segment suffered a corresponding percentage decline, which in turn accounted for 70% of IDT's total decrease in net revenues. In addition, the sale of EHB, one of IDT's divisions, in the first quarter accounted for 3% of the decrease in net revenues. The Heat Technology Division's cost of revenues declined by 8% to 84% of net revenues, compared with 83% in 1991. Included in cost of revenues for 1992 was a $1,100,000 write-down of property, plant and equipment for a facility which was anticipated to close during 1993. IDT's cost of revenues declined in line with the reduction in net revenues. However, project cost overruns in excess of $600,000 and enhanced pricing pressures caused by the market also resulted in the increase in cost of revenues as a percentage of net revenues to 83% compared with 79% in 1991. The project cost overruns were due to weaknesses in sales and project management in specific territories. Management controls have been established by IDT to minimize these types of overruns by the creation of centralized estimating and project management departments which are responsible for the preparation of costs estimates and ongoing cost management of all IDT projects. The increase in selling, general and administrative expenses for the Heat Technology Division reflects an adjustment to the workers' compensation and general liability insurance accrual accounts during the fourth quarter of 1992. Adience is self-insured for workers' compensation and general liability coverage for claims incurred during the period November 1988 to June 1992 for the first $250,000 of losses per occurrence. A loss calculation is performed at the end of each policy year summarizing incurred losses, paid losses and the outstanding reserve plus an estimate for potential changes in reserves and for new claims. Based upon this calculation, Adience recorded an additional $2,300,000 in insurance expense during the fourth quarter of 1992, representing Adience's portion of the outstanding reserves. In addition, as more fully described in the Notes to the Company's Consolidated Financial Statements, Adience agreed to indemnify IDT for any losses in excess of $250,000 resulting from the environmental issue at one of IDT's facilities. As a result of this indemnification, Adience recorded a $1,052,000 environmental liability which represents Adience's portion of IDT's liability for environmental issues. IDT's selling, general and administrative expenses decreased as a result of reduced sales commission expense on lower gross margin dollars. Included in reorganization items was the Company's settlement with its principal shareholder and his son as a result of Adience's Prepackaged Plan under Chapter 11 of the Bankruptcy Code. In addition, professional fees incurred as a result of the restructuring have also been segregated for presentation purposes. Liquidity and Sources of Capital As described above, the Company's financial position at December 31, 1993 as presented in its Consolidated Financial Statements reflects fresh start reporting and the amount of New Senior Notes negotiated under the Prepackaged Plan. Consequently, it is not comparable to prior periods and comparisons normally discussed under this heading would not be meaningful. The following comments on operating cash flows, capital expenditures, working capital and liquidity are considered to be relevant in evaluating the Company's present financial position. The Company's principal sources of liquidity are cash from operations, cash on hand, and certain credit facilities available to the Company. The Prepackaged Plan included forgiveness of accrued interest totaling approximately $8.8 million and the value of the New Senior Secured Notes, cash and securities distributed was $17.5 million less than the allowed claims. Management of the Company believes that cash on hand and funds from operations, together with borrowings under credit facilities described below, will be sufficient to cover its working capital, capital expenditure and debt service requirements through 1994. The Company is actively seeking an increase in its credit line through its current lender or different financing resources. The Company expects average borrowings in 1994 to exceed those of 1993. The Company intends to seek further to strengthen its financial position and increase its financial flexibility and may from time to time consider possible additional transactions, including other capital market transactions. Net cash flows provided by operating activities totaled $1.0 million and $1.2 million for the six months ended December 31 and June 30, 1993, respectively. Included in net cash flows provided by operating activities is $4.3 million received during the six months ended June 30, 1993, which relates to a federal tax refund for net operating loss carrybacks. The Company has exhausted any future refunds for net operating loss carrybacks. As discussed previously, the Company benefited as a result of the Reorganization from a forgiveness of interest on the Old Subordinated Notes during the six months ended June 30, 1993. Future cash flows from operations will no longer receive such benefit. In addition, Adience's restructuring under Chapter 11 of the Bankruptcy Code had forced Adience to comply with stricter payment terms from major vendors beginning in 1992. During the current year, however, these stricter payment terms were suspended and accounts payable and accrued expenses increased by $2,469,000 during the six months ended June 30, 1993. Capital expenditures used $1.7 million of funds through December 31, 1993. During 1993, Adience committed to purchase a new plant facility to expand current production of a specific product line. The estimated total cost of this facility and the necessary capital expenditures for machinery and equipment will be $1.5 million and is expected to be partially financed through the Pennsylvania Industrial Development Authority. It is anticipated that necessary capital expenditures in future years will not exceed depreciation expense but will represent a material use of operating funds. Adience and IDT together had $5,293,000 and $1,762,000 in available credit as of December 31, 1993 and February 28, 1994, respectively, under its short-term borrowing arrangement with Congress Financial Corporation ("Congress"). Short-term liquidity is dependent, in large part, on general economic conditions and the effect of those conditions on the steel industry. Due to the cyclical nature of the steel business and considering current trends and industry forecasts, it appears the recent period of low steel demand has ended. The Company's level of material shipments decreased by 29% during 1993, but construction activity remained relatively strong during the same period. It is anticipated that although construction activity will decline during the first half of 1994, material shipments are expected to increase during the same period. Financing Agreements. On the consummation date of the plan of reorganization, June 30, 1993, Adience entered into a financing agreement with Congress for the twelve month period ending June 30, 1994. Under this agreement, Adience may request loan advances not to exceed the lesser of $12 million or available collateral (80% of eligible accounts receivable less than 90 days plus 30% of raw material and finished goods inventory). The loan is collateralized by accounts receivable, inventory, fixed assets, intangible assets and Adience's shares of IDT. In addition, IDT guaranteed the Adience line of credit and pledged its own accounts receivable, inventory and equipment. The interest rate on the loan is 2.5% over the prime rate (effective rate of 8.5% at December 31, 1993). At December 31, 1993 and February 28, 1994, Adience had borrowed $8,007,000 and $11,595,000, respectively, under the credit facility. Letters of credit issued under the facility totaled $1 million at December 31, 1993, which reduced the availability under the financing arrangement in a like amount. IDT also renewed its financing agreement with Congress through June 30, 1994. Under this agreement, IDT may request loan advances not to exceed the lesser of $3 million or available collateral (80% of eligible accounts receivable less than 90 days plus 30% of raw material and finished goods inventory). The loan is collateralized by accounts receivable, inventory and fixed assets. Adience has guaranteed IDT's debt to Congress. The interest rate on the loan is 2.5% over the prime rate. At December 31, 1993 and at February 28, 1994, no amounts were outstanding under this agreement. Letters of credit issued under the facility totaled $700,000 at December 31, 1993, which reduced the availability under the financing arrangement in a like amount. Both Adience and IDT pay commitment fees on the unused portion of their credit facilities. Under the terms of the financing agreements, both companies are required to maintain minimum levels of net worth of $1,500,000 and working capital of $12,000,000. The agreements additionally contain other restrictive covenants applicable to Adience and its subsidiaries which, among other things, limit (i) the incurrence of additional indebtedness, (ii) the granting of liens, (iii) the making of loans, investments and guaranties, (iv) transactions with affiliates, (v) the payment of dividends and other distributions, (vi) the making of annual capital expenditures, and (vii) the disposition of real property. The following is a summary of certain of these covenants: Indebtedness. Adience may not, and may not permit any subsidiary to, create, incur, assume or permit to exist, contingently or otherwise, any indebtedness, except (a) indebtedness to Congress, (b) indebtedness consisting of unsecured current liabilities incurred in the ordinary course of its business which are not more than 90 days past due, (c) indebtedness incurred in the ordinary course of its business secured only by permitted liens (e.g., purchase money mortgages), (d) indebtedness other than for borrowed money, which is and remains contingent and unmatured, (e) indebtedness pursuant to the New Senior Notes, and (f) indebtedness to or from Adience's subsidiaries. Limitation on Liens. Adience may not, and may not permit any subsidiary to, create or suffer to exist any mortgage, pledge, security interest, lien, encumbrance, defect in title or restriction upon the use of their real or personal properties, whether now owned or hereafter acquired, except (a) the liens or security interest in favor of Congress, (b) tax, mechanics and other like statutory liens arising in the ordinary course of Adience's or its subsidiaries' respective businesses, (c) purchase money mortgages or other purchase money liens or security interest upon any specific fixed assets hereafter acquired, and (d) existing liens. Loans, Investments, Guaranties. Adience may not, and may not permit any subsidiary to, directly or indirectly, make any loans or advance money or property to any person, or invest in (by capital contribution or otherwise) or purchase or repurchase the stock or indebtedness or all or a substantial part of the assets or property of any person, or guarantee, assume, endorse, or otherwise be or become responsible for (directly or indirectly) the indebtedness, performance, obligations or dividends of any person or agree to do any of the foregoing, except (a) intercompany loans from and to Adience and its subsidiaries; (b) guarantees by any subsidiary of Adience with respect to the obligations in favor of Congress and guarantees by Adience and any subsidiary of Adience with respect to the obligations in favor of Congress and guarantees by Adience and any subsidiary of Adience with respect to the obligations of IDT in favor of Congress; (c) the endorsement of instruments for collection or deposit in the ordinary course of business; and (d) after written notice thereof to Congress, investments in the following instruments, which shall be pledged and delivered to Congress upon Congress' request, (i) marketable obligations issued or guaranteed by the United States of America or an instrumentality or agency thereof, maturing not more than one (1) year after the date of acquisition thereof, (ii) certificates of deposit or other obligations maturing not more than one (1) year after the date of acquisition thereof issued by any bank or trust company organized under the laws of and located in the United States of America or any state thereof and having capital, surplus and undivided profits of at least $100,000,000, and (iii) open market commercial paper with a maturity not in excess of two hundred seventy (270) days from the date of acquisition thereof which have the highest credit rating by either Standard & Poor's Corporation or Moody's Investors Service, Inc. Transactions with Affiliates. Adience may not, and may not permit any subsidiary to, directly or indirectly (a) purchase, acquire or lease any property or receive any services from, or sell, transfer or lease any property or services to, any affiliate of Adience, except for any such transactions between Adience and Adience's subsidiaries and except for such transactions on prices and terms no less favorable than would have been obtained in an arm's length transaction with a non-affiliated person; or (b) make any payment of management or other fees or of the principal amount of or interest on any indebtedness owing to any shareholder, officer, director or affiliate of Adience, except, that Adience and any subsidiary may make such payments to Adience or a subsidiary, as the case may be, when due. Dividends. Adience may not, and may not permit any subsidiary to, directly or indirectly, during any fiscal year, declare or pay any dividends on account of any shares of any class of capital stock of Adience or its subsidiary now or hereafter outstanding, or set aside or otherwise deposit or invest any sums for such purpose, or redeem, retire, defease, purchase or otherwise acquire any shares of any class of capital stock (or set aside or otherwise deposit or invest any sums for such purpose) for any consideration other than stock or apply or set apart any sums, or make any other distribution (by reduction of capital or otherwise) in respect of any such shares or agree to do any of the foregoing, except, that, dividends may be declared and paid to Adience by its subsidiaries on any class of capital stock or any other interest in, or measured by its profit, owned by Adience or any subsidiary of Adience, in each case out of legally available funds therefore and otherwise in accordance with applicable law. Capital Expenditures. (a) Adience may not, and may not permit any subsidiary to, in the aggregate for all of them, directly or indirectly, expend or commit to expend, capital expenditures in excess of $6,500,000 in any fiscal year of Adience, excluding capital expenditures paid under existing leases; and (b) Adience may not, directly or indirectly, expend or commit to expend, capital expenditures in excess of $4,000,000 in any fiscal year of Adience, excluding capital expenditures paid under existing leases. IDT is subject to a capital expenditure limit of $2,500,000 in any fiscal year, excluding capital expenditures paid under existing leases. Real Property. Adience may not, and may not, permit any subsidiary to sell, lease (as lessor) transfer, or otherwise dispose of any of its or their, as the case may be, real property or any interest therein. As of December 31, 1993, Adience and IDT were in compliance with the covenants of their respective agreements. Adience's ability to continue to comply with such conditions is dependent upon Adience's ability to achieve specified levels of sales, profitable operations and borrowing availability. Waivers or amendments may be required in the future. Inability to achieve compliance could affect Adience's access to further borrowings or require it to secure additional capital by other means. Both Adience and IDT anticipate that the financing agreements with Congress will be renewed at June 30, 1994 or, alternatively, both companies will be able to secure financing from other sources. However, no commitment letters have been requested or received. Long-term liquidity is dependent upon the Company's ability to operate profitably and generate cash flow following favorable changes made to its capital structure and the restructuring of its management structure. Adience's New Senior Notes are due in June 2002, and may not be redeemed at the option of Adience prior to December 15, 1997. Adience has not yet formulated plans to meet these long-term debt requirements. The Indenture under which the New Senior Notes were issued contains restrictive covenants similar to those included in the financing agreements with Congress, and additionally limits the use of cash proceeds from the sale of Adience's assets. The Indenture provides that Adience may not make any asset sale outside of the ordinary course of business unless (i) such asset sale is for fair value and (ii) at least 50% of the consideration therefor received by Adience is in the form of cash and/or cash equivalents. In the case of the sale by Adience of all or substantially all of the stock of IDT or any other asset for which the gross cash proceeds exceed $2 million, Adience is required, within 180 days after the receipt of the net cash proceeds of such asset sale, to make an offer to repurchase the New Senior Notes at a price equal to 100% of the principal amount of the New Senior Notes plus accrued interest thereon. In addition, a default on the Congress financing agreement will result in a default under the Indenture. Both internal and external factors are material to the Company's long-term liquidity. External factors include general economic conditions, the performance of the steel industry and spending by public school systems. Long- term liquidity is dependent upon the Company's ability to control costs during periods of low demand so as to sustain positive cash flow from operations. The Company, even after the Reorganization, continues to operate with a significant amount of interest-bearing debt. Should additional financing be needed, the Company's access to new sources of capital or the amount of available and unused lines of bank credit may be limited. As more fully described under "BUSINESS -- Legal Proceedings," in February 1992, IDT was cited by the Ohio Environmental Protection Agency (the "Ohio EPA") for violations of Ohio's hazardous waste regulations, including speculative accumulation of waste and illegal disposal of hazardous waste on the site of its Alliance, Ohio Facility. IDT had $1,106,000 accrued at December 31, 1992 for the clean-up of this site. In December 1993, IDT and Adience signed a consent order with the Ohio EPA and Ohio Attorney General which required IDT and Adience to pay to the State of Ohio a civil penalty of $200,000 (of which IDT paid $175,000 and Adience paid $25,000). In addition, the consent order requires the payment of stipulated penalties of up to $1,000 per day for failure to satisfy certain requirements of the consent order including milestones in the closure plan. IDT expects that the work to be conducted under the closure plan will be substantially completed in 1994, subject to IDT receiving all necessary approvals from the Ohio EPA. At December 31, 1993, environmental accruals amounted to $783,000 which represents management's reasonable estimate of the amounts remaining to be incurred in this matter, including the costs of effecting the closure plan, bonding and insurance costs, penalties and legal and consultants' fees. Since 1991, Adience and IDT have together paid $341,000 (excluding the civil penalty) for the environmental clean-up related to the Alliance facility. Under the acquisition agreement pursuant to which IDT acquired the property from Adience, Adience represented and warranted that, except as otherwise disclosed to IDT, no hazardous material has been stored or disposed of on the property. No disclosure of storage or disposal of hazardous material on the site was made, accordingly, Adience is required to indemnify IDT for any losses in excess of $250,000. IDT has notified Adience that it is claiming the right to indemnification for all costs in excess of $250,000 incurred by IDT in this matter, and has received assurance that Adience will honor such claim. Adience has reimbursed IDT $196,000; if Adience is financially unable to honor its remaining obligation, such costs would be borne by IDT. Item 8.

846972

1993

Item 6. SELECTED FINANCIAL DATA Selected financial data for each of the Company's five most recent fiscal years, set forth in the Company's 1993 Annual Report under "Review of Operations - Selected Financial Data (unaudited)," at page 21 (page 15 of Exhibit 13), are incorporated herein by reference. Item 7.

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Management's discussion and analysis of results of operations and financial condition, set forth in the Company's 1993 Annual Report under "Review of Operations - Operating Results" (pages 9-13), "Review of Operations - Financial Condition" (pages 13 and 16), and "Review of Operations - Environmental and Legal Matters" (page 16) (together, pages 1-7 of Exhibit 13), is incorporated herein by reference. Item 8.

59478

1993

5550

1993

743443

1993

Item 6. SELECTED CONSOLIDATED FINANCIAL DATA. Included in the First Mortgage Bond sinking fund payments and retirements amount for 1997 is $130 million of First Mortgage Bonds, Series T, which mature January 15, 1997. The Utility anticipates that it will refinance these bonds and the Secured Debentures due in 1999 through the issuance of additional First Mortgage Bonds or other debt securities, and/or the receipt of common equity from TNPE. The Utility does not need additional Available Additions (described below under "Capital Resources") in order to issue First Mortgage Bonds for the purpose of refunding outstanding First Mortgage Bonds. As a result of the assumption of the financing facilities for Unit 1 and Unit 2 in 1990 and 1991, respectively, and related refinancings, the Utility's capital structure consisted of 75.2% debt, 23.7% common equity and 1.1% preferred stock at December 31, 1993. Prior to 1990, the Utility's capital structure contained less than 50% debt. The Utility's long-term goal is to strive for a conservative capital structure with a debt ratio of less than 50%. Capital Resources At any time, the Utility's ability to access the capital markets on a reasonable basis or otherwise obtain needed financing for operating and capital requirements is subject to the receipt of adequate and timely regulatory relief and market conditions. The Utility's ability to access the capital markets at reasonable costs will specifically be impacted by the ultimate resolution of (1) the amount of rate relief granted for Unit 1 and Unit 2, (2) the contested disallowances of up to $40.3 million and $21.1 million of the costs of Unit 1 and Unit 2, respectively, and (3) the adverse PUCT ruling concerning the treatment of the Federal income tax component of the Utility's cost of service. In addition to the aforementioned Unit 2 financing facility, the Utility's external sources for acquiring capital are outlined below: First Mortgage Bonds. Assuming an interest rate of 9.25% and satisfactory market conditions, based upon December 31, 1993 financial information, the Utility could have issued approximately $59 million of additional First Mortgage Bonds under the Interest Coverage Ratio requirement. With certain exceptions, the amount of additional First Mortgage Bonds that may be issued is also limited by the Bond Indenture to a certain amount of physical properties which are to be collateralized by the first lien mortgage of the Bond Indenture (Available Additions). Because of the issuance of the New Bonds in September 1993, the Utility has limited ability to issue additional First Mortgage Bonds until more Available Additions are provided upon further repayment of amounts under the financing facilities. Secured Debentures. The indenture, under which the Series A Secured Debentures were issued, permits, generally, the issuance of additional secured debentures to the extent that the proceeds from such issuance are used to purchase an equal amount of loans under the Unit 1 and Unit 2 financing facilities. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES Preferred Stock. Due to interest and dividend coverage tests required for issuance of its preferred stock, the Utility cannot presently issue any preferred stock. The Utility does not expect to have the ability to issue preferred stock through 1996. Receipt of Common Equity One source for repayment of the Unit 2 financing facility is anticipated to be the receipt of common equity from TNPE. Receipt of future equity contributions by the Utility from TNPE will be largely dependent upon TNPE's ability to issue common stock. Since most of the assets, liabilities and earnings capability of TNPE are those of the Utility, the ability of TNPE to issue common stock and pay dividends will be largely dependent upon the Utility's operations and the Utility's restrictions regarding payment of cash dividends on its common stock. The Utility may not pay dividends on its common stock unless all past and current dividends on outstanding preferred stock of the Utility have been paid or declared and set apart for payment and all requisite sinking or purchase fund obligations for the preferred stock of the Utility have been fulfilled. Charter provisions relating to the preferred stock and the Bond Indenture under which First Mortgage Bonds are issued contain restrictions regarding the retained earnings of the Utility. At December 31, 1993, pursuant to the terms of the Bond Indenture, approximately $12.8 million of the Utility's $38.9 million of retained earnings was restricted. In addition, the financing facilities place certain restrictions on the Utility's ability to pay dividends on its common stock, unless certain threshold tests are met. The Utility has satisfied the threshold tests since they became effective, and the Utility does not expect that any of the aforementioned contractual restrictions on the payment of dividends will become operative in 1994. However, the Utility can give no assurance that the Utility will satisfy such tests in the future. The Utility's 1993 common stock dividends of $17.3 million exceeded 1993 earnings available for common stock of $10.6 million; however, the Utility's retained earnings were sufficient to allow the dividends to be paid. Contributing to the low-level of earnings in 1993 were the lower rates from the December 1992 adverse ruling of the PUCT regarding the Utility's Federal income tax component in its cost of service and significant interest charges. As discussed in "Net Earnings" under "Results of Operations", management has implemented cost saving measures during 1993 and is seeking equitable regulatory treatment in efforts to improve future results of operations. Cash dividend payments are subject to approval of the Board of Directors and are dependent, especially in the longer term, on the Utility's and TNPE's future financial condition and adequate and timely regulatory relief, including favorable resolution of pending judicial appeals of rate cases. Other Matters Accounting for Postretirement Benefits On January 1, 1993, the Utility implemented Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions," which addresses the accounting for other postretirement employee benefits (OPEBs). For the Utility, OPEBs are comprised primarily of health care and death benefits for retired employees. Prior to 1993, the costs of these OPEBs were expensed on a "pay-as-you-go" basis. Beginning in 1993, SFAS 106 requires a change from the "pay-as-you-go" basis to the accrual basis of recognizing the costs of OPEBs during the periods that employees render service to earn the benefits. The 1993 accrual for OPEBs of $2,952,000, based on adoption of SFAS 106, was $2,276,000 greater than the amount that would have been recorded under the "pay- as-you-go" basis. In March 1993, the PUCT issued its rules for ratemaking treatment of OPEBs. As part of a general rate case, a utility may request OPEBs expense in cost of service for ratemaking purposes on an accrual basis in accordance with generally accepted accounting principles. The PUCT's rule requires that the amounts included in rates shall be placed in an irrevocable external trust fund dedicated to the payment of OPEBs expenses. Based on the PUCT's rule, the Utility intends to seek recovery of OPEBs expense attributable to its Texas jurisdiction in its next Texas rate case. In order to comply with the PUCT's condition for possible recovery of OPEBs expenses, the Utility established in June 1993 a Voluntary Employees' Beneficiary Association (VEBA) trust fund, dedicated to the payment of OPEBs expenses. Monthly cash payments made to the VEBA, which began in June 1993, will fund OPEBs costs for the Utility's Texas and New Mexico operations. See note 1(j) to the consolidated financial statements for information about the funded status of the plan. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES On August 23, 1993, the Utility filed a rate application with the NMPUC which included a request for recovery of the applicable costs of OPEBs. A stipulated agreement among the parties to the proceeding, dated January 28, 1994, subject to approval by the NMPUC, would include such applicable costs in the proposed New Mexico rates, beginning in 1994. For future periods, the costs of OPEBs will be affected by changes in the assumed interest rate and the trends in health care costs; based on actuarial assumptions, national health care costs are expected to increase in the future, resulting in further increases in the Utility's costs. Accounting for Income Taxes On January 1, 1993, the Utility implemented Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes." The implementation of SFAS 109 did not result in any significant charge to operations. See note 4 to the consolidated financial statements for details relating to the implementation of SFAS 109. Accounting for Postemployment Benefits The FASB has issued Statement of Financial Accounting Standards No. 112 (SFAS 112), "Employers' Accounting for Postemployment Benefits" which addresses the accounting and reporting for the estimated costs of benefits provided by an employer to former or inactive employees after employment but before retirement. SFAS 112 is effective for fiscal years beginning after December 15, 1993. The Utility estimates such costs to be immaterial. Effects of Inflation The Utility does not believe that the effects of inflation, as measured by the Consumer Price Index over the last three years, have had a material impact on the Utility's consolidated results of operations and financial condition. Tax Law Change The Omnibus Budget Reconciliation Act of 1993 was signed into law on August 10, 1993. Beginning in 1994, the act provides for the disallowance of certain business deductions, the effect of which is not expected to be material for the Utility. The act also provided, effective January 1, 1993, for a corporate income tax rate increase from 34% to 35% to be phased in for taxable income between $10 million and $18 million. Results of Operations The following table sets forth the percentage relationship of items to operating revenues in the consolidated statements of earnings: TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES Operating Revenues Operating revenues for 1993 and 1992 reflect increases of $30,415,000 and $2,484,000 over the respective prior years. The following table presents the components of the changes in operating revenues: Base operating revenues are affected primarily by changes in base rates resulting from regulatory commission orders and the effects of variations in sales between customer classifications. The significant increase in base operating revenues for 1992 was primarily attributable to bonded rates for Docket No. 10200 being placed into effect in October 1991. The PUCT's final order approving these rates was received on October 16, 1992 and subsequently was amended by the PUCT in an Order on Rehearing on December 22, 1992. The result of this Order on Rehearing was to lower the previously approved increase in annualized revenues by approximately $7 million, from $26 million to approximately $19 million. The PUCT later increased, subject to refund, the annualized revenues by an additional $1.6 million. Because the increase continued to be subject to a possible refund, no additional revenues were recognized in 1992 or 1993 and such amounts were included in revenues subject to refund in the consolidated balance sheets. For more information regarding Docket No. 10200, see note 5 to the consolidated financial statements. Purchased power costs are recovered through cost recovery factor clauses in both Texas and New Mexico. Fuel costs are recovered through a fixed fuel factor approved by the PUCT. Recoveries of purchased power and fuel costs are discussed further in "Operating Expenses." Customer usage increased in 1993 due to a 3.6% increase in kilowatt- hour (KWH) sales to residential, commercial and industrial customers. The residential usage increase related to an increase in the number of residential customers and warmer temperatures in the Texas service areas; in 1992, milder than normal weather was experienced in the Texas service areas. Commercial usage increased in the Utility's Texas service areas as the result of general retail development in the Northern Division and Southeast Division and the addition of a greyhound race track in the Southeast Division. During 1993, the number of industrial customers decreased by 14, but that decrease included the consolidation of 10 customers into 2 customers for billing purposes and the reclassification of 3 customers to the commercial class of customers. The industrial usage increase in the Utility's New Mexico service area resulted from increased consumption of an existing mining customer and the addition of a new mining customer. The 1992 decrease in customer usage primarily reflected a 5.46% KWH sales decline. Part of the decrease in customer usage was attributable to the milder than normal temperatures experienced in Texas during 1992. Also contributing to the sales decline was the failure of new customers and revenues to materialize as expected within the industrial class to ameliorate the loss of KWH sales to certain industrial customers. From time to time, industrial customers of the Utility express interest in cogeneration as a method of reducing or eliminating reliance upon the Utility as a source of electric service, or to lower fuel costs and improve operating efficiency of process steam generation. During 1993, a major industrial customer in the Utility's Southeast Division requested proposals for a cogeneration project for evaluation by the customer. The Utility's operating revenues from this customer during 1993 were approximately $28 million. In January 1994, a potential developer for the proposed project was selected by the customer. The Utility's goal is to retain this customer and to lower overall system operating costs through coordination with the potential developer. Although the Utility cannot predict the ultimate outcome of the process, the current project as proposed by the customer, and as outlined by the potential developer, appears to present a means by which the Utility may retain electric service to this customer, at current levels. The Utility is actively pursuing the development of the necessary agreements with the potential developer to further define the degree to which electric service to this customer is retained and overall system operating costs may be lowered. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES For information relating to actual KWH sales, number of customers, and revenues, see Item 1, "Financial Information about Industry Segments." Operating Expenses As a regulated entity, the Utility must demonstrate to the regulatory commissions in its rate filings that its requests for recovery of operating expenses to provide service to its customers are reasonable and necessary. In order to provide reliable service to its customers at reasonable rates, management endeavors to control costs through budgeting and monitoring of operating expenses. Commencement of commercial operations of Unit 1 in September 1990 and Unit 2 in October 1991 led to increases in certain expenses and interest charges over prior years; however, the Utility experienced decreases in the potential cost of power purchased for resale as a result of the operations of Unit 1 and Unit 2. The 1993 and 1992 levels of expenses each reflect a full year's operations of both units. Variances in expenses from 1991 to 1992 due to a partial year's operation of Unit 2 in 1991 are noted in the following discussion. Power Purchased for Resale Factors affecting the expense of power purchased for resale are (1) the number of KWH purchased from suppliers, (2) the cost per KWH purchased, (3) the recovery or refund of prior under- or over-collections, respectively, of purchased power costs (deferred purchased power costs), and (4) occasional fuel cost refunds from the Utility's suppliers. The Utility's policy regarding the accounting for deferred purchased power costs is discussed in note 1(g) to the consolidated financial statements. Power purchased for resale increased $25,926,000 in 1993, and a decrease of $42,561,000 was experienced in 1992. The increase in purchased power expense for 1993 was mainly due to an increase in the average cost of KWH purchased from suppliers. Information concerning the Utility's suppliers is disclosed in Item 1 under "Sources of Energy." Also contributing to the increase in 1993 was an increase in the number of KWH purchased as a result of increased customer usage, discussed under "Operating Revenues." The decrease in 1992 resulted from a decline in the number of KWH purchased. This KWH decrease was caused by the replacement of purchased power with a full year's generation of Unit 2 of TNP One and the decrease in customer usage, discussed under "Operating Revenues." Partially offsetting the effect of this reduction in the number of KWH purchased in 1992 was an increase in the recovery of deferred purchased power costs. As in 1992, the 1993 level of KWH purchases reflects a full year's generation of TNP One; therefore, KWH purchases for 1993 and 1992 are comparable in this respect. No significant changes in KWH purchased resulting from TNP One's operations are expected in the future. While costs per KWH from purchased power suppliers are not directly controllable, wholesale rates charged by various suppliers are subject to regulatory authority. The Utility has intervened and will continue to intervene in suppliers' rate cases for the purpose of assuring fair and equitable costs to its customers. Fuel Fuel expense decreased $629,000 in 1993, as compared to an increase of $19,204,000 in 1992. The decrease in recovery of fuel costs for 1993 resulted from a slightly lower fuel cost recovery factor than that utilized in 1992. These differing fuel factors resulted from using a factor related to bonded rates in 1992 which was adjusted downward in 1993 to comply with the final order in Docket No. 10200. The large increase in 1992 was related to a full year's commercial operation of both Unit 1 and Unit 2. Fuel expense primarily represents the recovery of fuel costs through a fixed fuel factor set by the PUCT. The fixed fuel factor is intended to permit the Utility to recover the cost of fuel utilized to generate electricity sold in Texas. The factor may be changed only upon approval of the PUCT and is expected to be adjusted for any cumulative under- or over-recovery of fuel costs. At December 31, 1993, the Utility had under-recovered fuel costs, including interest, of approximately $13.6 million related to both units of TNP One. Any requests to the PUCT for recovery of fuel costs require the Utility's demonstration that the costs were reasonable. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES Beginning in 1993, a filing with the PUCT for a reconciliation of fuel costs is required if for any given period of time there is an over- or under-recovery of fuel costs of at least 4% of revenues. Under the PUCT's rules, the months in which utilities may initiate fuel reconciliation proceedings are specified; for the Utility, these months are June and December. In the event of an over- or under-recovery of fuel costs less than the 4% threshold, a filing to adjust the fuel factor may be made at the discretion of management. The Utility expects to file a fuel reconciliation with its next Texas rate application during the first half of 1994. Management will continue to monitor its fuel cost recovery to determine the need to request a change in its fixed fuel factor. For a discussion of the fuel supply agreement for TNP One, see "Other TNP One Matters" under "Financial Condition." Other Operating and General Expenses and Maintenance Other operating and general expenses decreased $597,000 in 1993 after an increase of $4,716,000 in 1992. The 1993 decrease represents primarily decreases in employee pension and thrift benefits and payroll costs which were offset somewhat by an increase in employee postretirement medical costs resulting from implementation of SFAS 106. The decrease in the employee benefits for 1993 was due to an amendment to the pension plan and the curtailment of employer thrift plan contributions on January 1, 1993. Payroll costs declined due to a 3.2% reduction in the number of employees. The increase in other operating and general expenses for 1992 was due primarily to additional wheeling costs which were incurred for a full year's transfer of power generated by Unit 2 and to amortization of previously deferred rate case expenses. Wheeling costs are incurred for the transfer of TNP One power over other utilities' transmission systems for delivery to the Utility's Texas systems. The years 1993 and 1992 reflected wheeling costs for both Unit 1 and Unit 2; therefore, any future changes in this level of expense would be the result of changes in monthly wheeling charges. Regarding deferred rate case expenses, a full year's amortization was reflected in both 1993 and 1992, making them comparable in this respect; in 1994, another year's amortization remains for the deferred rate case expenses. As previously discussed under "Financial Condition," implementation of SFAS 106 may lead to additional costs in the future. Other operating and general expenses will be affected in 1994 because of a 3% cost-of-living payroll adjustment for full-time employees effective January 10, and the restoration of employer thrift plan contributions scheduled to resume beginning July 1. Since the last cost-of-living payroll adjustment granted to the Utility's employees was in 1991, these changes were made to maintain the level of experienced personnel necessary for providing quality service to the Utility's customers. No significant variances have occurred in maintenance expense over the last three years. Maintenance outages are scheduled in the first and fourth quarters of 1994 for Unit 2 and Unit 1, respectively. Since prior years reflect expenses for past scheduled outages of the units, no significant increase in maintenance expense is anticipated in 1994. Depreciation of Utility Plant Depreciation expense increased $917,000 and $7,071,000 in 1993 and 1992, respectively. The 1993 increase was related to normal additions to utility plant while the large increase in 1992 reflects a full year's expense for Unit 2 and Unit 1. Future increases in depreciation would be the result of normal utility plant additions and regulatory approvals of changes in depreciation rates as supported by required periodic independent studies. Taxes, Other Than On Income Taxes, other than on income increased $1,046,000 and $5,462,000 in 1993 and 1992, respectively. The 1993 increase related primarily to an increase in revenue-related taxes which resulted from increased revenues upon which the taxes are based. The increase in 1992 was primarily related to an increase in property-related taxes resulting from (1) a full year's expense related to Unit 2 as compared to only a partial year in 1991 and (2) increases in the property tax rates in Texas. Income Taxes Income taxes increased $2,397,000 in 1993 after a decrease of $5,963,000 in 1992. The increase in 1993 resulted from an increase in earnings over 1992, a decline in the regulatory-ordered amortization of excess deferred taxes, and an increase in Federal income tax rates. Income taxes decreased in 1992 due to the decline in net earnings compared to 1991. For the years 1993, 1992 and 1991, the Utility incurred tax net operating losses due to accelerated tax depreciation deductions and increased interest charges on debt related to TNP One and subsequent refinancings; however, payments of current income taxes were required based on minimum tax (MT) requirements. To the extent that the Utility is subject to MT requirements and limitations on the utilization of available credits, payments of current Federal income taxes are expected to be required in 1994. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES As discussed in "Accounting for Income Taxes" under "Financial Condition," implementation of SFAS 109 did not result in any significant charge to earnings. For more information regarding the Utility's income taxes, see note 4 to the consolidated financial statements. As with all areas of the Utility's cost of service, recovery of income tax expenses is expected in rates charged to customers. However, as discussed in "PUCT Docket No. 10200" under "Financial Condition," uncertainties exist with respect to the Utility's Federal income tax expense component of cost of service. The Utility is pursuing reversal of the PUCT's adverse decisions. Other Income, Net of Taxes Other income, net of taxes increased in 1992 by $1,290,000 primarily because of interest earned on short-term investments, principally repurchase agreements and government money trusts, during the year. Considerable cash was used in 1993 to make optional payments under the Unit 2 financing facility thereby reducing cash available for the aforementioned investments. This contributed to the decrease of $901,000 in 1993. Interest Charges Total interest charges decreased slightly by $342,000 in 1993 after an increase of $24,723,000 in 1992. The slight decrease in interest on long-term debt in 1993 was the net result of several transactions. Decreases in 1993 expense resulted from (1) redemption of Series G First Mortgage Bonds at maturity on July 1, 1993, (2) redemption of Series H, I, J and K First Mortgage Bonds to permit issuance of Series U First Mortgage Bonds and (3) prepayments made under the Unit 1 and Unit 2 financing facilities. Partially offsetting these decreases in interest on long-term debt were the issuances of Series U First Mortgage Bonds and Series A Secured Debentures in September 1993. Interest on long-term debt increased in 1992 due to the issuance in January 1992 of $130 million of 11.25% Series T First Mortgage Bonds and $130 million of 12.50% Secured Debentures, due in 1999. The Utility used $194 million of the proceeds from the issuance to retire a portion of the Unit 1 and Unit 2 financing facilities, as was required for extended payment dates under the amended terms of the financing facilities. The notes payable under the financing facilities had lower interest rates than the new securities. Interest charges also increased in 1992 due to the debt for Unit 2 being outstanding for a full year as compared to a partial year in 1991. In 1994, the full effects of the 1993 redemptions and new issuances are expected to result in a net increase in interest on long-term debt. Any changes in the interest rates or balances related to the Unit 2 financing facility in 1994 will also have an effect on long-term debt interest. Other interest and amortization of debt discount, premium and expense for 1993 reflects a fourth quarter amortization of debt expense associated with the issuances of Series U Bonds and Series A Secured Debentures and further amendments to the Unit 1 and Unit 2 financing facilities; therefore, an increase in this expense can be expected in 1994 due to a full year's amortization. In 1993, other interest included interest on the provision for a refund of bonded revenues billed in excess of the amounts allowed under Docket No. 10200. Other interest and amortization of debt discount, premium and expense increased during 1992 primarily as the result of the issuances of the Series T Bonds and Secured Debentures, due 1999 discussed above, as well as the amortization of expenses related to the amendments of the Unit 1 and Unit 2 financing facilities. Other interest expense increased due to the accrual of interest on the provision for a refund of bonded revenues billed in excess of the amounts allowed in Docket No. 10200. Partially offsetting these increases was a decrease in interest on unsecured notes payable to banks. The Utility utilized a portion of the proceeds from the issuance of the Series T Bonds and Secured Debentures, due 1999 to retire $26 million of unsecured notes payable to banks. The remaining $10 million portion of such notes was retired in August 1992. Allowance for borrowed funds used during construction (AFUDC) decreased in 1992 when compared to 1991 because Unit 2 was placed in commercial operation on October 16, 1991. AFUDC for 1991 reflected primarily the qualified capitalization of interest on the financing facility for Unit 2 from the date of assumption (July 26, 1991) until the date Unit 2 began commercial operation. Receipt of equity contributions and proceeds from future issuances of debt securities are anticipated to help satisfy the scheduled repayments of the Unit 2 financing facility. Interest rates on debt securities are expected to be greater than those interest rates under the financing facility. Interest rates on additional debt may be further increased if the Utility's outstanding regulatory matters are not satisfactorily resolved. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES Net Earnings Net earnings increased $678,000 in 1993 after a significant decline of $8,995,000 in 1992. The decline of net earnings in 1992 was due primarily to (1) the decrease in customer usage as discussed in "Operating Revenues," (2) the PUCT's abandonment of its long-standing methodology for determination of the Federal income tax expense component of cost of service in the PUCT's Order on Rehearing in Docket No. 10200 and (3) the increases in interest expense. The slight increase in 1993 resulted from increased KWH sales, the effect of which was reduced by increases in depreciation expense, taxes, other than on income and income taxes and a decrease in other income as previously discussed. The level of 1993 net earnings also reflects the adverse tax ruling by the PUCT, discussed above in "PUCT Docket No. 10200" under "Financial Condition." Early in 1993, the Utility implemented cost saving measures such as (1) suspension of the Utility's matching contributions to the employees' thrift plan, (2) revision to the Utility's pension plan and (3) implementation of a general employee salary and wage freeze and limitations on hiring new employees and replacements. These cost saving measures more than offset the increase in expenses related to the health care and death benefits plans resulting from implementation of SFAS 106. With the exception of the Utility's wage-step progression increases reactivated in April 1993, these measures continued in effect throughout 1993. The Utility reduced its labor force by 3.2% during 1993, trimming $1.1 million from operations and maintenance expenses. Even so, the Utility's return on common equity for 1993 and 1992 was 4.97% and 4.80%, respectively, although the Utility's rate of return granted in Docket No. 10200 authorized a return on common equity of 13.16%. Based on the Utility's earnings for 1993 and 1992 and the expected increases in interest on long-term debt and certain other expenses, equitable rate relief in Texas appears to be necessary for any significant improvement in financial results to occur during 1994. Future regulatory treatment and court decisions regarding Docket Nos. 9491 and 10200, as previously discussed, will have a direct bearing on future earnings. TEXAS-NEW MEXICO POWER COMPANY AND SUBSIDIARIES Item 8.

22767

1993

Item 6. Selected Financial Data (in thousands, except per share amounts) The selected financial information presented below has been derived from the audited consolidated financial statements of the Company for each of the years ended December 31, 1989 through December 31, 1993. The information presented 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 thereto appearing elsewhere in this document. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations Interest Expense for the Year Ended December 31, 1993 and the Year Ended December 31, 1992 Compared with the Year-Earlier Periods Effective June 30, 1992, the Company refinanced approximately $100 million of the Senior Secured Notes ("Old Debt"), bearing a weighted average annual interest rate (based on stated rate under the indenture for the Old Debt) at June 30, 1992 of 12.8%, with approximately $100 million borrowed under a bank-financed credit facility (the "Old Credit Facility"), with a floating rate of interest (6.5% at December 31, 1992 on a weighted average basis). The Old Debt was accounted for in conformity with Financial Accounting Standards Board (FASB) Statement No. 15, "Accounting by Debtors and Creditors for Troubled Debt Restructurings," which under certain conditions prescribes the calculation of interest for financial reporting purposes. Application of FASB Statement No. 15 rules had the effect of reducing reported interest expense for the year ended December 31, 1992 by $5.9 million. Upon refinancing of the Old Debt, the required application of FASB Statement No. 15 rules to interest expense was eliminated. On July 28, 1993, the Company issued $100 million aggregate principal amount of 10 percent senior subordinated notes due July 2003 (the "Notes") and on July 29, 1993 amended and restated its senior secured credit facility (the "Credit Facility") with a syndicate of commercial bank lenders (the "Lenders") increasing the total facility to $122.5 million. Interest expense increased $5.5 million or 58.5% for the year ended December 31, 1993. The increase was principally due to the previously discussed effect of the application of FASB Statement No. 15 rules decreasing interest expense in the first half of 1992 and, to a lesser extent, the issuance of the Notes in July 1993. On a pro forma basis, interest expense for the year ended December 31, 1993, assuming the 1992 refinancing and 1993 Notes issuance occurred on January 1, 1992, was $17.3 million versus pro forma 1992 interest expense of $16.8 million. Pro forma income before extraordinary item for the year ended December 31, 1993 and 1992 assuming the 1992 refinancing and 1993 Notes issuance occurred on January 1, 1992, would have been $11.3 million or $.39 per share and $8.8 million or $.31 per share, respectively. See footnote 2 to the Company's consolidated financial statements for the year ended December 31, 1993 included in Item 8.

738339

1993

Item 6. Selected Financial Data The information set forth under the caption "Selected Financial and Other Data" on page 17 the 1993 Annual Report of the Registrant is incorporated by reference herein. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 16 and 17 of the 1993 Annual Report of the Registrant is incorporated by reference herein. Item 8.

29854

1993

ITEM 6: SELECTED FINANCIAL DATA ITEM 7:

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SELECTED RELATIONSHIPS WITHIN THE CONSOLIDATED STATEMENTS OF INCOME RESULTS OF OPERATIONS: 1993 Compared to 1992 Sales increased 5% in 1993, to $554.7 million. The increase in sales was primarily due to a 13% increase in sales of semiconductor test systems and, to a lesser extent, a 7% increase in sales of backplane connection systems. Sales of semiconductor test systems increased as semiconductor manufacturers added capacity in response to rising demand for their products. Sales of circuit-board test systems and telecommunications systems declined 7% and 18%, respectively, in 1993 compared to 1992. Incoming orders increased 19% in 1993 to $625.0 million over 1992 with increased orders occurring in each of the Company's major groups. The Company's backlog grew during 1993 to $288.0 million. Income before taxes increased by $25.3 million from 1992 to 1993 on a sales increase of $25.2 million as the Company continued to control the growth in its operating expenses. In addition, costs in 1993 were lower in the Company's circuit-board test operations following actions taken by the Company in 1992 to consolidate those operations. These lower costs helped to offset the impact of the reduced sales of circuit-board test systems. Cost of sales decreased from 59% of sales in 1992 to 57% in 1993. While sales increased in 1993, the fixed and semi-variable components of cost of sales decreased as a result of the Company's cost reduction programs. The changes in engineering and development expenses and selling and administrative expenses were each less than 1% in 1993, compared to 1992. These expenses have essentially remained at their current level since 1991, as the Company has controlled the growth of its fixed costs. Interest income increased 44% in 1993 as a result of a $76.2 million increase in the Company's cash and cash equivalents balance during the year. Interest expense decreased 12% in 1993 primarily as a result of the Company's retirement of its 9.25% outstanding convertible subordinated debentures in the fourth quarter. The Company's effective tax rate increased from 13.5% in 1992 to 30% in 1993. The Company had been able to utilize net operating loss carryforwards to lower its United States taxable income for financial reporting purposes in 1992, while in 1993 those carryforwards were no longer available. However, the Company's tax rate in 1993 was below the United States statutory rate of 35%, as a result of the utilization of tax credit carryforwards and foreign net operating loss carryforwards. There continue to be tax credit carryforwards and foreign net operating loss carryforward amounts which will lower the Company's prospective tax rate if utilized. The Company adopted Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" at the beginning of 1993. The effect of this change in accounting principle was not material to the Company's consolidated financial position. See "Note K: Income Taxes" in Notes to Consolidated Financial Statements. In connection with the retirement of the Company's outstanding 9.25% convertible subordinated debentures, the Company incurred, in the fourth quarter of 1993, an extraordinary charge of $0.7 million, net of income taxes, for the costs of the redemption premium of 3.7% and the write off of unamortized debt issuance costs. 1992 Compared to 1991 Sales increased 4% in 1992, to $529.6 million. The sales increase was primarily due to a 13% increase in sales of semiconductor test systems over 1991 and, to a lesser extent, a 7% increase in sales of connection systems. Offsetting the increased sales were reduced sales of circuit-board test systems and telecommunications systems which were down 12% and 5%, respectively. The Company believes that the over-all market for semiconductor test systems declined in 1992 and that, the increase in sales represents market-share growth. The decline in sales of circuit-board test systems was primarily due to a decrease in demand from U.S. government defense contractors. During the year, the Company decided to concentrate its efforts in Electronic Design Automation (EDA) on software products for test generation and design verification. This decision led to the closing of the EDA operation in Santa Clara, California and the consolidation of the EDA operation in Boston, Massachusetts with the circuit-board test division. The Company also decided to move the circuit-board assembly operation in Walnut Creek, California to the central circuit-board assembly operation in Boston. Cost of sales increased as a percent of sales from 58% to 59%. This increase was due to the fact that, while the Company reduced its overhead associated with circuit-board test systems and telecommunications systems, it did not reduce such expenses proportionately with the reduction in sales of these two product lines. Engineering and development expenses were essentially unchanged in 1992, while the amount of selling and administrative expenses increased less than 1% as the Company controlled the growth of these expenses. Interest income increased 78% in 1992 to $2.5 million due to an increase in the Company's cash and cash equivalents balance beginning in the second half of 1991. Cash had grown by $63.8 million from June 29, 1991 to December 31, 1992. Interest expense decreased 21% in 1992 due to a reduction in the average level of debt outstanding during the year and lower average short-term interest rates. The Company's effective tax rate increased from 10% in 1991 to 13.5% in 1992. At the end of 1992, the Company had utilized all of its available U.S. Federal net operating loss carryforwards for financial reporting purposes. LIQUIDITY AND CAPITAL RESOURCES The Company's cash balance increased by $76.2 million in 1993, following an increase of $32.0 million in 1992. Cash flow generated from operations was $91.8 million in 1993 and $40.7 million in 1992. Additional cash of $33.6 million in 1993 and $15.7 million in 1992 was generated from the sale of stock to employees under the Company's stock option and stock purchase plans. In 1992, cash of $3.2 million was also raised from a bank note to finance future construction of a plant in Kumamoto, Japan. Cash was used to fund additions to property, plant and equipment of $32.2 million in 1993 and $28.2 million in 1992. The Company also used $14.7 million of its cash to retire outstanding debt and $2.3 million to purchase stock from its shareholders pursuant to the Company's open market stock repurchase program. The debt retirement included $10.8 million for the repurchase of the outstanding convertible debentures and a cash payment of $3.2 million for the exercise of a purchase option on the Company's headquarters building in Boston, Massachusetts. The Company believes its cash and cash equivalents balance of $143.6 million, together with other sources of funds, including cash flow generated from operations and available borrowing capacity of $80.0 million under its line of credit agreement, will be sufficient to meet future working capital and capital expenditure requirements. Inflation has not had a significant long-term impact on earnings. If there were inflation, the Company's efforts to cover cost increases with price increases would be frustrated in the short term by its relatively high backlog. ITEM 8:

97210

1993

ITEM 6. SELECTED FINANCIAL DATA _______________________________ (1) The information in this Item should be read in conjunction with Armco's financial statements and the Notes thereto, which are incorporated by reference in Item 8. (2) In 1993, Armco adopted SFAS 106 and 109 which increased long-term employee benefits and total assets. (3) In April 1992, Armco acquired Cyclops Industries, Inc. (4) Special credits (charges) for the years 1991 through 1993 primarily relate to the shutdown and rationalization of operating facilities. The credit in 1989 is primarily a result of a $109.4 gain on the formation of Armco Steel Company, L.P. from the assets, liabilities and business of the Eastern Steel Division, and a credit for a favorable ruling on certain export commitments, partially offset by corporate restructuring charges. (5) The Class B common stock was issued by Eastern Stainless Corporation prior to Armco's acquisition of this 84%-owned former subsidiary of Cyclops Industries, Inc. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated herein by reference from pages 19-31 following the caption "Management's Discussion and Analysis" of the Consolidated Financial Statements in the Annual Report to Shareholders for the year ended December 31, 1993. Subsequent Developments On March 28, 1994, Armco announced its intention to idle the production facilities at its Empire-Detroit carbon steel plant in Mansfield, Ohio and the Dover, Ohio galvanizing plant. The plants are expected to remain idle until the previously announced construction of a $100 million thin-slab caster is completed, which is scheduled for mid-1995. Armco expects to recognize a special charge of up to $20 million in the first quarter of 1994 for the cost of benefits to employees on layoff and other costs of idling the facilities, as well as costs associated with planned permanent work force reductions. ITEM 8.

7383

1993

ITEM 6. SELECTED FINANCIAL DATA ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FINANCIAL CONDITION The Progressive Corporation is a holding company and does not have any revenue producing operations of its own. It receives cash through borrowings, equity sales, subsidiary dividends and other transactions, and may use the proceeds to contribute to the capital of its insurance subsidiaries in order to support premium growth, to repurchase its Common Shares and other outstanding securities, to redeem debt, and for other business purposes. In 1993, the Company sold 4,950,000 Common Shares for net proceeds of $177.0 million, $150.0 million of its 7% Notes due 2013 and filed a shelf registration for $200.0 million of its debt securities (in January 1994, the Company sold $200.0 million of its 6.60% Notes due 2004 under the shelf registration statement). During 1993, the Company repurchased .4 million of its Serial Preferred Shares, Series A, at a cost of $9.8 million, repaid $170.0 million borrowed under its credit facilities and redeemed the entire $70.0 million of its 8 3/4% Debentures. During the three-year period ended December 31, 1993, the Company also sold 4,000,000 Serial Preferred Shares, Series A, for net proceeds of $96.4 million, of which .4 million were repurchased as discussed above, repurchased 4.0 million Common Shares (not adjusted for the December 1992 three-for-one stock split) at a total cost of $215.6 million, and decreased its aggregate borrowings $167.3 million. During the same period, The Progressive Corporation received $393.3 million from its insurance subsidiaries, net of capital contributions made to these subsidiaries. The regulatory restrictions on subsidiary dividends are described in Item 5(c) DIVIDENDS, on page 11. The Company has substantial capital resources and is unaware of any trends, events or circumstances that are reasonably likely to affect its capital resources in a material way. The Company also has available a $20.0 million revolving credit agreement. The Company believes it has sufficient borrowing capacity and other capital resources to support current and anticipated growth. The Company's insurance operations create liquidity by collecting and investing premiums written from new and renewal business in advance of paying claims. For the three years ended December 31, 1993, operations generated a positive cash flow of $664.7 million, and cash flow is expected to be positive in both the short-term and reasonably foreseeable future. The Company's substantial investment portfolio is highly liquid, consisting almost entirely of readily marketable securities. The Company does not expect any material changes in its cash requirements and is not aware of any trends, events or uncertainties that are reasonably likely to have a material effect on its liquidity. Total capital expenditures for the three years ended December 31, 1993, aggregated $122.6 million. In spring 1992, construction began on the Company's new corporate office complex in Mayfield Village, Ohio, and in December 1993, the Company began occupying a portion of this complex. Construction is expected to be completed in 1994. The new facility will consist of approximately 520,000 square feet of space and will replace office space held under leases in a number of locations in the Cleveland, Ohio area. The cost of the project is currently estimated at $74.8 million, and is being funded through operating cash flows. As of December 31, 1993, $50.5 million of the project's cost had been paid. In June 1992, the Company reached an agreement with the California Department of Insurance to refund approximately $50 million of premiums (including interest) on business written between November 8, 1988 and November 7, 1989 to approximately 260,000 policyholders, thereby settling all rollback and refund exposure since Proposition 103 was adopted in November 1988. As a result, the Proposition 103 premium refund and rollback reserve was reduced by $106.0 million. During the second quarter 1992, the Company changed its financial arrangement with Progressive Partners Limited Partnership (Progressive Partners), its investment manager, as part of its strategy to compete more effectively for private passenger auto insurance by lowering costs. Under the new arrangement, Progressive Partners' people, now employed by a wholly-owned Progressive subsidiary, continue to provide the Company with investment and capital management. The transaction involved paying Progressive Partners a one-time fee for terminating the investment management contract, and an additional incentive fee for the period ended June 30, 1992, in the aggregate amount of $54.6 million. This transaction reduced the Company's costs for investment and capital management. In December 1992, Mr. Alfred Lerner, then Chairman of the Company, converted his $75.0 million Floating Rate Convertible Subordinated Debenture due 2008 into 9,000,000 Common Shares and sold 5,175,000 of those Common Shares in an underwritten public offering. The public offering was completed pursuant to the registration rights provisions of the convertible debenture, under which the Company paid $5.1 million in underwriting and other expenses of the offering. These expenses were charged directly to shareholders' equity in accordance with generally accepted accounting principles. On the same date, Mr. Lerner agreed to a termination of his employment agreement with the Company, and, in connection with these transactions, the Company paid Mr. Lerner $10.0 million. RESULTS OF OPERATIONS Direct premiums written increased 20 percent to $1,966.4 million in 1993, compared to $1,636.8 million in 1992 and $1,536.8 million in 1991. These amounts include premiums written under state-mandated involuntary Commercial Auto Insurance Plans (CAIP), for which the Company retains no indemnity risk, of $98.0 million in 1993, $142.2 million in 1992 and $180.0 million in 1991. In 1993, the Company provided policy and claim processing services to 28 state CAIPs, compared to 26 in 1992 and 25 in 1991; the size of the CAIP market continues to decrease. Net premiums written increased 25 percent to $1,819.2 million, compared to $1,451.2 million in 1992 and $1,324.6 million in 1991. Premiums earned, which are a function of the amount of premiums written in the current and prior periods, increased 17 percent in 1993, compared to 11 percent in 1992 and 8 percent in 1991. In 1989, the Company established a reserve for potential premium rollbacks and refunds under provisions of California Proposition 103 and added to the reserve in subsequent years; the reserve reduced premiums written and earned $10.2 million and $49.7 million in 1992 and 1991, respectively. In 1992, the Company settled its financial responsibility under Proposition 103 and reduced its reserve as described above. In 1993, the Company's Core business' net premiums written grew 25 percent, driven by an increase in unit sales. The Company anticipates continued growth in its Core business in 1994; however, the Company prices business to achieve a four percent underwriting margin. As a result, in the short run, operating earnings may not increase in proportion to volume growth. Claim costs, the Company's most significant expense, represent actual payments made and changes in estimated future payments to be made to or on behalf of its policyholders, including expenses required to settle claims and losses. These costs include a loss estimate for future assignments and assessments, based on current business, under state-mandated involuntary automobile programs. Claims costs are influenced by inflation and loss severity and frequency, the impact of which is mitigated by adequate pricing. Increases in the rate of inflation increase loss payments, which are made after premiums are collected. Accordingly, anticipated rates of inflation are taken into account when the Company establishes premium rates and loss reserves. Claim costs, expressed as a percentage of premiums earned, were 62 percent in 1993, compared to 65 percent in 1992 and 67 percent in 1991. The personnel reductions in late 1991 and early 1992, along with other cost-cutting measures and the favorable run-off of the Transportation business, reduced the Company's losses and loss adjustment expenses. Policy acquisition and other underwriting expenses as a percentage of premiums earned were 28 percent in 1993, compared to 31 percent in 1992 and 37 percent in 1991. The decrease reflects the cost-cutting measures discussed above, as well as process improvements, changed workflows and lower commission programs. Service revenues were $43.7 million in 1993, compared to $53.3 million in 1992 and $54.0 million in 1991; the decrease in revenues reflects the decrease in CAIP premiums written. Service businesses generated a pretax operating profit of $6.8 million in 1993, compared to a pretax loss of $4.3 million in 1992 and a pretax loss of $2.1 million in 1991. During 1992, loss adjustment expense reserves were increased $6.2 million. Recurring investment income (interest and dividends) decreased 3 percent to $134.5 million in 1993, 4 percent to $139.0 million in 1992 and 5 percent to $144.8 million in 1991, primarily due to lower prevailing interest rates. Net realized gains on security sales were $107.9 million in 1993, $14.5 million in 1992 and $7.4 million in 1991. A significant portion of the 1993 realized gains resulted from the sale of certain equity securities held in the Company's investment portfolio. President Clinton signed the Omnibus Budget Reconciliation Act of 1993, which, among other items, increased the statutory tax rate to 35 percent. Effective January 1, 1992, the Company adopted SFAS 109 and was able to demonstrate that the benefit of deferred tax assets was fully realizable. The cumulative effect of adopting SFAS 109 increased net income $14.2 million, or $.20 per share. In 1991, the deferred tax asset write-down, as required under SFAS 96, was included in the Federal income tax provision. INVESTMENTS The Company invests in fixed maturity, short-term and equity securities. The Company's investment strategy recognizes its need to maintain capital adequate to support its insurance operations. Therefore, the Company evaluates the risk/reward trade-offs of investment opportunities, measuring their effects on stability, diversity, overall quality and liquidity of the investment portfolio. The majority ($2,135.1 million, or 76.6%, in 1993 and $1,779.4 million, or 74.6%, in 1992) of the portfolio at December 31, 1993 and 1992, was in short-term and intermediate- term, investment-grade fixed-income securities. A relatively small portion ($453.9 million, or 16.3% in 1993 and $398.6 million, or 16.7% in 1992) of the investment portfolio was invested in preferred and common equity securities providing risk/reward balance and diversification. The remainder of the portfolio was invested in long-term investment-grade fixed-income securities ($77.6 million, or 2.8% in 1993 and $122.7 million, or 5.1% in 1992) and non-investment-grade fixed-income securities ($119.8 million, or 4.3% in 1993 and $85.4 million, or 3.6% in 1992). The non-investment-grade fixed-income securities, although constituting only a small portion of the portfolio, offer the Company high returns and added diversification without a significant adverse effect on the stability and quality of the investment portfolio as a whole. These securities may involve greater risks often related to creditworthiness, solvency and relative liquidity of the secondary trading market. The weighted average fully taxable equivalent yield of the portfolio was 8.7%, 8.6% and 9.4% as of December 31, 1993, 1992 and 1991, respectively. As of December 31, 1993, the Company elected to early adopt Statement of Financial Accounting Standards (SFAS) 115 "Accounting for Certain Investments in Debt and Equity Securities." For 1993, the adoption of SFAS 115 did not have any effect on the Company's results of operations or financial position. Fixed maturity securities which are held-to-maturity and short-term securities are reported at amortized cost; amortized cost of short-term securities approximates market. Available-for-sale securities are held for indefinite periods of time and include fixed maturities and equity securities. The available-for-sale securities are reported at market value with the changes in market value, net of deferred income taxes, reported directly in shareholders' equity as unrealized appreciation or depreciation. The quality distribution of the fixed-income portfolio is as follows: As of December 31, 1993, the Company held $122.5 million of Collateralized Mortgage Obligations ("CMOs"), which represented 4.4% of the total investment portfolio. There are four types of securities held in the CMO Portfolio. As of December 31, 1993, sequential bonds represented 51.0% of the portfolio ($62.5 million) and had an average life of 1.5 years. Planned Amortization Class ("P.A.C.") bonds represented 25.9% of the portfolio ($31.7 million) and had an average life of 1.6 years. P.A.C. Principal Only and Interest Only bonds represented the remaining 23.1% of the portfolio ($28.3 million) and had an average life of 1.8 years. The portfolio contains no residual interests. CMOs held by the Company are highly liquid with readily available quotes and, at December 31, 1993, had an average life of 1.6 years. Eighty- nine percent of the CMOs held by the Company are rated AAA by Moody's or Standard & Poor's. As of December 31, 1993, the Company's total CMO portfolio had an unrealized loss of $3.7 million. The single largest unrealized loss in any CMO security was $1.3 million, or only 1.1% of such position. Investments in the Company's portfolio have varying degrees of risk. Equity securities generally have greater risks than the non-equity portion of the portfolio since these securities are subordinate to rights of debt holders and other creditors of the issuer. As of December 31, 1993, the mark-to-market net gains in the Company's equity portfolio were $20.7 million ($13.5 million, net of taxes), as compared to $88.3 million ($58.3 million, net of taxes) in 1992. As of December 31, 1993 and 1992, the marketable equity portfolio of the Company was $453.9 million, or 16.3% and $398.6 million, or 16.7%, respectively, of the total investment portfolio. The 1993 marketable equity portfolio consisted of three principal components: (i) $73.0 million, or 16.1%, of standard adjustable rate preferreds (ARPS), (ii) $283.4 million, or 62.4%, of perpetual preferreds with mechanisms that may provide an opportunity to liquidate at par, and (iii) $97.5 million, or 21.5%, of common stocks. The 1992 marketable equity portfolio consisted of three principal components; (i) $138.9 million, or 34.8%, of standard adjustable rate preferred (ARPS), (ii) $64.1 million, or 16.1% of perpetual preferreds with mechanisms that may provide an opportunity to liquidate at par, and (iii) $195.6 million, or 49.1%, of common stocks. The Company continually evaluates the creditworthiness of each issuer for all securities held in its portfolio. Changes in market value are evaluated to determine the extent to which such changes are attributable to: (i) interest rates, (ii) market-related factors other than interest rates and (iii) financial conditions, business prospects and other fundamental factors specific to the issuer. Declines attributable to issuer fundamentals are reviewed in further detail. Available evidence is considered to estimate the realizable value of the investment. Evidence reviewed may include the recent operating results and financial position of the issuer, information about its industry, recent announcements and other information. The Company retains a staff of experienced security analysts to compile, review and evaluate such information. When a security in the Company's investment portfolio has a decline in market value which is other than temporary, the Company is required by GAAP to reduce the carrying value of such security to its net realizable value. It is the Company's general policy to dispose of securities when the Company determines that the issuer is unable to reverse its deteriorating financial condition and the prospects for its business within a reasonable period of time. In less severe circumstances, the Company may decide to dispose of a portion of its holdings in a specific issuer when the risk profile of the investment becomes greater than its tolerance for such risk. ENVIRONMENTAL AND PRODUCT LIABILITY EXPOSURES Because the Company has been primarily an insurer of motor vehicles, it has limited exposure for environmental, product and general liability claims. The Company has established reserves for these exposures, in amounts which it believes to be adequate based on information currently known by it and, in addition, has a supplemental reserve that is in an amount substantially in excess of the potential exposure for such claims. The Company does not believe that these claims will have a material impact on the Company's liquidity, results of operations or financial condition. However, the ultimate costs of the environmental and product liability claims are inherently difficult to project due to numerous uncertainties, including causation and policy coverage issues, the possible uncollectability of related reinsurance and third-party indemnity arrangements, unsettled and sometimes conflicting case law, difficulties in determining the scope of any contamination or injury and the nature and cost of the appropriate remedial action and the number and financial condition of responsible parties and their insurers, among other factors. Most of the Company's exposure for such claims results from Progressive's acquisition in 1985 of American Star Insurance Company, since renamed National Continental Insurance Company. When American Star was acquired, the seller agreed to administer all claims asserted under policies previously written by American Star and to pay all losses incurred under such policies, including those covered by reinsurance then in place on some of the policies. The seller encountered major financial difficulties as a result of losses in Hurricane Andrew and, despite having paid all losses and adjusted all claims on the old business since 1985, has contested its obligation to administer these claims and to pay the losses not being paid by some of the reinsurers. The dispute has been submitted to arbitration and is scheduled to be heard by an arbitration panel during the second quarter. If it is determined that the seller is responsible for all of these losses, the amounts could be material to it. According to a recent study by independent actuaries for the seller, aggregate reserves on this business are about $19.2 million. Of that amount, about $6.3 million is being contested in the arbitration, $7.8 million is the admitted obligation of the seller and the balance is the responsibility of reinsurance sources that are paying their obligations. The Company will continue to monitor these exposures, adjust the related reserves appropriately as additional information becomes known and disclose any material developments. ITEM 8.

80661

1993

ITEM 6. SELECTED FINANCIAL DATA THE COOPER COMPANIES, INC. AND SUBSIDIARIES FIVE YEAR FINANCIAL HIGHLIGHTS THE COOPER COMPANIES, INC. AND SUBSIDIARIES FIVE YEAR FINANCIAL HIGHLIGHTS ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. References to Note numbers herein are references to 'Notes to Consolidated Financial Statements' of the Company located in Item 8

711404

1993

ITEM 6. SELECTED FINANCIAL DATA ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION YEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992 Net sales in 1993 were $340.2 million, down 1.7% from 1992 sales of $346.2 million. The Company's domestic wholesale business of approximately $257 million in 1993 was 9.3% less than 1992 sales, due primarily to a decline in unit shipments of approximately 10% in 1993 from 1992. The decrease in domestic wholesale unit shipments related primarily to the effects of the competitive pricing environment in the children's wear business, the Company's difficulty in meeting the delivery requirements of its wholesale customers as well as the Company's expanding focus on its retail operations. The Company currently anticipates further reduction in its domestic wholesale unit shipments in 1994. In an effort to improve customer delivery requirements, the Company is currently undertaking a significant reengineering process. The Company anticipates continued improvement in its delivery performance in 1994. Company retail sales at its Oshkosh B'Gosh branded outlet stores and its wholly-owned subsidiary Essex Outfitters Trader Kids stores expanded to approximately $65.0 million in 1993, a 49.4% increase over 1992 retail sales of approximately $43.5 million. Retail sales increases resulted primarily from the opening of an additional 38 retail stores during 1993. The Company anticipates continued expansion in its retail business through the opening of an additional 35 to 45 retail stores in 1994, which should offset the reduction in the domestic wholesale business. Gross margin as a percent of sales improved to 28.0% in 1993, compared with 25.1% in 1992. During 1993, the Company experienced a slight improvement in its domestic wholesale gross margins. Increased retail store sales, at higher gross profit margins, had a significant impact on improved overall gross margin performance. Gross margins for 1992 were unfavorably impacted by manufacturing inefficiencies resulting from the restructuring of production lines and increasing workers' compensation insurance and employee health care costs. The Company currently anticipates further modest improvement in its gross margins in the second half of 1994. Selling, general and administrative expenses increased $12.1 million in 1993 from 1992. As a percent of net sales, selling, general and administrative expenses were 23.1% in 1993, up from 19.2% in 1992. The primary reason for increasing selling, general and administrative expenses is the Company's increasing focus on its retail business. In addition, the Company initiated a catalog division in the second half of 1993 which added approximately $1.2 million to its selling, general and administrative expense. Increasing emphasis on foreign sales opportunities, including the start-up costs associated with the opening of sales offices, have also added to the Company's selling, general and administrative expense structure. In 1994, the Company's continued expansion in its retail business, along with further development of its foreign business and catalog division will result in higher selling, general and administrative expenses in relation to its net sales. During 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. After review of the Company's manufacturing capacity, operational effectiveness, sales volume and alternative sourcing opportunities, the Company decided to sell its Camden, Tennessee and McKenzie, Tennessee manufacturing plants as well as evaluate other capacity reduction alternatives. During 1993 the Company reduced its total workforce by over 1,200 employees. Sale of the McKenzie plant in 1994 will reduce the Company's workforce by approximately 230 employees. The Company's $10.8 million restructuring charge includes approximately $3.3 million for facility closings, write-down of the related assets and severance costs pertaining to workforce reductions. The restructuring charge also reflects the Company's decision to market its Boston Trader line of children's apparel under the new trade name Genuine Kids and the resulting costs of the Company's decision not to renew the Boston Trader license arrangement beyond 1994, as well as expenses to consolidate its retail operations. Accordingly, the restructuring charge includes approximately $7.5 million for write-off of previously capitalized trademark rights and expenses related to consolidating the Company's retail operations. The Company anticipates that these restructuring actions, net of income tax benefit, will require expenditures of approximately $2.5 million of cash over the next year, which will be funded entirely by internally generated cash. Company management believes that while these restructuring actions will not result in material short term earnings improvement, the restructuring will better position the Company competitively over a longer term period of time. In 1991, the Company recorded the impact of its decision to discontinue the manufacturing and sale of its Absorba line of infant's apparel. A pretax restructuring charge of $5.6 million represented provisions for facility closing and lease termination costs, severance pay, write-down of the related assets and estimated operating losses until closing. These restructuring costs (net of income tax benefit) reduced 1991's net income by $3.6 million ($.25 per share). During 1992, the Company reduced its estimate of the Absorba line restructuring costs by $2.8 million due to the efficient and orderly wind down of operations and favorable settlement of lease obligations. This adjustment to restructuring costs (net of income taxes) increased 1992 net income by $1.8 million ($.12 per share). Royalty income, net of expenses, was $3.4 million in 1993, as compared to $2.6 million in 1992. The increase in net royalty income resulted primarily from additional foreign license agreements. The effective tax rate for 1993 was 51.3% compared to 39.8% in 1992. The higher 1993 effective tax rate is the result of the Company's foreign operating losses, which provide no tax benefit, combined with the Company's substantially lower income before income taxes in 1993 (which resulted in part from the restructuring charge). The Company's early adoption of Statement of Financial Accounting Standards No. 109 on accounting for income taxes in 1992 had no material impact on 1992's results of operations. Company management believes that the $10.7 million deferred tax asset at December 31, 1993 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. The Company elected early adoption of the of the Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," in 1992. The Company elected to record the entire transition obligation in 1992, which resulted in a net $.6 million after tax ($.04 per share) reduction in net income. In November of 1992, the Financial Accounting Standards Board issued its Statement No. 112 entitled "Employers' Accounting for Postemployment Benefits." The Statement must be applied in the preparation of the Company's consolidated financial statements for the year ending December 31, 1994. The Company has determined that this standard will not have a significant effect on its consolidated financial statements. In September 1993, the Company signed a letter of intent to purchase Rio Sportswear, Inc. and affiliated companies (collectively "Rio"). In March, 1994, the Company announced that negotiations with Rio had terminated. YEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991 Net sales for 1992 were $346.2 million, a 5.2% decrease from 1991 sales of $365.2 million. The decrease in net sales was due primarily to a 3.9% dollar decrease (1.2% in units) in the Oshkosh B'Gosh domestic wholesale business. The Company's decision to discontinue the sale of United States licensed Absorba products in 1992 also had a negative impact on reported 1992 sales, as 1991 sales of Absorba products amounted to $10.3 million. Sales by the Company's remaining subsidiaries totaled $23.2 million, a 44.2% increase over their 1991 sales. Gross margins as a percent of sales declined from 29.7% in 1991 to 25.1% in 1992. The decline resulted primarily from a 6.2% reduction in gross margins of the domestic wholesale children's wear business. Gross margins for 1992 were also unfavorably impacted by manufacturing inefficiencies resulting from the restructuring of production lines to meet the demands of product complexity and delivery schedules. Rapidly escalating workers' compensation insurance costs, employee health care costs, and other employee fringe benefit costs adversely impacted gross margins. In addition, in 1992 the Company initiated a volume discount program which placed added pressure on Company gross margins. Variations in gross margins of subsidiaries had no material effect on consolidated results. Selling, general and administrative expenses decreased $1.3 million from 1991. As a percent of net sales, selling, general and administrative expenses were 19.2% and 18.6% for 1992 and 1991 respectively. The primary reason for the decline in the dollar amount of selling, general and administrative expenses was the discontinuance of the Absorba operations, offset in part by increased advertising and factory store expenses. The increased factory store expenses were primarily the result of opening 7 additional Oshkosh B'Gosh retail stores. Subsidiary marketing and administrative expenses increased primarily from the addition of 16 retail stores at the Company's Essex Outfitters, Inc. subsidiary. During 1991 the Company decided to discontinue the manufacture and sale of its United States licensed Absorba products. An estimated pretax restructuring cost of $5.6 million was recorded in 1991 for facility closings, severance pay, loss on disposal of assets and estimated operating losses until closing. Favorable settlements of lease obligations, efficient and orderly wind down of operations, and disposition of remaining assets and inventories at favorable amounts resulted in a reduction in the Company's provision for restructuring costs by $2.8 million ($1.8 million net of income taxes). The net effect of this reduction in provision for restructuring costs increased 1992's income by $.12 per share. As of December 31, 1992, substantially all assets of Absorba, Inc. were sold and all operations were ceased. Results of operations of the Company's three remaining subsidiaries decreased 1992 income before tax by approximately $.4 million. Results of operations of the remaining subsidiaries (excluding Absorba) decreased 1991 income by approximately $.9 million. Losses were experienced in operations of Oshkosh B'Gosh Europe, S.A. and Manufacturera International Apparel, S.A. (our Honduras manufacturing subsidiary), while Essex Outfitters net income was approximately equal to that realized in 1991. The effective tax rate for 1992 and 1991 was 39.8%. The Company's early adoption of the Financial Accounting Standards Board Statement No. 109 on accounting for income taxes in 1992 had no material impact on 1992's results of operations. FINANCIAL CONDITION During 1993 total assets increased by $2.9 million or 1.3% over 1992. Accounts receivable at December 31, 1993 were $19.5 million compared to $24.4 million at December 31, 1992. Inventories at the end of 1993 were $100 million, up $7.2 million from 1992. This increase in inventories relates primarily to the Company's expanding retail business. Management believes that year end 1993 inventory levels are generally appropriate for anticipated 1994 business activity. Accrued liabilities at the end of 1993 were $29.8 million, up $13.6 million from 1992. This increase is due primarily to the Company's provision for restructuring costs recorded in the fourth quarter of 1993. On February 20, 1992, the Company finalized a $7 million Industrial Development Revenue Bond issue to finance construction of the Celina, Tennessee finishing plant. As a result of additional capital expenditures associated with the project and the possible restrictions to future expansion because of limits imposed by existing Industrial Development Revenue Bond regulations, the bonds were called on December 18, 1992 and paid off on January 19, 1993. LIQUIDITY AND CASH FLOW The Corporation maintains a relatively liquid financial position. Net working capital at the end of 1993 was $111.8 million, approximately the same as at the end of 1992. The current ratio was 3.8 to 1 at 1993 year end, compared to 4.2 to 1 at year end 1992. Cash provided by operations was approximately $21.6 million in 1993, compared to $22.9 million in 1992. Capital expenditures were approximately $9 million in 1993 and $12.6 million in 1992. Capital expenditures for 1994 are currently budgeted at approximately $12 million. Liquidity is also provided by short-term borrowings that fund seasonal working capital needs. The Company has unsecured credit arrangements, negotiated annually, which provide for maximum borrowings and letters of credit totaling $60 million at December 31, 1993 including $45 million under commercial paper borrowing arrangements. The Company believes its present liquidity, in combination with cash flow from future operations and its available credit facilities, is sufficient to meet its continuing operating and capital requirements in the foreseeable future. Dividends on the Company's Class A and Class B Common Stock totaled $.5125 per share and $.45 per share, respectively, in 1993, the same as in 1992. The dividend payout rate was 163% in 1993 and 49% in 1992. The Company's lower earnings from operations in 1993 combined with the fourth quarter 1993 restructuring charge resulted in the unusually high 1993 payout rate. INFLATION The effects of inflation on the Company's operating results and financial condition were not significant. ITEM 8.

75042

1993

ITEM 6. SELECTED FINANCIAL DATA ITEM 6. SELECTED FINANCIAL DATA (CONTINUED) (The remainder of this page is intentionally blank.) Item 7.

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company was significantly and adversely affected by certain events in 1991 and 1992. Among other consequences, these events have affected the Company's results of operations, its financial position, its liquidity, and resulted in certain defaults under the loan agreements. As a result of these adverse developments, the Company has, since mid-1991, experienced severe liquidity problems. In July 1992, the Board of Directors began reviewing various financial alternatives that the Company might pursue, including restructuring its outstanding debt by means of an exchange offer or by means of a Chapter 11 bankruptcy filing, with the goal of maximizing its investment in Century and implementing a long-term solution to the Company's financial situation. The review process resulted in the development of a proposed restructuring plan and a prepackaged bankruptcy plan of reorganization, which was circulated to noteholders and other creditors on May 13, 1993. Following creditor approval, CenCor filed for Chapter 11 bankruptcy reorganization on July 19, 1993. The prepackaged bankruptcy plan was confirmed by the bankruptcy court on August 30, 1993. On January 28, 1993, Century completed a restructuring of its debt obligations with its principal creditors (NOTE 5). Subsequent to the restructuring, Century sold or closed twelve non-strategic branches to obtain operating efficiencies. Century has also modernized many of its offices and has converted to an on-line computer system. According to its business plan, Century intends to achieve financial stability and profitability through internal growth with a program to grow its current branches and expand the branch network in states with strong operations. In addition, the business plan calls for the acquisition of compatible receivables and/or companies to achieve growth of receivables of $100 million in the next four years. The plan assumes that Century will be able to retain a substantial portion of acquired accounts as active customers and that acquisitions can be negotiated with acceptable yields and levels of credit risk. Century's acquisition program is also dependent on its ability to obtain additional financing. On August 22, 1992, the Century Board hired George C. Evans as President and CEO to direct the operations of Century. Mr. Evans' employment was terminated effective April 12, 1993 (see Note 13 to the financial statements). Dennis C. Berglund, who had 24 years of experience with Avco Financial Services, was then appointed to fulfill these duties. Effective June 15, 1993, Mr. Berglund was appointed to the positions of President and CEO. During 1993, Century also completed the installation of a modern management information and data processing system which is operated under contract with Norwest Financial Information Services Group ("Norwest"). Norwest provides similar services for the consumer loan operations of its own affiliate and for a large section of the consumer finance industry, which includes approximately 4,000 branch offices throughout the country. The system provides Century headquarter personnel on-line access to branch data and enables Century to provide more timely and informative reports to improve management decision making, supervision and control. CURRENT OVERALL TRENDS During the year ended December 31, 1993, the Company incurred a net loss from continuing operations of $7,256,000 as compared to a net loss of $12,352,000 for 1992. As discussed in further detail below, the loss resulted primarily from a decrease in total revenue of $2,768,000 (11%) and an increase in operating expenses of $4,687,000 (32%). Offsetting these was a decrease in provision for credit losses of $11,052,000 (84%). Century has shifted its emphasis away from sales finance contracts acquired from automobile dealers, and is focusing on more desirable and profitable direct loans, including home equity loans, which typically have lower yields but generally have lower charge-off and servicing costs. In addition, during 1993 Century sold four of its branches and sold an additional six branch offices during January and February of 1994. Management determined that these locations were outside of its focused market area and the cost of operating the offices was not providing adequate benefits. The sale of these branches will enable Century to focus on its more profitable and geographically desirable offices. Century also merged two of its branch offices into other nearby branches during 1993 in order to consolidate resources, improve efficiency, and eliminate overhead costs. Management feels that the above mentioned changes and the completion of the installation of the new data processing system will serve to reduce the amount of operating expenses in 1994. Management intends to closely evaluate and monitor operating expenses throughout the year. 1993 COMPARED TO 1992 Interest on finance receivables decreased by $2,131,000 (9%) in the year ended December 31, 1993. The decrease resulted primarily from the change in the concentration of high yielding assets, such as automobile sales finance contracts, to an increase in the level of lower yielding home equity loans. The provision for credit losses decreased by $11,052,000 to $2,104,000 for the year ended December 31, 1993. The decrease in the provision for credit losses is primarily attributable to the significant decrease in the auto paper portfolio, the increased recoveries of previously charged off receivables and the strengthening of management and controls. Operating expenses increased by $4,687,000 (31%) to $19,339,000 for the year ended December 31, 1993. The increase was mostly due to additional costs incurred to improve the quality and effectiveness of Century's operations. Most of the increase in operating expenses occurred in the following categories: salary and employment expenses (44%), rent expense (30%), computer system conversion (100%), incentives toward the growth of Century's portfolio (68%), settlement with a former employee (100%), and relocation expenses (78%). Interest expense decreased slightly in the year ended December 31, 1993 from $10,685,000 at December 31, 1992 to $9,263,000 at December 31, 1993. The decrease in the interest expense resulted from the restructuring of the outstanding long term debt (see Notes 2 and 5 to the financial statements). In addition, Century, in connection with its debt restructure on January 28, 1993, issued warrants to its noteholders in order to acquire 300,000 shares of Century common stock (see Note 5 to the financial statements). The value of the warrants in excess of the exercise price is being accrued as interest expense. As previously mentioned, Century sold four of its branch offices during 1993. The resulting gain from the sale of the branch receivables ($944,000) and the loss from the sale of the branch fixed assets ($18,000) was recorded as other income (loss) in the accompanying consolidated statement of operations. As a result of CenCor's reorganization plan (see Note 2 to the financial statements), CenCor issued New Notes, Convertible Notes, and stock to its noteholders. The New Notes and Convertible Notes were recorded at their net present value using an estimated market discount rate of 16%. As a result of these transactions, an extraordinary gain of $18,033,000 was recorded. No provision for income tax was recorded in 1993. See Note 10 to the financial statements. 1992 COMPARED TO 1991 Interest on finance receivables decreased in the year ended December 31, 1992 compared to 1991. Although yields were comparable between the two years, average earning balances for the period were lower in 1992 as compared to 1991. This resulted from Century's decision to significantly curtail the purchase of bulk automobile sales contracts subsequent to the discovery of the JoAnn's fraud in late 1991. As a result, net finance receivables were $74,777,000 at December 31, 1992 as compared to $100,905,000 at December 31, 1991. Because principal pay downs were not reinvested in bulk sales contracts, cash and cash equivalents increased $19,976,000 during 1992 to $23,401,000. Insurance commissions were down $306,000 or 15% from 1991. The decrease also reflected the lower consumer loan origination activity in 1992 compared to 1991. The provision for credit losses increased $1,023,000 to $13,156,000 for the year ended December 31, 1992. Net charge offs for 1992 included approximately $2,700,000 of JoAnn's notes of which $2,100,000 had been previously reserved. As a result of significant credit losses in Century's automobile sales contract portfolio, management has increased the related allowance for credit losses to approximately 22% of net outstanding balances. The allowance for credit losses on all other finance receivables is approximately 5% of net outstanding balances. Operating expenses for 1992 decreased to $14,652,000 from $18,169,000 in 1991. The 1991 results included $3,120,000 of service fees paid to JoAnn's and a $3,707,00 loss on fraudulent contracts which did not reoccur in 1992. The 1992 results reflect higher professional expenses incurred in connection with the JoAnn's fraud and dealing with defaults on CenCor's and Century's debt. The loss from discontinued operations for 1992 was $9,623,000 as compared to a loss from discontinued operations of $229,000 for the same period in 1991. The increase is primarily due to the $5,422,000 provision for credit losses related to the Junior Secured Debenture issued by Concorde Career Colleges ("Concorde") and the net loss on disposal of discontinued operations' assets of $3,699,000 (see Note 3 to the financial statements). An income tax benefit of $336,000 was recorded for the 1992 loss. A reconciliation of income tax benefit to the amount computed using the statutory federal income tax rate is included in Note 10 to the financial statements. LIQUIDITY AND CAPITAL RESOURCES DEBT AVAILABILITY On January 29, 1993, after extensive negotiations with its major creditors, Century successfully completed its debt restructuring. Prior to that date, Century had been in default on all its debt due to various covenant violations (see Note 5 to the financial statements for details of Century's debt restructure). The terms of Century's restructuring agreements limit Century's ability to incur additional indebtedness, within certain limits. On October 15, 1993 Century entered into a letter of intent with Congress Financial Corporation ("Congress") that provided for a revolving line of credit up to $25,000,000. The loan will be used to provide future working capital for Century in order to achieve its plan of portfolio growth. The facility is fully secured by a first lien on all of Century's assets. The interest rate on the proposed Congress loan is two percent (2%) above the prime commercial interest rate, adjusted monthly. The revolving credit line is provided for a minimum of two years with automatic year to year renewals unless terminated by either party. Management expects to complete the Congress agreement and have funds available by April 1, 1994. As previously mentioned, CenCor successfully restructured its debt on August 30, 1993. For a further discussion of CenCor's debt restructure, refer to Note 2 of the financial statements. CAPITAL OBLIGATIONS The Company has no significant obligations for capital purchases. DEFAULTS ON LONG-TERM DEBT At December 31, 1992, Century was in default of certain covenants in its long-term debt agreements. On January 29, 1993, Century entered into amendment and exchange agreements with the holders of its long-term debt (the Agreements), whereby the holders agreed to defer all principal payments until April 30, 1997. Additionally, many covenants of the debt agreements were amended. The covenants include, in part, maintaining net worth at certain minimum levels and limitations on indebtedness and payment of dividends. Century is in compliance with the amended covenants of the long-term debt agreements. Pursuant to the Agreements, all of Century's long-term debt will mature on April 30, 1997. However, certain scheduled principal installments as provided for in the original debt agreements are due prior to this date. In lieu of cash payment of the scheduled principal installments, Century will deliver Secured Deferred Payment Notes for the related senior debt and a combination of Secured Deferred Payment Notes and Secured Compound PIK Notes for the related subordinated and junior subordinated debt. These notes will bear interest at a fixed rate equal to the rate on 4.5 year Treasury notes as of the installment due date, plus 2.25% (senior notes), 3.75% (subordinated notes) and 5% (junior subordinated notes). Interest is payable monthly under all of the notes, except for the Secured Compound PIK Notes, for which interest compounds monthly and is payable on April 30, 1997. Prior to the restructuring of its debt, CenCor was in default on both its public and private debt. As part of the Restructuring, which was consummated on August 30, 1993, the old debt was exchanged for New Notes, Convertible Notes, and stock (see Note 2 to the financial statements). The Company is in compliance with all covenants and terms under the new indenture. INTERNAL REVENUE SERVICE EXAMINATION The Company's income tax returns for 1988 and 1989 were examined by the Internal Revenue Service (IRS), which has proposed certain adjustments, a portion of which have been protested by the Company. The Company has also claimed additional deductions in these years. Management believes that the ultimate disposition of the IRS examination will not have a material effect on the financial position of the Company. As a result of the unresolved IRS examination, management cannot precisely estimate the amount of the Company's net operating loss carryforward for financial statement or federal income tax purposes. CONTINUING OPERATIONS As noted earlier, CenCor successfully restructured its long-term debt pursuant to a plan confirmed by the U.S. Bankruptcy Court and approved by the majority of its creditors. Management believes that CenCor's financial condition will not have a material adverse impact on Century's financial condition, operations, or its ability to fund its operations. Funds that are available to CenCor, including cash on hand, investment income and the collection of certain receivables, are expected to be sufficient to support CenCor's limited activities through at least 1996. In addition, with the potential availability of the line of credit provided by Congress, Century intends to pursue its business plans of expansion through acquisitions of consumer finance businesses and portfolios of consumer loans and also through expansion of business with its existing and former customers. INFLATION AND GENERAL ECONOMIC CONDITIONS The cost of Century's operating expenses has increased due to normal inflationary increases. Century foresees no detrimental effects from inflation as long as inflation remains at or near current levels. Changes in interest rates can affect Century. Its liabilities are more sensitive to interest rate changes than its assets. While economic conditions affecting the country have an impact on Century's business, primarily with its cost of funds, the business is such, that specific local economies have a much greater financial impact. For example, a major employer either adding or reducing employees will have a ripple effect in a community which will impact Century's ability to make and collect loans. Century, as it is now structured, does not anticipate any major economic effect on its business. ITEM 8.

18497

1993

Item 6. Selected Financial Data The following table sets forth (i) selected historical consolidated financial data of the Company prior to the Acquisition ("Predecessor") as of and for the nine month period ended September 30, 1992, and each of the years in the three year period ended December 31, 1991, (ii) selected historical consolidated financial data of the Company after the Acquisition ("Successor") as of and for the year ended December 31, 1993 and the three month period ended December 31, 1992, and, (iii) combined historical consolidated financial data of Successor for the three month period ended December 31, 1992 and Predecessor for the nine month period ended September 30, 1992. This data should be read in conjunction with "Management's Discussion and Analysis of Results of Operations and Financial Condition" and the consolidated financial statements and related notes included elsewhere herein. The selected historical consolidated financial data presented below as of and for each of the years in the two year period ended December 31, 1990, were derived from the audited consolidated financial statements of Predecessor (not presented herein). The selected historical consolidated financial data presented below, as of and for the year ended December 31, 1993, the three month period ended December 31, 1992, the nine month period ended September 30, 1992, and the year ended December 31, 1991, were derived from the consolidated financial statements of Successor and Predecessor, which were audited by Ernst & Young, independent auditors, whose report with respect thereto, together with such financial statements, appears elsewhere herein. (Footnotes on following page) (Footnotes continued from previous page) (a) Represents a combination of Successor's three month period ended December 31, 1992 and Predecessor's nine month period ended September 30, 1992. Such combined results are not directly comparable to the consolidated results of operations of the Predecessor for each of the three years ended December 31, 1991, nor are they necessarily indicative of the results for the full year due to the effects of the Acquisition and Merger and related refinancings and the concurrent adoption of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes," ("FAS 109"). See Notes to Consolidated Financial Statements. Financial data of the Company as of October 1, 1992 and thereafter reflect the Acquisition using the purchase method of accounting, and accordingly, the purchase price has been allocated to assets and liabilities based upon their estimated fair values. However, to the extent that Holdings management had a continuing investment interest in Holdings' common stock, such fair values (and contributed stockholder's equity) were reduced proportionately to reflect the continuing interest (approximately 10%) at the prior historical cost basis. (b) In connection with the Acquisition and Merger, debt issuance costs of $1.5 million and $1.8 million associated with debt retired were included in interest expense for the year ended December 31, 1993 and the three month period ended December 31, 1992, respectively. (c) In connection with the Acquisition and Merger, the Predecessor recorded certain merger related expenses of $18.1 million consisting primarily of bonus and option payments to certain employees and certain merger fees and expenses, which have been charged to the Predecessor's operations in the nine month period ended September 30, 1992. In May 1989, the Predecessor paid cash bonuses to certain members of its management from the proceeds of the debentures issued by Holdings. (d) Holdings and the Company file a consolidated U.S. federal income tax return. Through December 31, 1990 the deductible expenses of Holdings (primarily interest) were included in the calculation of the Company's income taxes under a tax sharing agreement with Holdings. The tax sharing agreement was amended, effective January 1, 1991, to provide that the Company's aggregate income tax liability be calculated as if it were to file a separate return with its subsidiaries. The tax benefits recorded in 1990 and 1989 for the deductible expenses of Holdings were $8.7 million and $4.8 million, respectively. The pro forma net income reflecting income taxes on a separate return basis is presented for 1990 and 1989 as if such benefits had not been recorded. (e) During 1993, Successor recognized extraordinary charges of $3.1 million, net of applicable tax benefit, representing the write off of unamortized debt costs associated with the repayment of the outstanding balance of the Company's term loans, and $0.3 million, net of applicable tax benefit, representing the net loss resulting from the redemption of the Company's 12 3/8% Senior Subordinated Debentures ("Debenture Repurchases"). During 1992 and 1991, Predecessor made Debenture Repurchases which had a carrying value of $13.8 million and $42.0 million, respectively. The net loss resulting from these repurchases, which includes the write off of a portion of unamortized debt costs, was reflected as an extraordinary charge of $0.1 million and $1.5 million, net of applicable income tax benefit for Predecessor during 1992 and 1991, respectively. (f) For purposes of this computation, earnings consist of income before income taxes plus fixed charges (excluding capitalized interest). Fixed charges consist of interest on indebtedness (including capitalized interest and amortization of deferred financing fees) plus that portion of lease rental expense representative of the interest factor (deemed to be one-third of lease rental expense). Earnings of the Successor were insufficient to cover fixed charges by the amount of $7.1 million for the three month period ended December 31, 1992. Item 7.

Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition Introduction The Company is engaged in one principal line of business, the production of electrical wire and cable. The Company classifies its operations into four major divisions based on the markets served: Wire and Cable Division, Magnet Wire and Insulation Division, Telecommunication Products Division and Engineered Products Division. See "Business" for a description of the principal products offered by each division and the total sales for each major product line for the years ended 1993, 1992 and 1991. For financial statement purposes, the Acquisition and Merger was accounted for by Holdings as a purchase acquisition effective October 1, 1992. Because the Company is a wholly-owned subsidiary of Holdings, the effects of the Acquisition and Merger have been reflected in the Company's financial statements, resulting in a new basis of accounting reflecting estimated fair values for Successor's assets and liabilities at that date. However, to the extent that Holdings' management had a continuing investment interest in Holdings' common stock, such fair values (and contributed stockholder's equity) were reduced proportionately to reflect the continuing interest (approximately 10%) at the prior historical cost basis. As a result, the Company's financial statements for the periods subsequent to September 30, 1992 are presented on the Successor's new basis of accounting, while the financial statements for September 30, 1992 and prior periods are presented on the Predecessor's historical cost basis of accounting. The consolidated results of operations of the Company for the twelve month period ended December 31, 1992 are not directly comparable to the consolidated results of operations of the Predecessor due to the effects of the Acquisition and Merger and related refinancings and the concurrent adoption of FAS 109. See Notes 1 and 7 of Notes to Consolidated Financial Statements. In connection with the Acquisition and Merger and the concurrent adoption of FAS 109, the Successor recognized $142.2 million of excess of cost over net assets acquired that is being amortized over 35 years on the straight line method. Results of Operations The Year Ended December 31, 1993 Compared With The Twelve Months Ended December 31, 1992 Net sales for 1993 were $868.8 million or 4.5% lower than 1992. Record sales volume in 1993 exceeded the previous record-level volume of 1992 by approximately 5.1% but was more than offset by reduced product prices reflecting lower copper costs, the Company's principal raw material, and competitive pricing pressures. Copper costs are generally passed on to customers through product pricing. The average price for copper on the New York Commodity Exchange, Inc. (the "COMEX") declined 17.0% from 1992. The Company believes the improved sales volume resulted from increased demand for wire products within the served markets and was attributable to an improving economy, especially as it affected the markets served by the Magnet Wire and Insulation and Engineered Products Divisions. For a discussion of the Company's practices with respect to the purchase, internal distribution and processing of copper, see "Business-Metals Operations." Also see "General Economic Conditions and Inflation" under this caption. Sales for the Magnet Wire and Insulation Division were up 5.3% compared to 1992. Sales volume increased 12.5% over 1992 resulting from increased demand for magnet wire products in the automotive, electric motor and transformer markets in addition to increased sales to distributors. Product pricing was down approximately 6.9% due primarily to lower copper prices in 1993 compared to 1992. The Engineered Products Division experienced a 5.3% increase in sales over 1992 attributable primarily to increased demand for the division's automotive wire products. Automotive wire volumes increased approximately 21% from 1992 due in part to improved demand from its primary customer and to several new accounts. See "Business-Division Operations-Engineered Products Division". Of the increased automotive sales volume, 27% resulted from new customers. Sales of non-automotive products also experienced volume improvements despite decreased demand for pump and welding cable products resulting from flooding in the midwest during 1993. The Wire and Cable, and Telecommunication Products Divisions experienced sales declines in 1993 compared with 1992. The Wire and Cable Division's sales were off 11.3% from 1992 due principally to lower copper prices and reduced product pricing. Volume was down slightly compared with 1992 due mainly to selective market participation during part of the year. Sales by the Telecommunication Products Division were down approximately 11.8% compared with 1992. In addition to reduced product pricing, unit sales volume to the domestic telephone markets was down 22.0% partially offset by a 19.3% increase in export unit volume. Product demand within the domestic markets was down due primarily to general uncertainty about the economy as well as the ongoing restructuring of the U.S. telephone cable industry. Cost of goods sold decreased 4.4% in 1993 compared with 1992 due primarily to lower copper prices partially offset by higher sales volume and additional depreciation expense resulting from the application of purchase accounting in connection with the Acquisition and Merger and the concurrent adoption of FAS 109 (See Notes 1 and 7 of Notes to Consolidated Financial Statements). The Company's cost of goods sold as a percentage of net sales was 85.8% in each of 1993 and 1992. The cost of goods sold percentage in 1993 was adversely impacted by generally lower selling prices and additional depreciation expense resulting from the application of purchase accounting in connection with the Acquisition and Merger and the concurrent adoption of FAS 109 partially offset by lower manufacturing costs resulting from increased capacity utilization. Cost of goods sold in 1992 includes a charge of $2.6 million relating to planned plant consolidations, primarily costs to move equipment and personnel related expenses. Raw material costs in 1993, excluding copper, were generally unchanged from 1992. Selling and administrative expenses in 1993 were 7.9% lower than 1992 due primarily to the expiration of a non-compete agreement with UTC in the first quarter 1993 resulting in the elimination of the related amortization charge, a $2.1 million reduction in the Company's health insurance expense and a $1.5 million accrual in 1992 for the relocation of a business unit in 1993. In connection with the 1988 Acquisition, UTC agreed that until March 1, 1993, it would not engage in any business directly competing with any business carried on by the Company on February 29, 1988. The $34.0 million purchase price allocated to the covenant not to compete was amortized over five years on the straight line method. The reduction in health insurance expense was attributable to favorable experience in health related expenditures. Partially offsetting these expense reductions was a $4.0 million amortization charge recorded in 1993 for excess of cost over net assets acquired compared to a $1.0 million charge recorded in the last quarter of 1992 and a $2.5 million reduction in the Company's allowance for doubtful accounts recorded in the third quarter of 1992. In connection with the Acquisition and Merger and concurrent adoption of FAS 109, the Successor recognized $142.2 million of excess of cost over net assets acquired that is being amortized over 35 years on the straight line method. The Company's allowance for doubtful accounts was reduced on the basis of the collection of a substantial receivable which had been considered doubtful as well as management's assessment of collection risk in the primary markets served. Interest expense in 1993 was $25.2 million as compared to $22.6 million in 1992. The increase was principally caused by $19.0 million in additional weighted average debt outstanding and an increase in the Company's average interest rate incurred (from 8.9% to 9.7%). The additional debt outstanding was primarily attributable to Acquisition- related borrowings and the May 1993 sale by the Company of its 10% Senior Notes due 2003 (the "Senior Notes"). Average interest rates increased reflecting the higher interest rate on the Senior Notes compared with the rate of interest on the Term Credit which was repaid from the sale of the Senior Notes, partially offset by the redemption of all outstanding 12 3/8% Senior Subordinated Debentures due 2000 (the "Debentures") which were also repaid in connection with the issuance of the Senior Notes. See also "Liquidity, Capital Resources and Financial Condition". In connection with the Acquisition and Merger, the Company incurred certain merger related expenses in the amount of $18.1 million consisting primarily of bonus and option payments to certain employees, and certain merger fees and expenses which were charged to operations of the Predecessor in the quarter ended September 30, 1992. These Acquisition and Merger expenses had the effect of reducing 1992 net income by $12.5 million (after applicable tax benefit of $5.6 million). See Note 1 of Notes to Consolidated Financial Statements. Income tax expense was $13.1 million, or 58.2% of pretax income in 1993 compared with $7.4 million, or 95.2%, of pretax income in 1992. The Company elected not to step up its tax bases in the assets acquired in either the Acquisition or the 1988 Acquisition. Accordingly, the Company's income tax bases in the assets acquired have not been changed from those prior to the 1988 Acquisition. Depreciation and amortization of the higher allocated financial statement bases are not deductible for income tax purposes, thus causing the effective income tax rate of the Predecessor to be generally higher than the combined federal and state statutory rate. Because of the adoption of FAS 109 by the Successor, concurrent with the Acquisition, deferred income taxes have been provided for bases differences in all assets and liabilities other than excess of cost over net assets acquired. In compliance with the Omnibus Budget Reconciliation Act of 1993, the Company's tax balances were adjusted in the third quarter of 1993 to reflect the new federal statutory tax rate of 35%. The adjustment had the effect of increasing income tax expense by $2.3 million for 1993 or 10.0% of pretax income. See Note 7 of Notes to Consolidated Financial Statements. The Company recorded net income of $6.0 million in 1993 as compared to net income of $0.3 million in 1992. The 1993 results include extraordinary charges of $3.4 million ($5.5 million before applicable tax benefits) associated with the repayment of the Term Credit and redemption of the Debentures. See also "Liquidity, Capital Resources and Financial Condition". The 1992 results include $18.1 million of Acquisition and Merger related expenses, $12.5 million net of applicable tax benefit, and a $0.1 million extraordinary charge ($0.2 million before applicable tax benefit) resulting from the partial repurchase of a portion of the outstanding Debentures. Twelve Months Ended December 31, 1992 Compared With The Year Ended December 31, 1991 Net sales for 1992 were $909.4 million or 2.7% greater than 1991 due principally to a record volume year with an 8.0% increase in sales volume over 1991. The Company attributes the increase in sales volume at least in part to the strengthening U.S. economy during the period. The positive effects of an increase in sales volumes were partially offset, however, by lower copper prices, the Company's principal raw material, and competitive product pricing. Copper costs are generally passed on to customers through product pricing and the average price for copper on the COMEX declined 2.1% from 1991. Due to increased competitive pressures, primarily in the building wire and telecommunication cable product lines, overall product pricing was below 1991 levels. For a discussion of the Company's practices with respect to the purchase, internal distribution and processing of copper, see "Business Metals Operations." Also see "General Economic Conditions and Inflation" under this caption. The Wire and Cable Division's sales, after reflecting the transfer to the Engineered Products Division of an industrial wire product line representing $32.7 million in sales in 1992, declined 3.1% from 1991 sales levels. Despite such product line transfer, Wire and Cable Division sales volume was nearly 4.7% ahead of 1991 due to improved demand for building wire products. Sales for the division would have increased 5.8% and sales volume would have increased 10.9% in 1992 over 1991 had the industrial wire product line transfer occurred on January 1, 1991. Increased competitive pressures in the fourth quarter of 1992, however, caused an overall deterioration in product pricing for the year. Sales volume during the fourth quarter was essentially unchanged from the same period in 1991. The Magnet Wire and Insulation Division's sales increased 2.7% over 1991 due primarily to a 7.5% improvement in sales volume. Increased automobile and truck production coupled with an upturn in housing starts contributed to the higher volumes. Magnet Wire and Insulation Division product pricing declined marginally from 1991. Telecommunication Products Division sales were off 5.5% from 1991 levels. During 1992, the Telecommunication Products Division experienced more severe pricing pressures in its domestic markets and therefore, diverted a larger portion of its manufacturing capacity to serve export markets. Consequently, export sales for the division were up 111.4% from 1991. Due to the change in product mix and continued pricing pressures, average Telecommunication Products Division product pricing declined moderately from 1991. Engineered Products Division's sales were up $37.1 million from 1991 although $32.7 million of that increase was attributable to the transfer from the Wire and Cable Division of the industrial wire product line. Without giving effect to that transfer, sales were up 6.2% due to an increase in automotive and industrial wire sales volumes. A generally improved economy coupled with an approximate 8.9% rise in domestic automobile and truck production were the primary contributors to this improvement. Cost of goods sold in 1992 increased 3.6% from 1991 due primarily to higher sales volume partially offset by lower copper costs and generally lower other material costs. The Company's cost of goods sold as a percent of net sales was 85.8% and 85.0% in 1992 and 1991, respectively. The cost of goods sold percentage in 1992 was higher than in 1991 because the Company's major business units experienced greater competitive pricing pressure resulting in generally lower selling prices. The higher sales volume, however, lead to increased capacity utilization resulting in generally lower manufacturing costs. Cost of goods sold in 1992 was also impacted by a charge of approximately $2.6 million to reflect anticipated plant consolidations and approximately $1.6 million in additional depreciation expense resulting from the October 1, 1992 application of purchase accounting in connection with the Acquisition and Merger and the concurrent adoption of FAS 109 on a prospective basis. Selling and administrative expenses for 1992 were up 2.2% from 1991 but remained at approximately 9.0% of sales. Contributing to this increase was a $1.5 million accrual in 1992 for the anticipated relocation of a business unit in 1993 and a $1.0 million amortization charge for the excess cost over net assets acquired associated with the Acquisition and Merger and adoption of FAS 109. A reduction of $2.5 million in the Company's allowance for doubtful accounts and a $1.0 million reduction in its health insurance accrual in 1992 offset the foregoing charges. The Company's allowance for doubtful accounts was reduced by $2.5 million (net $1.8 million after approximately $0.7 million current provision) on the basis of the collection of a substantial receivable which had been considered doubtful as well as management's assessment of risk of collection in the primary markets served. In addition, actual health related expenditures did not increase to the levels previously anticipated. The 1991 results include a charge for a warranty claim settlement of approximately $1.7 million. Interest expense in 1992 was $22.6 million as compared to $25.0 million in 1991. This 9.5% decrease was due principally to a $17.5 million reduction in the Company's weighted average total debt outstanding during 1992 and generally lower interest rates on the Company's bank credit facilities. During 1992, Debenture Repurchases totalled $13.8 million while the Company's weighted average interest rate on debt outstanding declined from 10.4% to 8.7%. Partially offsetting these favorable outcomes was an amortization charge related to the deferred debt costs incurred to place the new credit agreement and amortization of deferred debt costs on debt retired and to be retired in connection with the Acquisition. See "Liquidity, Capital Resources and Financial Condition." In connection with the Acquisition and Merger, the Company incurred certain merger related expenses in the amount of $18.1 million consisting primarily of bonus and option payments to certain employees, and certain merger fees and expenses which were charged to operations of the Predecessor in the quarter ended September 30, 1992. These Acquisition and Merger expenses had the effect of reducing net income by $12.5 million (after applicable tax benefit of $5.6 million). See Note 1 of Notes to Consolidated Financial Statements. Income tax expense was $7.4 million, or 95.2% of pretax income in 1992 compared with $13.2 million, or 47.7%, of pretax income in 1991. The Company elected not to step up its tax bases in the assets acquired in either the Acquisition or the 1988 Acquisition. Accordingly, the Company's income tax bases in the assets acquired have not been changed from those prior to the 1988 Acquisition. Depreciation and amortization of the higher allocated financial statement bases are not deductible for income tax purposes, thus causing the effective income tax rate of the Predecessor Company to be generally higher than the approximate statutory rate of 39%. Because of the adoption of FAS 109 by the Successor Company concurrent with the Acquisition, deferred income taxes have been provided for bases differences in all assets and liabilities other than excess of cost over net assets acquired. See Notes 2 and 7 of Notes to Consolidated Financial Statements. The Company's net income for the twelve month period ended December 31, 1992 (after giving effect to $18.1 million of Acquisition and Merger related expenses, $12.5 million net of applicable tax benefit) was $0.3 million which included a $0.1 million ($0.2 million before applicable tax benefit) extraordinary charge resulting from Debenture Repurchases. Liquidity, Capital Resources and Financial Condition The Company had a ratio of debt (consisting of current and non-current portions of long-term debt) to stockholder's equity of approximately 0.7 to 1 at December 31, 1993 and 1992. In connection with the Acquisition and Merger, the Company entered into a credit agreement in September 1992, among BE, the Company, Holdings, the lenders named therein and Chemical Bank, as agent (the "Credit Agreement"). Under the Credit Agreement, the Company borrowed $130.0 million in term loans (the "Term Credit") of which $94.0 million was used to repay all indebtedness outstanding under the Company's previous credit agreement and the balance was used to pay a portion of the consideration payable to Holdings' shareholders and option holders in the Merger and certain fees and expenses of the Company and Holdings related to the Acquisition and Merger and for other general corporate purposes. The Credit Agreement also provided for $155.0 million in revolving credit expiring April 9, 1998. In May 1993, the Company issued $200.0 million aggregate principal amount of its Senior Notes. The net proceeds to the Company from the sale of the Senior Notes, after underwriting discounts, commissions and other offering expenses, were approximately $193.5 million. The Company applied approximately $111.0 million of such proceeds to the repayment of the Term Credit and in June 1993 applied the balance of such proceeds together with new borrowings of approximately $7.5 million under the revolving credit facility of the amended and restated credit agreement (see immediately following paragraph), to redeem all of its outstanding Debentures. The Company recognized extraordinary charges in the second quarter of 1993 of approximately $3.4 million ($5.5 million before applicable tax benefit) associated with the repayment of the Term Credit and redemption of the Debentures. Upon application of the net proceeds received from the Senior Notes to repay the Term Credit, as discussed above, an amendment and restatement of the Credit Agreement became effective (the "Restated Credit Agreement"). The Restated Credit Agreement provides for $175.0 million in revolving credit, subject to specified percentages of eligible assets, reduced by outstanding letters of credit (the "Revolving Credit"). The Revolving Credit expires in 1998. Revolving Credit loans bear interest at floating rates at bank prime rate plus 1.25% or a reserve adjusted Eurodollar rate (LIBOR) plus 2.25%. The effective interest rate can be reduced by 0.25% to 0.75% if certain specified financial conditions are achieved. The Company has purchased interest rate cap protection through 1994 covering up to $100.0 million of Revolving Credit borrowings. No term facility is available under the Restated Credit Agreement. Through December 31, 1993, the Company fully complied with all of the financial ratios and covenants contained in the Restated Credit Agreement and the indenture under which the Senior Notes were issued (the "Indenture"). The Restated Credit Agreement and the Indenture contain provisions which may restrict the liquidity of the Company. These include restrictions on the incurrence of additional indebtedness and, in the case of the Restated Credit Agreement, mandatory principal repayment requirements for all indebtedness that exceeds the Borrowing Base as defined in the Restated Credit Agreement. Net cash provided by operating activities in 1993 was $60.7 million, an increase of $27.2 million over 1992. Cash flow provided by operating activities in 1993, together with borrowings under the revolving credit facility of the Credit Agreement and the Restated Credit Agreement were sufficient to meet the Company's cash interest requirements, working capital and capital expenditure needs and to pay mandatory principal payments on the Term Credit portion of the Credit Agreement. As previously discussed, the Term Credit was repaid in full in May 1993 out of proceeds from the issuance and sale of the Senior Notes. Capital expenditures in 1993 were $26.2 million or $5.0 million less than in 1992. Such expenditures included $2.6 and $9.2 million for a new magnet wire manufacturing facility in Franklin, Indiana in 1993 and 1992, respectively. This new facility is occupied by both the Company and Femco. Femco was established in 1988 as a joint venture between the Company and The Furukawa Electric Company, Ltd., Tokyo, Japan. At December 31, 1993, approximately $8.6 million was committed to outside vendors for capital projects to expand capacity, complete modernization projects, reduce costs and ensure continued compliance with regulatory provisions. Capital expenditures in 1994 are expected to approximate 1993 spending levels. In November 1993, the Company acquired a majority interest in Interstate Industries, Inc. for cash of $4.3 million, subject to final purchase price adjustments and the minority interest ownership percentage. See "Business--Business Development." The Restated Credit Agreement imposes annual limits on the Company's capital expenditures and business acquisitions. The Company anticipates that its working capital, capital expenditure and cash interest requirements for 1994 will be satisfied through a combination of funds generated from operating activities together with funds available under the Revolving Credit. Management bases such belief on historical experience and the substantial availability of funds under the Revolving Credit. Increased working capital needs occur whenever the Company experiences strong incremental demand in its business as well as a significant rise in copper prices. Average quarterly cash flow generated from operations for the three year period ended December 31, 1993 was $13.7 million; at December 31, 1993 the entire $175.0 million of Revolving Credit was available, subject to specified percentages of eligible assets, (less $13.9 million in outstanding letters of credit). During 1993, average borrowings under the Company's revolving credit facilities were $10.1 million compared to $66.8 million during 1992. In 1993 certain pension actuarial assumptions were revised to reflect changes in their underlying economic fundamentals. The effect of such revisions on the Company's results of operations and cash flows for 1994 is not expected to be material. The Company expects that it may also make certain cash payments to Holdings or other affiliates from time to time to the extent cash is available and to the extent it is permitted to do so under the terms of the Restated Credit Agreement and the Indenture. Such payments may include (i) an amount necessary under the tax sharing agreement between the Company and Holdings to enable Holdings to pay the Company's taxes as if computed on an unconsolidated basis; (ii) a management fee to an affiliate of BHLP of up to $1.0 million; (iii) amounts to repurchase outstanding Senior Discount Debentures due 2004 of Holdings (the "Holdings Debentures") to the extent they may become available for repurchase in the open market at prices which Holdings and the Company find attractive and to the extent such repurchases are permitted under the terms of the instruments governing Holdings and the Company's indebtedness; and (iv) other amounts to meet ongoing expenses of Holdings (such amounts are considered to be immaterial both individually and in the aggregate). To the extent the Company makes any such payments, it will do so out of operating cash flow or borrowings under the Restated Credit Agreement and only to the extent such payments are permitted under the terms of the Restated Credit Agreement and the Indenture. Each of the foregoing payments is either completely discretionary on the part of the Company or may be waived by an affiliate of the Company. Notwithstanding any of the foregoing payments which the Company may make to Holdings, Holdings' actual liquidity requirements are expected to be insubstantial in 1994 on an unconsolidated basis because Holdings has no operations (other than those conducted through the Company) or employees and is not expected to have any tax liability on an unconsolidated basis. Holdings' Series A Cumulative Redeemable Exchangeable Preferred Stock, Liquidation Preference $25 Per Share (the "Series A Preferred Stock"), which was issued in connection with the Acquisition and Merger, provides that dividends may be paid in kind at the option of Holdings until 1998 and is not subject to mandatory redemption until 2004 (except upon the occurrence of certain specified events). The redemption price is $25 per share plus accrued and unpaid dividends to the date of redemption. For the year ended December 31, 1993 Holdings recorded dividends in kind of $5.2 million. The Restated Credit Agreement permits Holdings to pay dividends in cash on the Series A Preferred Stock subject to certain limitations. However, in the near term, Holdings expects to pay dividends on the Series A Preferred Stock in additional shares of such stock. The Holdings Debentures are not expected to have an impact on the Company's liquidity prior to November 15, 1995 (unless they are repurchased or refinanced prior to that date) when cash interest at 16.0% first becomes payable semi-annually. The Holdings Debentures were issued in May 1989. As of December 31, 1993, Holdings had a liability, net of repurchases, of $228.9 million in respect of the Holdings Debentures ($277.8 million aggregate principal amount). Through December 31, 1993 Holdings had repurchased $64.2 million aggregate principal amount of its Holdings Debentures in the open market using cash dividends, management fees and income taxes paid to Holdings by the Company together with available cash. Such payments were made pursuant to the Company's prior credit agreement which was terminated October 9, 1992. There have been no repurchases of Holdings Debentures since 1991 and further repurchases, if any, may be made at the discretion of Holdings and will depend upon market conditions, and, in particular, the prices at which the Holdings Debentures are trading as well as Holdings' available cash. The Holdings Debentures are unsecured debt of Holdings and are effectively subordinated to all outstanding indebtedness of the Company, including the Senior Notes, and will be effectively subordinated to other indebtedness incurred by direct and indirect subsidiaries of Holdings, if issued. Because Holdings is a holding company with no operations and has virtually no assets other than the outstanding capital stock of the Company (all of which is pledged to the lenders under the Restated Credit Agreement), Holdings' ability to meet its cash obligations will be dependent upon the Company's ability to pay dividends, loan or to otherwise advance or transfer funds to Holdings in sufficient amounts. The Company believes that the Restated Credit Agreement and the Indenture permit the Company to dividend or otherwise provide funds to Holdings to enable Holdings to meet its known cash obligations provided that the Company meets certain conditions. Among such conditions, however, are that the Company meet various financial maintenance tests. There can be no assurance that such tests will be met, in which case the Company would not be able to pay dividends to Holdings without the consent of the percentage of the lenders specified in the Restated Credit Agreement and/or the holders of the percentage of the Senior Notes specified in the Indenture. There can be no assurance that the Company would be able to obtain such consents, or meet the terms on which such consents might be granted if they were obtainable. Moreover, a violation of the Restated Credit Agreement and/or the Indenture could lead to an event of default and acceleration of outstanding indebtedness under the Restated Credit Agreement and to acceleration of the indebtedness represented by the Senior Notes and the Holdings Debentures. Because the capital stock of the Company and its subsidiaries, as well as virtually all of the assets of the Company and its subsidiaries, are pledged to the lenders under the Restated Credit Agreement, such lenders would have a claim over such assets prior to holders of the Senior Notes and the Holdings Debentures. In the event Holdings were unable to meet its cash obligations, a sequence of events similar to that described above could ultimately occur. General Economic Conditions and Inflation The Company faces various economic risks ranging from an economic downturn adversely impacting the Company's primary markets to marked fluctuations in copper prices. In the short-term, pronounced changes in the price of copper tend to affect the Wire and Cable Division's gross profits because such changes affect raw material costs more quickly than those changes can be reflected in the pricing of the Wire and Cable Division's products. In the long-term, however, copper price changes have not had a material adverse effect on gross profits because cost changes generally have been passed through to customers over time. In addition, the Company believes that its sensitivity to downturns in its primary markets is less significant than it might otherwise be due to its diverse customer base and its strategy of attempting to match its copper purchases with its needs. During 1993, the Company experienced general improvement in most of its markets served coinciding with general economic conditions. The Company cannot predict either the continuation of current economic conditions or future results of its operations in light thereof. The Company believes that it is not particularly affected by inflation except to the extent that the economy in general is thereby affected. Should inflationary pressures drive costs higher, the Company believes that general industry competitive price increases would sustain operating results, although there can be no assurance that this will be the case. Item 8.

33565

1993

ITEM 6. SELECTED FINANCIAL DATA Selected financial data included in the Registrant's 1993 Annual Report to Shareholders, portions of which are furnished to the Commission as Exhibit 13 to this Report, under the headings "Statement of Operations Data," "Share Data" and "Balance Sheet Data," are hereby incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information included under the heading "Discussion of Financial Information" in the Registrant's 1993 Annual Report to Shareholders, portions of which are furnished to the Commission as Exhibit 13 to this Report, is hereby incorporated herein by reference. ITEM 8.

745287

1993

Item 6. Selected Financial Data The information set forth under the heading "Supplemental Information - Five Year Summary of Selected Financial Data" appearing on page 33 of the Company's 1993 Annual Report to Stockholders is incorporated herein by reference. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information set forth under the heading "Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition" appearing on pages 34-35 of the Company's 1993 Annual Report to Stockholders is incorporated herein by reference. Item 8.

93469

1993

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following commentary presents Management's discussion and analysis of the Corporation's financial condition and results of operations. The review highlights the principal factors affecting earnings and the significant changes in balance sheet items for years 1993, 1992 and 1991. Financial information for prior years is presented when appropriate. The objective of this financial review is to enhance the reader's understanding of the accompanying tables and charts, the consolidated financial statements, notes to the financial statements and financial statistics appearing elsewhere in this report. Where applicable, this discussion also reflects Management's insights of known events and trends that have or may reasonably be expected to have a material effect on the Corporation's operations and financial condition. All financial data has been restated to give effect to acquisitions accounted for on a pooling of interest basis and stock splits in previous periods. The results of other bank and branch acquisitions, accounted for as purchases, have been included effective with the respective dates of acquisition. EARNINGS SUMMARY First Bancorporation of Ohio's net income for 1993 totaled $55.2 million. This represents an 8.9% increase over 1992 and a record high for the Corporation. Net income was favorably affected by a strong net-interest margin, improved asset quality and increased non-interest income. Net income for 1993 of $55.2 million compares to $50.7 million in 1992 and $39.6 million in 1991. The return on average assets for the Corporation equaled 1.39% in 1993 compared to 1.34% in 1992 and 1.07% in 1991. The Corporation's return on average equity, which is largely affected by its strong capital base, equaled 14.69% in 1993 compared to 14.80% and 12.50% in 1992 and 1991, respectively. On August 19, 1993 the Corporation's Board of Directors declared a 2-for-1 split of the Corporation's common stock, to shareholders of record as of August 30, 1993. The per share data is restated to reflect the stock split. Net income on a per share basis totaled $2.19 compared to $2.02 in 1992 and $1.58 in 1991. The following table summarizes the changes in earnings per share for 1993 and 1992. NET INTEREST INCOME Net interest income, the difference between interest and loan fee income on earning assets and the interest paid on deposits and borrowed funds, is the principal source of earnings for the Corporation. Throughout this discussion net interest income is presented on a fully taxable equivalent (FTE) basis which restates interest on tax-exempt securities and loans as if such interest was subject to federal income tax at the statutory rate. Net interest income is affected by market interest rates on both earning assets and interest bearing liabilities, the level of earning assets being funded by interest bearing liabilities, non-interest bearing liabilities and equity and the growth in earning assets. The following table shows the allocation to assets, the source of funding and their respective interest spreads. Net interest income totaled $189.7 million in 1993, an increase of $4.1 million or 2.2% compared to 1992. Net interest income in 1993 continued to be affected by market interest rates, as lower rates impacted both average earning assets as well as interest-bearing liabilities. The yield on earning assets fell 82 basis points, or 7.87% in 1993 compared to 8.69% in 1992, while the Corporation's cost of funds dropped from 4.01% in 1992 to 3.21% in 1993, or a total of 80 basis points. In addition to changes in market interest rates, the funding of earning assets with non-interest bearing liabilities and equity increased to 19.2% of earning assets in 1993 compared to 17.2% in 1992. Average earning assets grew 4.0% compared to one year ago. The table below provides an analysis of the effect of changes in interest rates and volumes on net interest income in 1993 and 1992. Total interest income decreased by $17.6 million or 5.8% in 1993 compared to 1992. Lower interest rates accounted for $28.8 million of the decrease which was offset by a $11.2 million increase due to increased volumes. Interest income from taxable investment securities increased $3.3 million due to increased volume while income from tax-exempt securities was down slightly due to maturities within the portfolio. The overall increase in interest income due to increases in the investment portfolio was offset by a combined decrease due to interest rates of $11.3 million. Interest income from loans and leases increased $8.0 million as a result of a 4.4% increase in outstandings, while lower interest rates decreased interest income $17.1 million for a net decrease of $9.0 million. Lower market interest rates not only reduced interest expense but also continued to affect the mix of interest bearing liabilities as depositors moved funds to more liquid deposits. Overall, interest expense decreased $21.7 million compared to one year ago or 18.9%. Lower interest rates accounted for virtually all of the drop as the decrease due to rate changes was $21.2 million compared to $.5 million due to volume. As noted above, lower market rates resulted in a shift to more liquid deposits as lower outstandings reduced interest expense on certificates and other time deposits. The interest expense on savings and interest bearing demand accounts increased due to higher volumes. The $4.1 million increase in net interest income in 1993 resulted from an $11.7 million increase due to changes in volume which was offset by a $7.6 million decrease due to changes in interest rates. The net interest margin is calculated by dividing net interest income FTE by average earning assets. As with net interest income, the net interest margin is affected by the level and mix of earning assets, the proportion of earning assets funded by non-interest bearing liabilities and the interest rate spread. In addition, the net interest margin is also impacted by changes in federal income tax rates and regulations as they affect the tax equivalent adjustment. The net interest margin was 5.28% in 1993 compared to 5.37% in 1992 and 4.71% in 1991. As interest rates continued their decline in 1993, the yield on earning assets ended the year at 7.87% down from 8.69% in 1992. The cost of funding the earning assets during 1993 fell 73 basis points to 2.59% compared to 3.32% in 1992. The mix of earning assets continued to be affected by economic uncertainty during 1993 as average loans outstanding increased 4.1% compared to one year ago. Average loans equalled 65.9% of average earning assets compared to 65.8% and 64.6% in 1992 and 1991, respectively. The amount of average earning assets funded by non-interest bearing liabilities and equity totaled 19.2% in 1993 compared to 17.2% in 1992 and 15.2% in 1991. NON-INTEREST INCOME Non-interest income totaled $54.3 million, an increase of 7.0% compared to 1992. This follows a 13.9% increase for 1992 compared to 1991. Service charges on deposit accounts increased 2.6% compared to 1992 and accounted for 37.5% of non-interest income compared to 39.1% and 39.7% in 1992 and 1991, respectively. Trust fees increased 8.8% compared to one year ago and represent 18.2% of non-interest income. Credit card fees accounted for 14.7% of non-interest income while increasing 9.2% compared to one year ago. Lower market interest rates continued to have a significant impact on mortgage lending activities throughout 1992 and into 1993. Mortgage sales and loan servicing fees increased from $3.8 million in 1992 to $4.7 million in 1993, an increase of 22.5%. The Corporation's policy is to sell all fixed rate thirty year residential mortgage loans originated while retaining the servicing for these loans. Non-interest income covered 35.9% of non-interest expense in 1993, compared to 36.2% in 1992 and 34.3% in 1991. The Corporation continues to pursue new business opportunities which generate fee income and are not subject to interest rate volatility. NON-INTEREST EXPENSE Non-interest expense increased 7.9% in 1993 compared to 1992 after a 7.8% increase for 1992 compared to 1991. Salaries and wages increased 5.9% in 1993 compared to 1992 and represent 38.4% of non-interest expense compared to 39.2% one year ago. Employee benefit expense increased $3.7 million or 24.7% in 1993. Approximately $3.0 million of the increased employee benefit expense was a result of a change made to the Corporation's benefit plan for postretirement medical and life insurance discussed below. During 1993 the Corporation adopted the Financial Accounting Standards Board Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." SFAS No. 106 requires that the cost of all postretirement benefits expected to be provided by an employer to current and future retirees be accrued over those employees' service periods. In addition to recognizing the cost of benefits for the current service period, SFAS No. 106 also provides for the recognition of the cost for postretirement benefits earned in prior service periods as well as for employees currently retired (the transition obligation). This Statement became effective for the Corporation on January 1, 1993. The Corporation has a benefit plan which presently provides postretirement medical and life insurance for retired employees. Effective January 1, 1993 the Corporation made significant plan changes for future retired participants. For employees who retire after January 1, 1993 the Corporation's medical contribution is capped at 200% of the 1993 level while the medical portion for employees retired prior to January 1, 1993 anticipates the Corporation's contribution to continue to increase as a proportion of the cost of the plan. The Corporation reserves the right to terminate or make additional plan changes at any time. As of January 1, 1993 the Corporation's accumulated postretirement benefit obligation (APBO) totaled $19.0 million, and the annual postretirement benefit cost amounted to $2.1 million. The Corporation has elected to amortize the APBO over twenty years at an annual cost of $.9 million, bringing the total expense to $3.0 million for 1993. During 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FDICIA mandated the FDIC to develop a risk-based assessment system no later than January 1, 1994. During 1993, the FDIC issued regulations that will take effect on January 1, 1994 and that will adopt, with few changes, the transitional assessment system that was in effect in 1993 as the final assessment system. Under the final system, the annual assessment rate for each insured institution is determined on the basis of both capital and supervisory measures, and can range from $.23 per $100.00 of deposits to $.31 per $100.00 of deposits, depending on the capital and supervisory strength of the institution. At December 31, 1993, all the subsidiaries of the Corporation would be assessed at the rate of $.23 per $100.00 of deposits. Total premiums paid by the Corporation during 1993 were $7.4 million compared to $7.2 million and $6.7 million in 1992 and 1991, respectively. Various legislative proposals concerning the banking industry and regulatory reform are pending in Congress. Given the uncertainty of the legislative process, Management cannot assess the impact of such legislation on the Corporation's financial condition or results of operations. In November of 1992 the Financial Accounting Standards Board issued Statement No. 112, "Employers' Accounting for Postemployment Benefits." SFAS No. 112 establishes standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to former or inactive employees after employment, but before retirement. Currently the Corporation does not provide any postemployment benefits to employees which would have any material impact on the Corporation's results of operations or capital level. FEDERAL INCOME TAX On August 10, 1993 Congress enacted the Omnibus Budget Reconciliation Act of 1993 which included among its provisions an increase in the statutory rate from 34% to 35%. Other provisions which will impact the Corporation include changes in the deductibility of certain business expenses, changes in determining benefits and contributions under its qualified retirement plan, and the ability to depreciate future intangible assets. Federal income tax expense totaled $25.5 million in 1993 compared to $22.4 million in 1992 and $15.4 million in 1991. The effect of the increase in the statutory rate, which was retroactive to the beginning of the year, totaled $.5 million. The remainder of the increase for 1993 over the prior periods resulted from increased income before federal income taxes and increases in the Corporation's effective federal income tax rate. In 1993 the effective federal income tax rate for the Corporation equaled 31.6% compared to 30.6% in 1992 and 28.0% in 1991. One of the factors which continues to affect the effective tax rate was the Tax Reform Act of 1986 which raised the disallowance of interest cost on funds employed to carry most tax-exempt securities and loans acquired after August 7, 1986 from 20% to 100%. The result is that a greater proportion of pre-tax earnings are subject to federal income tax. The Corporation continues to invest in obligations of the local communities it serves. During 1993 the Corporation adopted the Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes." The objective of SFAS No. 109 is to recognize the amount of taxes payable or refundable for the current year as well as to recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns. The Corporation had accounted for income taxes in accordance with SFAS No. 96. As a result the adoption of SFAS No. 109 did not have a material impact on the Corporation's results of operations or level of capital. INVESTMENT SECURITIES The investment portfolio is maintained by the Corporation to provide liquidity, earnings, and a means of diversifying risk. Investment securities are purchased with the ability and the intent to hold them to maturity and, therefore, are carried at amortized cost. At December 31, 1993 investment securities totaled $1,209.7 million compared to $1,167.2 million one year ago, an increase of 3.6%. Investment securities totaled $1,119.3 million at December 31, 1991. During 1993 approximately $20.6 million of investment securities were sold for which a $29 thousand net gain was realized. A summary of investment securities' book value is presented below as of December 31, 1993, 1992 and 1991. Presented with the summary is a maturity distribution schedule with corresponding weighted average yields. The schedule reflects the liquidity within the investment securities portfolio as 15.6% of the total securities have maturities of one year or less. BOOK VALUE OF INVESTMENT SECURITIES MATURITIES OF THE INVESTMENT SECURITIES AT DECEMBER 31, 1993 As a result of lower market interest rates and the impact of Tax Reform Act of 1986, noted in the discussion of federal income taxes, the Corporation continued to increase its investment in U.S. Government agencies, mortgage- backed securities and other securities helping to maximize the yield of the investment portfolio while maintaining its soundness. At December 31, 1993 these securities represented 63.5% of the total portfolio compared to 59.4% and 58.3% in 1992 and 1991, respectively. At December 31, 1993 the investment portfolio had a book value of $1,209.7 million compared to a market value of $1,224.7 million for an unrealized net gain of $15.0 million. The yield on the portfolio fell to 6.67% in 1993 compared to 7.69% in 1992 and 8.52% in 1991. Continued low market interest rates in 1993 will further impair re-investment opportunities going forward. In May 1993, the Financial Accounting Standards Board issued Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The statement requires debt and equity securities to be classified as held- to-maturity, available-for-sale, or trading. Securities classified as held- to-maturity are measured at amortized or historical cost, securities available-for-sale and trading at current market. Adjustment to fair value of the securities available-for-sale, in the form of unrealized holding gains and losses, is excluded from earnings and reported as a net amount in a separate component of shareholders' equity. Adjustment to fair value of securities classified as trading is included in earnings. This statement becomes effective in 1994. Management is continuing to analyze the investment securities portfolio in order to determine the appropriate classification of held-to-maturity and available-for-sale. Current analysis indicates approximately 70% of the portfolio would be held-to-maturity and 30% available-for-sale. At this time the Corporation does not foresee any securities being classified as trading. While the adoption of SFAS No. 115 should not have a material impact on results of operations or level of capital, the above mentioned analysis would result in an adjustment to capital of approximately $12.0 million based upon a 300 basis point movement in current market interest rate at year end. LOANS Total loans outstanding at December 31, 1993 increased 3.2% compared to one year ago or $2,396.5 million compared to $2,321.8 million. A breakdown by category follows along with a maturity summary of commercial, financial, and agricultural loans. Real estate loans at December 31, 1993 totaled $1,311.8 million or 54.7% of total loans outstanding compared to 58.5% one year ago. Residential loans (1-4 family dwellings) totaled $726.8 million, home equity loans $87.5 million, construction loans $35.2 million and commercial real estate loans $462.3 million. Commercial real estate loans include both commercial loans where real estate has been taken as collateral as well as loans for commercial real estate. The majority of the commercial real estate loans look to the tenants' business for cash flow to service the debt and not to rents of the building itself. These loans are generally a part of an overall relationship with existing customers primarily within northeast Ohio. There are no loans outstanding which in total could be considered a concentration of lending in any particular industry or group of industries. Most of the Corporation's business activity is with customers located within the state of Ohio. ASSET QUALITY Credit risk is managed through the Corporation's loan policy which provides the Credit Risk Management Division of the Parent Company the responsibility for managing asset quality. The Division's responsibilities include the development of credit policies to ensure sound credit decisions, loan review, early identification of problem loans, and overseeing loan workouts in subsidiary banks. The Corporation's credit policies and review procedures are meant to minimize the risk and uncertainties inherent in lending. In following these policies and procedures, Management must rely upon estimates, appraisals, and evaluations of loans and the possibility that changes in such estimates, appraisals and evaluations could occur quickly because of changing economic conditions and the economic prospects of borrowers. NON-PERFORMING ASSETS Non-performing assets consist of loans on non-accrual, loans which have been restructured and other real estate, which are defined as follows: bullet Non-accrual loans are loans which are 90 days past due and with respect to which, in Management's opinion, collection of interest is doubtful. These loans no longer accrue interest and are accounted for on a cash basis. bullet Loans are classified as restructured when, due to the deterioration of a customer's financial ability, the original terms have been favorably modified or either principal or interest has been forgiven. bullet Other real estate consists of real estate acquired through foreclosure as satisfaction of debt and loans for which, in Management's opinion, in-substance foreclosure has occurred. Loans which are 90 days or more past due but continue to accrue interest are loans which, in Management's opinion, are well secured and are in the process of collection. Non-performing assets at December 31, 1993 totaled $17.7 million down, from $32.5 million in 1992 and $34.2 million in 1991. As a percent of total loans outstanding, non-performing assets were .74% in 1993 compared to 1.40% in 1992 and 1.52% in 1991. At December 31, 1993 other real estate owned included $4.3 million of loans which have been classified as in-substance foreclosures and have been charged down to their fair value. For the year ended December 31, 1993 interest income that would have been earned had these loans not been classified as non-accrual or restructured amounted to $646,000. The interest income actually earned on these loans amounted to $594,000. In addition to the loans classified as non-performing or past due 90 days or more accruing interest, there were $36.9 million at December 31, 1993 that Management believes to be potential problem loans. The loans are closely monitored by the Credit Risk Management Division to assess the borrowers' ability to comply with the terms of the loans. Management's most recent review indicates that a charge against the allowance for possible loan losses or classification as non-performing is not warranted for these loans at this time. ALLOWANCE FOR POSSIBLE LOAN LOSSES The Corporation's policy is to maintain the allowance for possible loan losses at a level considered by Management to be adequate for potential future losses. The evaluation performed by the Credit Risk Management Division of the Parent Company is based upon a continuous review of delinquency trends; the amount of non-performing loans (non-accrual, restructured, and other real estate owned); loans past due 90 days or more and classified loans; historical and present trends in loans charged-off; changes in the composition and level of various loan categories; and current economic conditions. At December 31, 1993, the allowance for possible loan losses was $31.2 million or 1.30% of loans outstanding compared to $29.2 million or 1.26% in 1992 and $24.8 million or 1.10% in 1991. The allowance for loan losses coverage of non-performing assets equalled 176.38% and 6.84 times 1993 net charge-offs. Net charge-offs for 1993 were $4.6 million, down from $13.0 million and $10.1 million in 1992 and 1991, respectively. As a percent of average loans outstanding, net charge-offs dropped from .57% and .46% in 1992 and 1991, respectively, to .19% in 1993. Management continues to believe that loans should be charged against the allowance for possible loan losses as soon as losses are identified. A six year summary of loan losses follows: Allocation of the Allowance for Loan Losses DEPOSITS Average deposits in 1993 increased 4.2% compared to 1992 as market interest rates continued at their lowest level in over 30 years. Total deposits averaged $3,394.9 million compared to $3,256.7 million and $3,192.2 million in 1992 and 1991, respectively. As market interest rates continued their downward trend throughout the year, the mix of deposits continued to shift toward the more liquid types of deposits. The average yield on certificates and other time deposits dropped from 6.76% in 1991 and 5.00% in 1992 to 4.01% in 1993 as the percent of certificates and other time deposits to total deposits fell to 35.3% in 1993 compared to 46.3% in 1991. Savings deposits increased 11.7% compared to one year ago and represent 37.3% of total deposits. Interest bearing demand deposits also increased 9.2%, totaling 8.6% of deposits as the average rate dropped to 2.35%. Non- interest bearing demand deposits totaled $639.3 million, an increase of 18.7%, and represent 18.8% of total deposits. The average cost of deposits was down 77 basis points compared to one year ago, or 2.63% compared to 3.40%. Based upon prior interest rate cycles, deposits tend to move back into certificates of deposits as interest rates rise, to obtain a premium for investing in longer term certificates. The following table summarizes the certificates and other time deposits in amounts of $100,000 or more as of December 31, 1993, by time remaining until maturity. INTEREST RATE SENSITIVITY Interest rate sensitivity measures the potential exposure of earnings and capital to changes in market interest rates. The Corporation has a policy which provides guidelines in the management of interest rate risk. This policy is reviewed periodically to ensure it complies with trends within the financial markets and within the industry. The analysis presented below divides interest bearing assets and liabilities into maturity categories and measures the "GAP" between maturing assets and liabilities in each category. The analysis shows that liabilities maturing within one year exceed assets maturing within the same period by a moderate amount. The Corporation uses the GAP analysis and other tools to monitor rate risk. At December 31, 1993 the Corporation was in a moderate liability- sensitive position as illustrated in the following table: CAPITAL RESOURCES Shareholders' equity at December 31, 1993 totaled $391.6 million compared to $358.3 million at December 31, 1992, an increase of 9.3%. The following table reflects the various measures of capital: The risk-based capital guidelines issued by the Federal Reserve Bank in 1988 require banks to maintain capital equal to 8% of risk-adjusted assets effective December 31, 1992. At December 31, 1993 the Corporation's risk- based capital equalled 16.46% of risk-adjusted assets, far exceeding the minimum guidelines. As noted earlier, the Corporation's Board of Directors declared a 2-for-1 split of the Corporation's common stock on August 19, 1993. The split was paid to shareholders of record as of August 30, 1993. In addition to the stock split, the Directors of First Bancorporation of Ohio increased the quarterly cash dividend, marking the twelfth consecutive year of annual increases since the Corporation's formation in 1981. The cash dividend of $.235 paid has an indicated annual rate of $.94 per share. Over the past five years the dividend has increased at an annual rate of 7.4%. LIQUIDITY The Corporation's primary source of liquidity is its strong core deposit base, raised through its retail branch system, along with a strong capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments. The banking subsidiaries individually maintain sufficient liquidity in the form of temporary investments and a short-term maturity structure within the investment portfolio, along with cash flow from loan repayment. Asset growth in the banking subsidiaries is funded by the growth of core deposits. The liquidity needs of the Parent Company, primarily cash dividends and other corporate purposes, are met through cash, short-term investments and quarterly dividends from banking subsidiaries. Management is not aware of any trend or event which will result in or that is reasonably likely to occur that would result in a material increase or decrease in the Corporation's liquidity. REGULATION AND SUPERVISION FDICIA, which was enacted on December 19, 1991, substantially revised the regulation of financial institutions, including the creation of a strict uniform system of capital-based regulation, which became effective on December 19, 1992. FDICIA established five different levels of capitalization of financial institutions, with "prompt corrective actions" and significant operational restrictions imposed on institutions that are capital deficient under the categories. The five categories are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. To be considered well capitalized an institution must have a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, a leverage capital ratio of 5%, and must not be subject to any order or directive requiring the institution to improve its capital level. An institution falls within the adequately capitalized category if it has a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4% and a leverage capital ratio of at least 4%. Institutions with lower capital levels are deemed to be undercapitalized, significantly undercapitalized or critically undercapitalized, depending on their actual capital levels. The appropriate federal regulatory agency may also downgrade an institution to the next lower capital category upon a determination that the institution is in an unsafe or unsound condition or is engaged in an unsafe or unsound practice. Institutions are required under FDICIA to monitor closely their capital levels and to notify their appropriate regulatory agency of any basis for a change in capital category. On December 31, 1993, the Parent Company and its subsidiaries all exceeded the minimum capital levels of the well capitalized category. Regulatory oversight of an institution becomes more stringent with each lower capital category, with certain "prompt corrective actions" imposed depending on the level of capital deficiency. For example, under "prompt corrective action" the regulators may restrict dividends and management fees, require capital restoration plans, require parent guarantees of capital restoration plans and limit senior executive compensation. In addition to these actions, further restrictions may be applied to institutions which fail to provide a capital undercapitalized restoration plan or which are categorized as significantly or critically undercapitalized. Among these remedies are selling or liquidating the institution, dismissing directors or senior executive officers, and restricting transactions. EFFECTS OF INFLATION The assets and liabilities of the Corporation are primarily monetary in nature and are more directly affected by the fluctuation in interest rates than inflation. Movement in interest rates is a result of the perceived changes in inflation as well as monetary and fiscal policies. Interest rates and inflation do not move with the same velocity or within the same time frame; therefore, a direct relationship to the inflation rate cannot be shown. The financial information presented in this annual report, based on historical data, has a direct correlation to the influence of market levels of interest rates. Therefore, Management believes that there is no material benefit in presenting a statement of financial data adjusted for inflationary changes. ITEM 8.

354869

1993

ITEM 6 SELECTED FINANCIAL DATA The information called for by this Item is incorporated herein by reference to Selected Financial Data Table in the 1993 Annual Report. ITEM 7

ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information called for by this Item is incorporated herein by reference to Consolidated Financial Review Section in the 1993 Annual Report and the following tables and graphs in the 1993 Annual Report: GRAPHS: - ------- Return on Average Equity Return on Average Assets Earnings Per Share Earnings Trend Net Interest Margin and Spread Profitability Per Employee Earning Asset Mix as a Percentage of Average Assets Average Loan Composition Deposits and Other Interest-Bearing Liabilities as a Percentage of Average Assets Net Charge-Offs Nonperforming Loans Nonperforming Assets to Total Loans Cumulative Changes in Nonaccrual Loans and Other Real Estate since Year-End 1988 (Quarterly) Cumulative Changes in Classified Assets Since Year-End 1988 (Quarterly) TABLES: - ------- Analysis of Changes in Net Interest Income Analysis of Noninterest Income and Noninterest Expense Summary of Quarterly Financial Information Rate Sensitivity Analysis at December 31, 1993 Maturities of Investment Securities at December 31, 1993 Maturities of Loans at December 31, 1993 Consumer Loans by Product at December 31 Regulatory Capital at December 31 Net Loans and Foreclosed Real Estate at December 31 FTBNA Loans Secured by Real Estate at December 31 Analysis of Allowance for Loan Losses Changes in Nonperforming Assets at December 31 Nonperforming Assets at December 31 Selected Financial Data Credit Ratings at December 31,1993 Net-Charge Offs as a Percentage of Average Loans, Net of Unearned Income Obligations of States and Municipalities by Quality Rating at December 31, 1993 Consolidated Average Balance Sheet and Related Yields and Rates ITEM 8

36966

1993

Item 6. Selected Consolidated Financial Data The following selected consolidated financial data for the five years ended December 31, 1993; are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein. The comparability of the results for the periods presented is affected by certain transactions as described in Note 18 of Notes to the Consolidated Financial Statements. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS 1993 Compared to 1992 Division Overview The income (loss) before income taxes by Division for 1993 and 1992 are as follows (in thousands): 1993 1992 Insurance: Health Unit $ 8,578 $(26,613) Life Unit 7,623 340 Marketing 10,205 3,345 Managed Care (1,211) 335 Corporate (6,431) (2,843) Total $18,764 $(25,436) Health The significant increase in pre tax income for 1993 is due principally to the $30 million pre tax write-down of deferred policy acquisition costs in 1992. The remaining increase is due to the improved loss ratios on the Medicare supplement business and stabilized loss ratios on major hospital products. The improved loss ratios on Medicare supplement (63.4% in 1993 versus 67.6% in 1992) allowed the Company to freeze 1994 premiums for certain of these products in many states. The Company has received positive customer response to this action and expects that will increase retention on this business. Cost reduction programs have reduced the general insurance expense ratios (excludes commissions) down to 9.8% in 1993 from 10.2% in 1992 despite one-time consolidation costs of certain operations. Life The consolidation of all life insurance administration to one location on December 31, 1992, contributed to reduced general expenses in 1993 and the resulting increase in pre tax income. The unit cost per policy in- force decreased from $150 in 1992 to approximately $80 in 1993. In addition, interest spreads on life and annuity business improved despite the decline in investment yields in 1993. The mortality on the existing block of life business continued to improve in 1993 from the levels experienced in 1992. The Company is placing more emphasis on increasing life and annuity business during the next five years to mitigate any adverse effects due to healthcare reform. Marketing The increase in pre tax income was due to a 14% increase in revenue over a relatively fixed expense base. The division continued to lower lead generation costs and development costs associated with a new commission payment system during 1993. The 1992 results were negatively affected by approximately $2 million due to the settlement of certain disputes with former agents. The Marketing Division currently receives the commission overrides previously due these agents pursuant to the settlement. Managed Care The division experienced a pre tax loss of $1.2 million primarily due to start-up costs associated with a new third-party administrator and occupational medical management company formed in 1993, as well as costs of a complete rewrite of the medical criteria. The division discontinued the operation of the third-party administrator in the fourth quarter of 1993. The core business of the division increased over 100% during 1993. The significant increase in revenue was offset by sales development costs and personnel additions to support a foundation for future growth. Corporate Interest expense increased from $2,189,000 in 1992 to $3,276,000 in 1993 due to the issuance of convertible debentures. Corporate expenses also increased due to costs associated with new investor relations programs, expenses related to the public offering, and reallocation of certain senior management personnel who monitor and control division profitability at the corporate level. Consolidated Financial Condition and Results of Operations The Company reported net income of $12,145,000 for the twelve months ended December 31, 1993, compared to a net loss of $16,959,000 for the comparable period in 1992. The net loss for 1992 was primarily attributable to a $30,000,000 pre-tax write-down of deferred policy acquisition costs. The remaining increase was due to improved loss ratios on the Medicare supplement business, expense reductions in the Life Insurance Unit and increased revenue and margins in the Marketing Division. Total revenues increased $47,751,000 or 7% for the twelve month period in 1993 as compared to 1992. The increase in revenue is due to the increase in premiums and policy charges of $50,449,000 which was partially offset by reduced levels of net investment income. Accident and health insurance premiums increased $41,790,000, or 7%, in 1993 as compared to 1992. Premiums from major hospital plans increased $56,694,000 in 1993 as compared to 1992 due to rate increases implemented in 1993, and approximately $11,000,000 from the acquisition of Continental Life & Accident Company. Offsetting the increase was a decline in Medicare supplement premiums of $9,176,000 due to lower than anticipated new sales and a $3,496,000 decrease in premiums of specialty health care plans. Life and annuity premiums and policy charges increased $8,659,000 due to an increase in new life sales during 1993. Net investment income decreased $3,313,000 or 8% in 1993 compared to 1992. Annualized investment yields decreased from 7.9% in 1992 to 6.8% in 1993. The decrease in investment yield was due to the general decline in current interest rates and a higher quality portfolio with a shortened duration. Other income and realized investment gains and losses increased $615,000, or 4% in 1993 as compared to 1992. Other income increased $1,904,000 in 1993 due to increased sales to unaffiliated customers in both the Marketing and Managed Care Divisions. Realized investment losses increased $1,289,000 due to write-downs on certain mortgage-backed derivative securities. As disclosed in Note 3 to the Consolidated Financial Statements, the Company has established an allowance for losses on investments held in the amount of $4,200,000, which the Company believes is adequate to provide for other-than-temporary market declines. Total benefits increased $26,310,000 or 6% in 1993 as compared to 1992. Life and annuity benefits decreased $3,607,000 or 8% due to the general decline in credited rates during 1993 and improved mortality over the higher levels experienced during 1992. Accident and health benefits, which includes the change in unearned premiums, increased $29,917,000 or 8% in 1993 as compared to 1992. The change was primarily due to the 7% increase in accident and health premiums. The Company's accident and health loss ratios were unchanged over 1992 at 66%. The improved loss ratios on the Medicare supplement business were offset by the fourth quarter loss ratio on Continental Life & Accident business of 79%. The Company is attempting to control claim costs on this block of business by implementing additional managed healthcare efforts. In 1993 and 1992, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $41 million and $27 million, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows: 1993* 1992* 1991* PPOs (preferred provider organization) networks 49% 64% 72% Precertification 5 17 16 Large case management 32 11 2 Other 14 8 10 100% 100% 100% * Percent of total estimated savings from managed healthcare efforts. The Company expects to continue to emphasize managed care procedures to control claim costs. Although the Company cannot accurately determine the amount savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of growth in cost savings due to the efficiencies that have already been achieved. Amortization of deferred policy acquisition costs (DAC) decreased $23,840,000, or 24%, in 1993 as compared to 1992. The decrease was due to the $30 million pre tax write-down of DAC in the fourth quarter of 1992 primarily on major medical policies sold in the self-employed and small business owner market. The 1993 amortization rate on Medicare supplement is higher than 1992 because of the accelerated rate increase implementation which occurred in 1993. As discussed previously, the Company expects the Medicare supplement persistency to improve in 1994 with the modest rate action required. The Company continues to monitor persistency closely since future rate increases and regulatory reforms could adversly impact lapses in the future. Increased lapses resulting in an increase in the amortization rate of DAC could adversely impact future earnings. The Company's effective tax rate was approximately 35% in 1993. The Company recorded a tax benefit for 1992 due to the operating loss incurred. The effective federal income tax rate increased in 1993 due to the Revenue Reconciliation Act of 1993. Effective January 1, 1993 the Company adopted Financial Accounting Standards Board (FASB) Statement No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." FASB Statement No. 113 requires that reinsurance receivables, including amounts related to claims incurred but not reported, and prepaid insurance premiums, be reported as assets as opposed to reductions in the related liabilities. As a result of the adoption of FASB Statement No. 113, amounts on deposit and due from reinsurers and policy liabilities each increased $19,453,000 at December 31, 1993. Effective January 1, 1993, the Company also changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109 "Accounting For Income Taxes." The cumulative effect of adopting FASB Statement No. 109 was not significant. President Clinton presented his health care reform policy in September of 1993. Numerous proposals have been introduced to Congress and the state legislatures to reform the current healthcare system. Proposals have included, among other things, modifications to the existing employer-based insurance system, a quasi-regulated system of "managed competition" among health plans and a single payer, public program which would replace some of the Company's current major hospital products. Changes in healthcare policy could significantly affect the Company's Health Unit. The Company is unable to accurately predict what effects these reforms may have on its future operations and is unable to evaluate what impact the expectations of such reforms may have had on past consumer behavior. The Company expects the final package approved by Congress will differ significantly from the program presented by President Clinton. (See Healthcare Reform Section) Investments, equipment, policy liabilities, and general expenses and other liabilities increased due to the acquisition of Continental Life & Accident. Other assets increased primarily due to expenses capitalized in conjunction with the public offering of the convertible subordinated debentures. RESULTS OF OPERATIONS 1992 Compared to 1991 The Company reported a net loss of $16,959,000 for the twelve months ended December 31, 1992, compared to net income of $8,872,000 for the comparable period in 1991. The net loss for 1992 was primarily attributable to a $30,000,000 write-down of deferred policy acquisition costs. The remaining decrease was primarily due to reduced levels of new production of senior health insurance, the continued impact of medical inflation, increased utilization of medical services in the health insurance small business market, and lower other income and realized investment gains. Total revenues decreased $52,649,000 or 7% in 1992 as compared to 1991. The decrease was primarily due to reduced writings of accident and health insurance policies principally in the senior market and lower other income and realized gains. Total premiums and policy charges decreased $31,444,000, or 5%, in 1992 as compared to 1991. During 1992 and 1991, in an effort to control the volume and quality of the business produced, the Company reduced the number of brokers and agents selling its products and restructured certain of its agency relationships. These changes resulted in reduced levels of new business being written. Accident and health insurance premiums decreased $33,342,000, or 6%, in 1992 as compared to 1991. Premiums from the Company's Medicare supplement plans decreased approximately $35,203,000. In addition, $7,135,000 of the decrease was attributable to a decrease in premium in specialty health care plans. Somewhat offsetting the decrease were premiums from major hospital plans which increased $9,694,000 in 1992 as compared to 1991. Life and annuity premium and policy charges were relatively unchanged for the twelve month period in 1992 as compared to 1991. Net investment income decreased $4,303,000, or 9%, in 1992 compared to 1991. Annualized investment yields decreased from 9.0% in 1991 to 7.9% in 1992. The decrease in net investment income was primarily due to the general decline in interest rates, and also the sale of a subsidiary, Union Benefit Life Insurance Company on September 1, 1991. Other income and realized investment gains and losses decreased $16,902,000, or 49%, in 1992 as compared to 1991. Other income decreased $8,957,000 in 1992 as compared to 1991. The decrease is principally due to reduced revenues from the Company's non-insurance marketing subsidiaries. The Company's Marketing Division experienced a $6,287,000, or 32%, decrease in revenues, which reflected the discontinuation of certain agent programs. The Company does not expect further declines in revenue from the discontinuation of these agent programs. The Company's Managed Care Division contributed revenues comparable to those in 1991. Realized investment gains, excluding the sale of a subsidiary, decreased $7,236,000 in 1992 as compared to 1991. This is primarily due to the write-down of $5,700,000 on mortgage-backed derivative securities in 1992. As disclosed in Note 3 to the Consolidated Financial Statements, the Company has established an allowance for losses on investments held in the amount of $1,900,000, which the Company believes is adequate to provide for any other-than-temporary market declines. Total benefits decreased $7,280,000, or 2%, in 1992 as compared to 1991 due to the reduced writings of accident and health insurance policies. Life and annuity benefits were relatively unchanged in 1992 as compared to 1991. Accident and health benefits, which include the increase in unearned premiums, decreased $8,774,000, or 2%, in 1992 as compared to 1991. In 1992 the Company's accident and health loss ratio increased to 66% as compared to 64% in 1991. The increase was due to the continued impact of medical inflation and increased utilization of medical services in the small business market. The Company is attempting to minimize the effect of medical inflation and control claim costs by implementing certain managed healthcare efforts. In 1992 and 1991, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $27 million and $13 million, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows: 1992* 1991* PPOs (preferred provider organization) networks 64% 72% Precertification 17 16 Large case management 11 2 Other 8 10 100% 100% * Percent of total estimated savings from managed healthcare efforts. The Company expects to continue to emphasize managed care procedures to control claim costs. Although the Company cannot accurately determine the amount of any savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of cost savings due to the efficiencies that have already been achieved. The Company initiated group medical premium rate adjustments in September 1992. These adjustments were intended to offset the impact of increased benefits and to improve loss ratios. These adjustments helped stabilize loss ratios in the fourth quarter. Policy lapses increased only modestly in the fourth quarter due to the Company's aggressive conservation activities. Insurance and general expenses decreased $10,853,000, or 6%, in 1992 as compared to 1991. The reduction in these expenses is primarily due to the reduced level of new business being written and the corresponding cost reduction programs in the insurance units, which was partially offset by an increase in the level of expenses incurred by the Company's non-insurance subsidiaries. Interest expense decreased $727,000, or 25%, in 1992 as compared to 1991 due to a decrease in the weighted average notes payable outstanding and a decrease in interest rates. However, notes payable increased from December 31, 1991, as Pioneer Life Insurance Company of Illinois entered into a loan agreement in March of 1992. Amortization of deferred policy acquisition costs increased $4,967,000, or 5%, in 1992 as compared to 1991. In the fourth quarter of 1992 the Company wrote off approximately $30,000,000 of deferred policy acquisition costs. The adjustment was primarily the result of certain policies sold in the self-employed and small business owner market. These were policies issued without managed care and cost containment features (including scheduled benefits) which are part of all of the Company's policies now issued. The adjustment included primarily individual policy contracts issued in certain states where strict regulatory approval requirements have delayed implementation of necessary premium adjustments. In all other states, the Company sells group medical plans to the small business owner market. While these group policies are individually underwritten, they provide more latitude for expedient rate adjustments that correspond with actual claims experience. Recently, the Company has experienced improved persistency, primarily on the policies issued in 1991 and 1992, which has resulted in decreased amortization of deferred acquisition costs in 1992 as compared to 1991 on this block of business. The Company continues to monitor persistency closely since general economic conditions and future premium rate adjustments could adversely impact lapses in the future. Increased lapses resulting in an increase in the amortization rate of deferred policy acquisition costs could adversely impact future earnings. The Company recorded a net tax benefit for 1992 due to the operating loss incurred. Investments increased during 1992 as a result of the investment of loan proceeds received in March of 1992 and a reduced level of ceded reinsurance. Premiums and other receivables, accrued investment income, and general expenses and other liabilities decreased due to reduced levels of new business. Deferred policy acquisition costs decreased as a result of the fourth quarter write-down and the decrease in 1992 new business issues. Other assets increased due to federal income tax recoverables and the prepayment of certain agent compensation. Federal legislation required all states to adopt certain standardized benefit provisions for the sale of Medicare supplement policies. The Company has introduced new Medicare supplement plans in response to this legislation. In addition, in 1991, the National Association of Insurance Commissioners adopted the Small Employers Availability Act (Act). The Act affects the rating and underwriting methodology that can be applied to insurance coverage sold to small employers, generally categorized as those employing 25 people or less. The Company believes the Act will not have a material impact on its existing business. In response to the Act, the Company has modified its products, and will continue to modify products (if required) for sale in those states adopting the Act. Deferred Policy Acquisition Costs Under generally accepted accounting principles, a deferred acquisition cost asset (DAC) is established to properly spread the acquisition costs for a block of policies against the expected future revenues from the policies. The acquisition costs which are capitalized and amortized consist of first year commissions in excess of renewal commissions and certain home office expenses related to selling, policy issue, and underwriting. The deferred acquisition costs for accident and health policies and traditional life policies are amortized over future revenues of the business to which the costs are related. The rate of amortization depends on the expected pattern of future revenues for the block of policies. The scheduled amortization for a block of policies is established when the policies are issued. The amortization schedule is based on the expected persistency of the policies. The actual amortization of DAC reflects the actual persistency of the business. For example, if actual policy terminations are higher than expected, DAC will be amortized more rapidly than originally scheduled. Effect of Inflation In pricing its insurance products, the Company gives effect to anticipated levels of inflation; however, the Company believes that the high rate of medical cost inflation during the last three years had an adverse impact on its major hospital accident and health claims experience. The Company has implemented rate increases in response to this experience. Liquidity and Capital Resources The Company's consolidated liquidity requirements are created and met primarily by operations of its insurance subsidiaries. The primary sources of cash are premiums, investment income, proceeds from public offerings and investment sales and maturities. The primary uses of cash are operating costs, repayment of notes payable, policy acquisition costs, payments to policyholders and investment purchases. In addition, liquidity requirements of the Company are created by dividend requirements of the $2.125 Preferred Stock and debt service requirements. The Company's liquidity requirements are met primarily by dividends declared by its non-insurance subsidiaries. As disclosed in Note 9 of Notes to Consolidated Financial Statements, payment of dividends by the insurance subsidiaries to the Company is subject to certain regulatory restrictions. The Company's life and health insurance subsidiaries require capital to fund acquisition costs incurred in the initial year of policy issuance and to maintain adequate surplus levels for regulatory purposes. These capital requirements have been met principally from internally generated funds, including premiums and investment income, and capital provided from reinsurance and the financing or sale of agent debit balances. The Company has terminated existing financial reinsurance agreements with respect to policies issued subsequent to July 1991. The current reinsurance agreements in force have been approved by the appropriate regulatory authorities and the Company believes they meet the current NAIC model regulations. If circumstances arose that would affect the Company's continued ability to include capital provided from reinsurance in the insurance subsidiaries' statutory capital and surplus, it could have an adverse impact on the Company's business. The Company is not aware of any circumstances that would have such an effect. Certain subsidiaries of the Company have entered into agreements for the sale of agent debit balances. Proceeds from such sales during 1993 and 1992 were $25.4 million and $20.3 million, respectively. The Company's agent debit balance program has been reviewed without objection by applicable regulatory authorities. If restrictions are imposed on including in capital the proceeds from this type of financing in the future, the Company would consider alternative financing arrangements or discontinue its agent advancing program. In the past, the Company has obtained funds from public stock and debt offerings and bank borrowings and contributed a portion of the proceeds to the insurance subsidiaries to support the growth of its insurance business. The level of premium volume of the Company's insurance subsidiaries will depend on the amount of their statutory capital and surplus. The statutory basis premium to surplus ratio for 1993 for the Company's major insurance subsidiaries were as follows: Manhattan National Life: 1.5 times; Pioneer Life Insurance Company of Illinois: 4.4 times; Continental Life & Accident Company 6.8 times; and National Group Life Insurance Company: 3.3 times. The concept of risk-based capital has been adopted for regulatory monitoring of the life and health insurance industry. The risk-based capital rules for life and health insurance companies were effective for 1993 annual statement filings. Risk based capital standards will be used by regulators to set in motion appropriate regulatory actions relating to insurers which show signs of weak or deteriorating conditions. The Company's insurance subsidiaries total adjusted capital, authorized control risk based capital, and related ratio by company as disclosed in the 1993 annual statement are as follows: Authorized Adjusted Control Company Capital Level RBC RBC Ratio (Dollars in thousands) Pioneer Life Insurance Company of Illinois $77,460 $23,080 336% Manhattan National Life Insurance Company 24,424 4,316 566% National Group Life Insurance Company 34,756 9,016 385% Continental Life & Accident Company 11,791 4,996 236% Health & Life Insurance Company of America 3,803 240 1,585% The Company has offered agent commission financing to certain of its agents and marketing organizations which consists primarily of annualization of first year commissions. This means that when the first year premium is paid in installments, the Company will advance a percentage of the commissions that the agent would otherwise receive over the course of the first policy year. On October 31, 1990, the Company through a subsidiary entered into an agreement with an unaffiliated corporation to provide financing for its agent commission financing program through the sale of agent receivables. This financing program was replaced with an amended agreement which was executed on October 1, 1992, to provide such subsidiary with the same type of financing. Pursuant to this amended agreement the termination date of the program is December 31, 1994, subject to extension or termination as provided therein. In April 1992, the Company settled certain disputes with several former agents and in addition to certain cash payments issued promissory notes representing future commission. The remaining total of $1,490,000 at December 31, 1993 was repaid in January 1994. In July 1993 the Company issued $57.5 million of 8% convertible subordinated debentures due 2000. Interest on the debentures is payable in January and July of each year. Net proceeds from the offering totaled approximately $54 million. The debentures are convertible into the Company's common stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share. The proceeds were used in part to repay the $15,000,000 and $10,000,000 term loans outstanding. In August 1993 the Company borrowed $1,500,000 to finance the acquisition of Healthcare Review Corporation. Interest on the note is payable quarterly at six percent. The note requires principal repayments of $75,000 per quarter through July 31, 1998. Interest paid amounted to $1,023,000, $2,274,000 and $2,416,000 for 1993, 1992, and 1991, respectively. Management believes that the diversity of the Company's investment portfolio and the liquidity attributable to the large concentration of investments in highly liquid United States government agency securities provide sufficient liquidity to meet foreseeable cash requirements. In the fourth quarter of 1992 the Company segregated the fixed maturity portfolio into two components: fixed maturities held to maturity and fixed maturities available for sale. Because the Company's insurance subsidiaries experience strong positive cash flows, including sizeable monthly cash flows from mortgage-backed securities, the Company does not expect its insurance subsidiaries to be forced to sell the held to maturity investments prior to their maturities and realize material losses or gains. However, if the Company experiences changes in credit risk, it may be required to sell assets whose fair value is less than carrying value and incur losses. Life insurance and annuity liabilities are generally long term in nature although subject to earlier surrender as a result of the policyholder's ability to withdraw funds or surrender the policy, subject to surrender and withdrawal penalties. The Company believes its policyholder liabilities should be backed by an investment portfolio that generates predictable investment returns. The Company seeks to limit exposure to risks associated with interest rate fluctuations by concentrating its invested assets principally in high quality, readily marketable debt securities of intermediate duration and by attempting to balance the duration of its invested assets with the estimated duration of benefit payments arising from contract liabilities. The Company has no material commitments for capital expenditures at the present time. The Company acquired its corporate headquarters in Schaumburg, Illinois in January 1994 which will be primarily used for investment real estate. Investment Portfolio At December 31, 1993, the Company had invested assets of $674 million, compared to $568 million at December 31, 1992. The Company manages all of its investments internally with resource and evaluation assistance provided by independent investment consultants. Government and mortgage-backed obligations and corporate fixed maturity securities collectively comprised approximately 87% and 84% of the Company's investment portfolio at December 31, 1993 and 1992, respectively. The remainder of the invested assets were in short-term investments, equity securities, policy loans and mortgage loans. Fixed Maturity Investments. With the adoption of risk based capital rules and consumer concerns over insurance company solvency and financial stability, the asset quality of insurance companies' investment portfolios has become of greater concern to policyholders and has come under closer scrutiny by insurance regulators and investors. In response, the Company reduced its investments in below-investment grade fixed maturity securities to less than 1% of its invested assets at December 31, 1993, and 3.4% at December 31, 1992, down from 4.5% at December 31, 1991, and 5.0% at December 31, 1990. These reductions resulted from sales and write-downs of the carrying value of such securities in each of these periods, and the elimination of new purchases. The Company has a policy not to invest more than 5% of its total invested assets in securities below investment grade. Investments in below-investment grade fixed maturity securities generally have greater risks (and potentially greater returns) than other corporate fixed maturity investments. Risk of loss upon default by the issuer is significantly greater for these securities because they are generally unsecured and are often subordinated to other creditors of the issuer, and because these issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. Also, the market for below-investment grade securities is less liquid and not as actively traded as the market for investment grade securities. The investment objectives of the Company are to maximize investment yield without sacrificing high investment quality and matched liquidity. The Company continually evaluates the creditworthiness of each issuer of securities held in its portfolio. When the fair value of an individual security declines materially, or when the Company's ongoing evaluation indicates that it may be likely that the Company will be unable to realize the carrying value of its investment, significant review and analytical procedures are performed to determine the extent to which such declines are attributable to changing market expectations regarding general interest rates and inflation and other factors, such as a perceived increase in the credit risk of the issuer, a general decrease in a particular industry sector or an overall economic decline. Declines in fair value attributable to factors other than market expectations regarding general interest rates and inflation are reviewed and analyzed in further detail to determine if the decline in value is other than temporary, and the carrying amount of the investment is reduced to its net realizable value based upon estimated non-discounted cash flows. The amount of the reduction is reported as a realized loss on investments and the net realizable value becomes the new cost basis of the investment. In addition, the Company reverses any accrued interest income previously recorded for the investment and records future interest income only when cash is received. The Company's use of non-discounted cash flows to evaluate net realizable value may result in lower realized losses in the current period than if the Company had elected to use discounting in its evaluation process. Also, yields recognized in future periods on such investments may be less than yields recognized on other investments and will be less than the yield expected when the fixed maturity security was originally purchased. The affect on net income from declines in interest income and portfolio yield from impaired securities in future periods will depend on many factors, including, in life insurance business, the level of interest rates credited to policyholder account balances. Inasmuch as interest rates credited to the Company's policyholders are typically only guaranteed for one year, the Company does not expect any material adverse affect on net income in future periods from declines in yields from impaired securities. Mortgage-Related Securities. At December 31, 1993, the Company had $324 million, or 55%, of its fixed maturities portfolio in mortgage-related securities ($351 million at December 31, 1992). The yield characteristics of mortgage-related securities differ from those of traditional fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possiblity that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. The yields to maturity of the mortgage-related securities will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans. In general, prepayments on the underlying mortgage loans, and subsequently the mortgage-related securities backed by these loans, increases when the level of prevailing interest rates declines significantly below the interest rates on such loans. When declines in interest rates occur, the proceeds from the prepayment of such securities are likely to be reinvested at lower rates than the Company was earning on such securities. Prior to 1991, the Company's investments in mortgage-related securities consisted primarily of pass-through certificates which provide for regular monthly principal and interest payments. During 1991 and 1992, the Company restructured its portfolio by investing in principal only and inverse floaters/interest only tranches of collateralized mortgage obligations (CMOs) and accrual bonds (derivative securities) and other CMOs by selling pass-through certificates. The Company also purchased additional CMO investments with cash flows generated by policyholder premium collections, reinvestment of investment income and scheduled principal payments or maturities of investments and proceeds from the sales of fixed maturity investments, including significant sales of higher-coupon mortgage-related securities in 1991 and 1992. The Company's mortgage-related securities portfolio is well diversified as to collateral, maturity/duration and other characteristics. The majority of the mortgage-related securities portfolio has the guarantee or backing of agencies of the United States government. Generally, the mortgage-related securities consist of pools of single-family, residential mortgages. The derivative securities were acquired to protect the Company in the event of adverse interest rate fluctuations. The yields and fair values of the derivative securities are generally more sensitive to changes in interest rates and prepayments than other mortgage-related securities. Accrual bonds are CMOs structured such that the payments of coupon interest is deferred until principal payments begin on the bonds. On each accrual date, the principal balance is increased by the amount of the interest (based upon the stated coupon rate) that otherwise would have been payable. As such, these securities act much the same as zero coupon bonds until cash payments begin. Cash payments typically do not commence until earlier classes in the CMO structure have been retired, which can be significantly influenced by the prepayment experience of the underlying mortgage loan collateral in the CMO structure. Because of the zero coupon element of these securities and the potential uncertainty as to the timing of cash payments, their fair values and yields are more sensitive to changing interest rates than pass-through securities and coupon bonds. The Company's mortgage-related securities portfolio at December 31, 1993, also included $37 million of CMOs and pass-through certificates issued by non-government agencies ($57 million at December 31, 1992). The Company's holdings consist solely of senior securities in the CMO structures which are collateralized by first mortgage liens on single family residences. These securities are rated AAA or AA by Standard & Poor's, or the comparable equivalent rating by another independent nationally recognized rating agency. The credit worthiness of these securities is based solely on the underlying mortgage loan collateral and credit enhancements in the form of senior/subordinated structures, letters of credit, mortgage insurance or surety bonds. The underlying mortgage loan collateral principally consists of whole loan mortgages that exceed the $202,000 maximum imposed by both the Federal National Mortgage Associaton and the Federal Home Loan Mortgage Corporation and, as such, the collateral tends to be concentrated in states with the greatest number of higher priced single family residences, including California, New York, New Jersey, Maryland, Virginia and Illinois. The maximum average loan-to-value ratio for the collateral is 80%. The following table summarizes the components of the Company's mortgage-related securities portfolio at December 31, 1993, and December 31, 1992 (in thousands): December 31, 1993 December 31, 1992 Estimated Estimated Carrying Fair Carrying Market Value Value (1) Value Value (1) Inverse floaters and interest only CMO tranches $ 18,954 $ 16,003 $ 30,810 $ 24,632 Accrual bonds: U.S. government agency 6,968 7,386 7,852 8,215 Other CMOs: U.S. government agency 187,871 190,141 200,860 204,161 Non-government agency 21,154 21,919 40,635 41,772 Total other CMOs 209,025 212,060 241,495 245,933 U.S. government agency pass-through73,285 74,004 54,902 56,104 Non-government agency pass-through 15,895 16,041 16,252 16,584 Total mortgage-backed securities $324,127 $325,494 $351,311 $351,468 (1) Fair values are generally derived from independent pricing services. Fair values for principal only and inverse floater/interest only tranches of CMOs at December 31, 1993, and 1992 reflect a discounted cash flow due to a lack of a liquid market for these securities. Recently Issued Accounting Standards For a discussion of a new income tax accounting standard and a new reinsurance accounting standard and the impact these standards had on the financial statements of the Company, see Note 2 of Notes to Consolidated Financial Statements. Item 8.

799036

1993

ITEM 6. SELECTED FINANCIAL DATA FIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA Certain reclassifications of prior years' data have been made to improve comparability. Crown Cork & Seal Company, Inc. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (in millions, except per share, employee, shareholder and statistical data) Management's discussion and analysis should be read in conjunction with the financial statements and the notes thereto. Share data for prior years have been restated for the 3 for 1 common stock split declared in 1992. RESULTS OF OPERATIONS NET INCOME AND EARNINGS PER SHARE BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES Net income before cumulative effect of accounting changes for 1993 was a record $180.9, an increase of 16.4% compared with $155.4 for 1992. Net income for 1991 was $128.1. Net income for 1992 and 1991 represents increases of 21.3% and 19.6%, respectively, over the preceding year. Earnings per share before cumulative effect of accounting changes for 1993 was a record $2.08 per share, an increase of 16.2% compared with $1.79 per share for 1992. Earnings per share for 1991 was $1.48 per share. Earnings per share for 1992 and 1991 represents increases of 20.9% and 19.4%, respectively, over the preceding year. The sum of per share earnings by quarter does not equal earnings per share for the year ended December 31, 1993, due to the effect of shares issued during 1993. SALES Net sales during 1993 were $4,162.6, an increase of $381.9 or 10.1% versus 1992 net sales of $3,780.7. Net sales during 1991 were $3,807.4. Domestic sales increased by $430.9 or 17.9% in 1993 versus 1992, while 1992 domestic net sales decreased $53.6 or 2.2% versus 1991. Domestic net sales in 1991 increased 38.3% over 1990. The increase in 1993 domestic net sales primarily reflects (i) a full year sales of CONSTAR, $600 in 1993 versus approximately $100 in 1992 for two months from the date of acquisition, (ii) $130 from the acquisition of Van Dorn and (iii) increased sales unit volume in aerosol and composite cans; offset by (i) lower raw material costs which were passed on to customers in the form of reduced selling prices and (ii) continued competitive pricing in the North America beverage can market. The decrease in 1992 domestic net sales was primarily a result of lower material costs passed on as reduced selling prices to customers offset partially by the addition of CONSTAR sales of $100 for two months. The increase in 1991 net sales was primarily due to the Company's acquisitions as described in Note C to the Consolidated Financial Statements. International sales decreased $49 or 3.6% in 1993 versus 1992, which compares to increases of 2.0% and 4.0% in 1992 and 1991 over the respective preceding years. The decrease in international net sales reflects (i) $100 due to the continued strengthening of the U.S. dollar against most currencies in which the Company's affiliates operate and (ii) the continuing recession in Europe; offset partially by the acquisition of Wellstar Holding B.V. which contributed $85 from the date of acquisition. International sales unit volumes for plastic closures, beverage cans, food cans and aerosol cans improved in 1993, while crown volumes declined. COST OF PRODUCTS SOLD Cost of products sold, excluding depreciation and amortization for 1993 was $3,474.0, an 8.7% increase from the $3,197.4 in 1992. This increase follows a 2.8% decrease and a 24.6% increase in 1992 and 1991, respectively. The increase in 1993 cost of products sold primarily reflects increased sales levels as noted above offset by lower raw material costs and continuing company-wide cost containment programs. The 1992 decrease was primarily due to lower material costs while the 1991 increase reflects higher sales level of the Company's products. Crown Cork & Seal Company, Inc. As a percent of net sales, cost of products sold was 83.5% in 1993 as compared to 84.6% in 1992 and 86.4% in 1991. SELLING AND ADMINISTRATIVE Selling and administrative expenses for 1993 were $126.6, an increase of 12.9% over 1992. This increase compares to increases of 6.4% for 1992 and 22.3% for 1991. Selling and administrative expenses have increased in recent years as a result of businesses acquired. As a percent of net sales, selling and administrative expenses were 3.0% in 1993 and 1992, and 2.8% in 1991. OPERATING INCOME The Company views operating income as the measure of its performance before interest costs and other non-operating expenses. Operating income of $378.7 in 1993 was $58.7, or 18.3% greater than in 1992. Operating income was $320.0 in 1992, an increase of 17.6% over 1991, and $272.0 in 1991, an increase of 17.1% versus 1990. Operating income as a percent of net sales was 9.1% in 1993 as compared to 8.5% in 1992 and 7.1% in 1991. Operating profit in the Company's U.S. operations was 10.2% of net sales in 1993 versus 10.5% and 6.9% in 1992 and 1991, respectively. Productivity improvement, research and development and continuing programs to contain and reduce cost have all contributed to retain and increase domestic margins in 1993 and 1992 despite competitive pricing pressures. European operating profit increased to 5.7% of net sales in 1993 from 4.9% in 1992. The higher operating profit margins reflect the benefits associated with the Company's continuing efforts to restructure its European operations in response to the changing economic environment in the region. Operating profit in North and Central America (other than the United States) at $23.3 in 1993 was 5.0% of net sales as compared to 1.8% in 1992. These increased results are a result of (i) costs associated with closing three Canadian plants in 1992 and (ii) better market conditions and demand in 1993 compared to 1992 in Canada; offset by lower unit sales in most product lines in Mexico. The Company is pleased with the signs of improvement in its Canadian operations, a result of several restructuring actions taken in 1992 and 1991 and is poised to take the necessary steps to compete in the changing economic environment in Mexico. NET INTEREST EXPENSE/INCOME Net interest expense was $79.7 in 1993, an increase of $15.8 when compared to 1992 net interest of $63.9. Net interest expense was $66.6 in 1991. The increase in 1993 net interest expense is due primarily to bank borrowings necessary to finance the CONSTAR acquisition, offset by lower interest rates and the repayment of a $100 note in June 1993 which carried an interest rate of 9.17%. The decrease in 1992 net interest expense was due to declining interest rates and the repayment, in June 1992, of a $100 note which had an interest rate of 9.13%. The increase in 1991 net interest expense was due to bank borrowings necessary to fund 1991 and 1990 acquisitions. Specific information regarding acquisitions is found in Note C to the Consolidated Financial Statements, while information specific to company financing is presented in the Liquidity and Capital Resources section of this discussion and Notes I and L to the Consolidated Financial Statements. TAXES ON INCOME The effective tax rates on income were 34.8%, 39.7% and 40.1% in 1993, 1992 and 1991, respectively. The lower effective rate for 1993 was primarily a result of lower effective tax rates in non-U.S. operations compared to 1992. The higher effective tax rates versus the U.S. statutory rate in 1992 and 1991 are primarily due to the effect of different tax rates in non-U.S. operations and the increase in non-deductible amortization of goodwill and other intangibles, as a result of recent acquisitions. Crown Cork & Seal Company, Inc. EQUITY IN EARNINGS OF AFFILIATES, NET OF MINORITY INTERESTS Equity in earnings of affiliates was $5.0, $6.3 and $6.2 for 1993, 1992 and 1991, respectively. The decrease in equity earnings in 1993 is primarily a result of the Company selling 30% of its interest in its joint venture in Saudi Arabia. Minority interests were $6.5, $4.6 and $3.1 in 1993, 1992 and 1991, respectively. The increases in minority interests relate to (i) more favorable results in the Company's 50.1% interest in a Hong Kong joint venture, (ii) the commencement of production and sales in the Company's 50% interest in Dubai, United Arab Emirates and (iii) the late 1992 sale by the Company of 50% of its South African affiliate and 30% of certain other African businesses to form a joint venture partnership with another South African packaging company. During 1993 the Company's CONSTAR International subsidiary acquired the remaining 56% of Wellstar Holding, B.V. The Company, beginning in 1993, consolidates this wholly-owned subsidiary. With the acquisition of Continental Can International Corporation, Inc. (CCIC) in 1991, the Company acquired minority interests in joint ventures in the Middle East, Korea and South America. Additionally, the Company acquired a 50.1% ownership interest in a joint venture in Hong Kong. As a result of these ownership interests, the Company now has sources of income and cash flow from non-consolidated affiliates and additional liabilities of minority partners. Due to the acquisition of CCIC, the Company has entered many new markets. These new markets provide excellent future growth potential for the Company's products and services while at the same time introducing the Company to viable business partners. The Company believes that the use of business partners in many overseas locations presents another cost-effective means of entering new markets. The Company has presented earnings from equity affiliates, net of minority interests (the components of which can be found in Notes F and P to the Consolidated Financial Statements), as a separate component of net income. Management believes that presenting such earnings as a component of pre-tax income would distort the Company's effective tax rate, and as such, has presented equity earnings after the provision for income taxes. INDUSTRY SEGMENT PERFORMANCE This section presents individual segment results for the last three years. The after-tax charge of $81.8 or $.96 per share related to adoption of SFAS 106, SFAS 109 and SFAS 112 in 1993 is included as an after tax charge in the Metal Packaging segment of $83.7 or $.98 per share and an after-tax credit in the Plastic Packaging segment of $1.9 or $.02 per share, and is excluded in making comparisons of 1993 results with prior years. Net sales for the Metal Packaging segment in 1993 were $3,367.0, down $206.1 or 5.8% compared to 1992 net sales of $3,573.1. Net sales during 1991 were $3,733.0. Sales in the segment have declined in recent years primarily as a result of lower raw material costs which have been passed on to customers in the form of reduced selling prices. Metal Packaging 1993 operating income was $308.5 or 9.2% of net sales compared to $296.4 in 1992 which was 8.3% of net sales. Operating income in 1991 was $261.4 or 7.0% of net sales. The increase in operating income reflects the successful integration of acquisitions made since 1989. Despite competitive price pressures and costs associated with restructuring efforts in North America and Europe, the Company has streamlined its organizational structure and improved efficiency to achieve significant cost reductions and increase operating profits. Net sales for the Plastic Packaging segment in 1993 increased $588.0 or 283.2% to $795.6 in 1993 from $207.6 in 1992. Net sales for 1992 increased $133.2 or 179.0% against 1991 net sales of $74.4. The increase in 1993 is primarily a result of the Company's October 1992 acquisition of CONSTAR International Inc. ("CONSTAR") and the acquisition during 1993 of the remaining 56% interest in Wellstar Holding B.V. Crown Cork & Seal Company, Inc. ("Wellstar") by CONSTAR. The full year sales of CONSTAR contributed approximately $600 in 1993 compared to two months sales in 1992 of approximately $100. Wellstar from the date of acquisition contributed net sales of $85 in 1993. Plastic Packaging 1993 operating income was 8.8% of net sales at $70.2 compared to 11.4% or $23.6 in 1992. Operating income in 1991 was $10.6 or 14.2% of net sales. Increased competition, product sales mix and the recession in Europe have contributed to decreased margins. ACCOUNTING CHANGES The Company, as required, adopted SFAS 106 and SFAS 109 on January 1, 1993. Additionally, during the fourth quarter, the Company adopted SFAS 112 retroactive to January 1, 1993. The after-tax effect of these accounting changes was a one-time charge to 1993 earnings of $81.8 or $.96 per share, with an incremental charge to 1993 earnings of $2.5 or $.03 per share. These accounting changes are more fully described in Note B to the Consolidated Financial Statements. Adoption of the above three statements did not and will not have any cash flow impact on the Company. FINANCIAL POSITION LIQUIDITY AND CAPITAL RESOURCES The Company's financial position remains strong. Cash and cash equivalents totaled $54.2 at December 31, 1993, compared to $26.9 and $20.2 at December 31, 1992 and 1991, respectively. The Company had working capital of $43.8 at December 31, 1993. The Company's primary sources of cash in 1993 consisted of (i) funds provided from operations, $352.5; (ii) proceeds from short-term debt borrowings, $136.5; (iii) proceeds from sale of businesses, $83.6; and, (iv) proceeds from long-term debt borrowings, $548.3. The Company's primary uses of cash in 1993 consisted of (i) payments on long-term debt, $715.0; (ii) acquisition of and investments in businesses, $66.2; (iii) capital expenditures, $271.3 and (iv) repurchases of common stock, $86.5. The Company funds its working capital requirements on a short-term basis primarily through issuances of commercial paper. The commercial paper program is supported by revolving bank credit agreements with several banks with equal maturities on December 12, 1994 and December 20, 1995. Maximum borrowing capacity under the agreements is $550. There are no borrowings currently outstanding under these agreements. There was $324.0 and $154.0 in commercial paper outstanding at December 31, 1993 and 1992, respectively. In January 1993, the Company filed with the Securities and Exchange Commission a shelf registration statement for the possible offering and sale of up to $600 aggregate principal amount of debt securities of the Company. On April 7, 1993 the Company sold $500 of public debt securities in three maturity tranches through Salomon Brothers Inc. and The First Boston Corporation. The notes and debentures were issued pursuant to the shelf registration of debt securities and are rated Baa1 by Moody's Investors Service and BBB+ by Standard & Poor's Corporation. The three tranches include $100 of 5.875% notes due 1998, priced at par; $200 of 6.75% notes due 2003, priced at 99.625% to yield 6.80%; and $200 of 8% debentures due 2023, priced at 99.625% to yield 8.03%. Net proceeds from the issues were used to repay the bank facility which financed the acquisition of CONSTAR International in October 1992. The Company has $100 remaining on the shelf registration. The Company has, when considered appropriate, hedged its currency exposures on its foreign denominated debt through various agreements with lending institutions. The Company also utilizes a corporate "netting" system which enables resources and liabilities to be pooled and then netted, thereby mitigating the exposure. During 1993, the Company acquired businesses for approximately $222, following acquisitions in 1992 and 1991 of $539 and $235, respectively. The details of such acquisitions are discussed in Note C to the Crown Cork & Seal Company, Inc. Consolidated Financial Statements. The Company has established reserves to restructure acquired companies. At December 31, 1993 and 1992, these reserves totaled $105.2 and $94.9, respectively, and have been allocated to the purchase price of acquired companies. These reserves relate primarily with the costs associated with Company plans to combine acquired company operations with existing operations such as, severance costs, plant consolidations and lease terminations. The Company estimates that 1994 cash expenditures related to its restructuring efforts will approximate $54.3 and cash expenditures for the three years ended December 31, 1996, will approximate $90. Cash expenditures for restructuring efforts were $81, $30 and $18 for the years ended December 31, 1993, 1992, and 1991, respectively. The Company's ratio of total debt (net of cash and cash equivalents) to total capitalization was 50.1%, 52.1% and 40.5% at December 31, 1993, 1992 and 1991, respectively. Total capitalization is defined by the Company as total debt, minority interests and shareholders' equity. The increase in the Company's total debt in recent years is due to businesses acquired since December 29, 1989. As of December 31, 1993, $101.9 of long-term debt matures within one year. During the year the Company repaid $100 private placement debt which carried an interest rate of 9.17%. Additionally, the Company's Canadian subsidiary repaid CDN $100 private placement debt, partially with funds received from a property settlement and the balance with a capital increase from the parent Company. Management believes that, in addition to current financial resources (cash and cash equivalents and the Company's commercial paper program), adequate capital resources are available to satisfy the Company's investment programs. Such sources of capital would include, but not be limited to, bank borrowings. Management believes that the Company's cash flow is sufficient to maintain its current operations. CAPITAL EXPENDITURES Capital expenditures in 1993 amounted to $271.3 as compared with $150.6 in 1992. During the past five years capital expenditures totaled $730.7. Expenditures in the North American Division totaled $93 with major spending for beverage end conversion in Dayton, Ohio, a new technical center and aerosol plant in Alsip, Illinois and 2-piece food cans in Owatonna, Minnesota. Additional projects to convert beverage can and end lines in other plants to a smaller diameter began in 1993. Investments of $83 were made in the International Division. The Company constructed new plants and installed both beverage can and plastic cap production lines in Dubai, United Arab Emirates and Argentina. The Company is currently constructing a beverage can plant in Shanghai, China. Additionally, the Company constructed a new aerosol plant near Amsterdam, The Netherlands to service a major customer's centralized European filling plant. Expansion of existing plastic cap production in Italy and Germany, as well as the installation of single-serve PET equipment in Portugal have diversified the International Division from primarily metal packaging to include plastic products. With the acquisition of CONSTAR in October 1992, the Company made a commitment to service global customers with plastic containers. The Company continued this commitment with spending of $94 in 1993 within the Plastics Division. Major spending included capacity expansion of existing products and installation of several single-serve PET lines in the United States. New single-serve PET preform and bottle lines were also installed in CONSTAR's subsidiaries in England, Holland and Hungary. The Company expects its capital expenditures in 1994 to approximate $400. The Company plans to continue capital expenditure programs designed to take advantage of technological developments which enhance productivity and contain cost as well as those that provide growth opportunities. Capital expenditures, exclusive of potential acquisitions, during the five year period 1994 through 1998 are expected to approximate $1,500. Cash flow from operating activities will provide the principal support for Crown Cork & Seal Company, Inc. these expenditures; however, depending upon the Company's evaluation of growth opportunities and other existing market conditions, external financing may be required from time to time. ENVIRONMENTAL MATTERS The Company has adopted a Corporate Environmental Protection Policy. The implementation of this Policy is a primary management objective and the responsibility of each employee of the Company. The Company is committed to the protection of human health and the environment, and is operating within the increasingly complex laws and regulations of federal, state, and local environmental agencies or is taking action aimed at assuring compliance with such laws and regulations. Environmental considerations are among the criteria by which the Company evaluates projects, products, processes and purchases and, accordingly, does not expect compliance with these laws and regulations to have a material effect on the Company's competitive position, financial condition, results of operations or capital expenditures. The Company is dedicated to a long-term environmental protection program and has initiated and implemented many pollution prevention programs with the emphasis on source reduction. The Company continues to reduce the amount of metals and plastics used in the manufacture of steel, aluminum and plastic containers through a "lightweighting" program. The Company not only recycles nearly 100 percent of scrap aluminum, steel, plastic and copper used in the manufacturing process, but through its Nationwide Recyclers subsidiary is directly involved in post-consumer aluminum and steel can recycling. Nationwide Recyclers, in 1994, will also be directly involved in post-consumer plastics recycling. Additionally, the Company has already exceeded the Environmental Protection Agency's (EPA) 1995 goals for its 33/50 program which calls for companies, voluntarily, to reduce toxic air emissions by 33% by the end of 1992 and by 50% by the end of 1995, compared to the base year of 1988. The Company, at the end of 1993, had achieved a more than 64% reduction in the releases of such emissions for all U.S. facilities. The cost to accomplish this reduction did not materially affect operating results. Many of the Company's programs for pollution prevention lower operating costs and improve operating efficiencies. The Company has been identified by the EPA as a potentially responsible party (along with others, in most cases) at a number of sites. Estimated remedial expenses for active projects are recognized in accordance with generally accepted accounting principles governing probability and the ability to reasonably estimate future costs. Actual expenditures for remediation were $2.2 during 1993 and $1.7 in 1992. The Company's balance sheet reflects a net accrual for future expenditures to remediate known sites of $11.3 at December 31, 1993 and 1992, respectively. Gross remediation liabilities were estimated at $30.7 and $33.3 at December 31, 1993 and 1992, respectively. Indemnification received from the sellers of acquired companies and the Company's insurance carriers was estimated at $19.4 and $22.0 at December 31, 1993 and 1992, respectively. Environmental exposures are difficult to assess for numerous reasons, including the identification of new sites, advances in technology, changes in environmental laws and regulations and their application, the scarcity of reliable data pertaining to identified sites, the difficulty in assessing the involvement of the financial capability of other potentially responsible parties and the time periods (sometimes lengthy) over which site remediation occurs. It is possible that some of these matters (the outcome of which are subject to various uncertainties) may be decided unfavorably against the Company. It is, however, the opinion of Company management after consulting with counsel, that any unfavorable decision will not have a material adverse effect on the Company's financial position. COMMON STOCK AND OTHER SHAREHOLDERS' EQUITY Shareholders' equity was $1,251.8 at December 31, 1993, as compared with $1,143.6 at December 31, 1992. The increase in 1993 equity represents the retention of $99.1 of earnings in the business (net of $81.8 of accounting changes as more fully described in Note B to the Consolidated Financial Statements), the issuance of 3,631,624 common shares for the acquisition of Van Dorn Company and the issuance of 1,415,711 common shares for various stock purchase and savings plans offset by the effect of 2,580,982 common shares repurchased, $46.3 minimum pension liability adjustment as more fully described in Note Crown Cork & Seal Company, Inc. N to the Consolidated Financial Statements and equity adjustments for currency translation in non-U.S. subsidiaries of $29.3. The book value of each share of common stock at December 31, 1993, was $14.09, as compared to $13.24 at December 31, 1992. In 1993, the return on average shareholders' equity before cumulative effect of accounting changes was 14.6% as compared with 13.9% in 1992. The Company purchased 2,536,330 shares of its common stock from CCL Industries Inc. ("CCL") on January 7, 1993 for approximately $84.8. The Company and CCL had agreed to the share repurchase in August of 1992 at a then agreed purchase price of $33.00 per share, plus an adjustment computed at a rate of 3.5% per annum. The January 7, 1993 settlement was funded by cash flow from operations, borrowings and cash received from CCL of approximately $21. The cash received from CCL related to the settlement of guarantees made by CCL to the Company regarding the value of certain properties in connection with the Company's 1989 acquisition of Continental Can Canada Inc. The Company issued to CCL a total of 7,608,993 shares in the 1989 acquisition of Continental Can Canada Inc. The purchase of common stock from CCL was made pursuant to the Company's right of first refusal to purchase common stock offered for sale by CCL. After giving effect to the repurchase transaction, CCL held 2,536,331 shares or approximately 2.9% of the Company's shares then outstanding following the January 7, 1993 settlement date. In August 1992, the Company repurchased 1,500,000 shares from the Connelly Foundation for approximately $50.1 or approximately $33.38 per share. The purchase of shares from the Connelly Foundation was funded by cash flow from operations of $25 and an interest bearing note, at 3.5%, of approximately $25.1. The Company settled the note in December 1992 with cash flow from operations. At December 31, 1993, the Connelly Foundation held 8,554,700 shares of the Company's common stock which represented approximately 10% of the 88,814,533 shares then outstanding. The Board of Directors has approved resolutions authorizing the Company to repurchase shares of its common stock to meet the requirements for the Company's various stock purchase and savings plans. The Company acquired 2,580,982, 1,747,774, and 2,735,898 shares of common stock in 1993, 1992, and 1991 for $86.5, $61.4, and $69.1, respectively. These purchases included the purchases of stock held by the Connelly Foundation in 1992 and by CCL in 1993 and 1991. The Company has traditionally not paid dividends and does not anticipate paying dividends in the foreseeable future. At December 31, 1993 common shareholders of record numbered 6,168 compared with 4,193 at the end of 1992. INFLATION General inflation has not had a significant impact on the Company over the past three years due to strong cash flow from operations. The Company continues to maximize cash flow through programs designed for cost containment, productivity improvements and capital spending. Management does not expect inflation to have a significant impact on the results of operations or financial condition in the foreseeable future. Crown Cork & Seal Company, Inc. ITEM 8.

25890

1993

846902

1993

Item 6. Selected Financial Data Information on this Item 6 is not required. See General Instruction J. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The Company derives its earnings primarily from financing sales and leases of Caterpillar products and from loans extended to Caterpillar customers and dealers. New retail financing during 1993 totaled $1,967.4 million, a 28% increase over the $1,531.8 million financed in 1992 and a 59% increase over the 1991 new business of $1,240.0 million. New retail financing volume for 1993 exceeded 1992 and 1991 levels due to increased machine financing in the United States and Europe. New business volume for 1992 exceeded the 1991 level primarily as the result of financing activity in Germany. The Company had wholesale financing during 1993 of $228.2 million. New retail financing in 1994 is expected to remain at about 1993 levels. Wholesale financing in 1994 is expected to exceed 1993 levels due to expansion of the Caterpillar dealer rental fleet financing program in the United States. In 1994, the Company will offer financial services to the customers of the Caterpillar dealer in Spain through a new subsidiary, Alquiler de Equipos Industriales, S.A. Revenues from operations in the United States were more than 80% of total revenues in 1993, 1992, and 1991. Net income from operations in the United States was more than 90% of total net income in 1993, 1992, and 1991. For more geographic segment information, see Note 12 of the Notes to the Consolidated Financial Statements. Past due percentages decreased in 1993 primarily as a result of an improving U.S. economy and collection efforts. The allowance for credit losses will continue to be monitored to provide for an amount which, in management's judgement, will be adequate to cover uncollectible receivables. The composition of the Company's portfolio (see "Item 1. Business") by financing plans did not change significantly from 1992 to 1993. The Company's wholesale financing increased due to a higher floor planning receivable balance in Germany and the addition of receivables from dealers under the inventory rental assistance program in the United States. 1993 Compared With 1992 Total revenues for 1993 were $363.6 million, a 6% increase over 1992 revenues of $342.4 million. The increase in revenues, limited by a low interest rate environment, was primarily the result of earnings from the larger portfolio which increased to $3,522.1 million at December 31, 1993 from $2,812.7 million at December 31, 1992. The annualized interest rate on finance receivables (computed by dividing finance income by the average monthly finance receivable balances) was 9.1% for 1993 compared with 10.3% for 1992. Tax benefits associated with governmental lease- purchase contracts and a portion of tax benefits associated with long-term tax-oriented leases are not reflected in such annualized interest rates. The decrease in the annualized interest rate reflected a decrease in the interest rates charged to customers. Other income, net, of $15.7 million for 1993 included fees, gains on sales of equipment returned from lease, and other miscellaneous income. The increase of $1.3 million for 1993 was primarily due to a higher amount of fees collected and earned. Interest expense for 1993 was $173.1 million, $1.3 million less than 1992. Although there were increased borrowings to support the larger portfolio, interest expense decreased due to lower borrowing rates as the average cost of borrowed funds was 6.5% in 1993 compared with 7.8% in 1992. Depreciation expense increased from $63.1 million in 1992 to $69.6 million in 1993 due to the increase in equipment on operating leases which, computed as a monthly average balance, increased 9%. General, operating, and administrative expenses increased $8.8 million over 1992 primarily due to staff-related and other expenses required to service the larger portfolio and expansion into Europe. The Company's full-time employment increased from 324 at the end of 1992 to 361 at December 31, 1993. Provision for credit losses during 1993 increased from $20.4 million in 1992 to $20.8 million in 1993. This increase, partially offset by a higher provision taken in 1992 for the U.S., Australian, and Canadian companies, reflected increased levels of new business for 1993. Receivables, net of recoveries, of $18.8 million were written off against the allowance for credit losses during 1993 compared with $14.3 million during 1992 due to an acceleration of write-offs from point of sale to point of repossession. Receivables past due over 30 days were 1.9% of total receivables at December 31, 1993 compared with 2.5% at December 31, 1992. Past due percentages decreased primarily as a result of an improving U.S. economy and collection efforts. The allowance for credit losses is monitored to provide for an amount which, in management's judgment, will be adequate to cover uncollectible receivables. At December 31, 1993, the allowance for credit losses was $41.5 million which was 1.3% of finance receivables, net of unearned income, compared with $36.5 million and 1.4% at December 31, 1992, respectively. The effective income tax rate for 1993 was 36% compared with 34% for 1992. For information on this change, see Note 8 of the Notes to the Consolidated Financial Statements. Consolidated net income in 1993 was $37.8 million, compared with $34.0 million, excluding the cumulative effect of the change in accounting for income taxes in 1992. The increase in net income generally reflected the increased revenues from a larger portfolio and lower cost of borrowed funds, partially offset by increased costs to support the larger portfolio and European expansion. 1992 Compared With 1991 Total revenues for 1992 were $342.4 million, an 8% increase over 1991 revenues of $316.4 million. The increase in revenues, limited by a low interest rate environment, was primarily the result of earnings from the larger portfolio, which increased to $2,812.7 million at December 31, 1992 from $2,437.1 million at December 31, 1991. The annualized interest rate on finance receivables (computed by dividing finance income by the average monthly finance receivable balances) was 10.3% for 1992 compared with 11.1% for 1991. Tax benefits associated with governmental lease- purchase contracts and a portion of tax benefits associated with long-term tax-oriented leases are not reflected in such annualized interest rates. The decrease in the annualized interest rate reflected a decrease in interest rates charged to customers. Other income, net, of $14.4 million for 1992 included fees, gains on sales of equipment returned from lease, and other miscellaneous income. The increase of $3.7 million for 1992 was primarily due to larger gains on sales of equipment returned from lease, more commitment fees earned, and more late charge fees collected. Interest expense for 1992 was $174.4 million, $1.9 million less than 1991. Although there were increased borrowings to support the larger portfolio, interest expense decreased due to lower borrowing rates as the average cost of borrowed funds was 7.8% in 1992 compared with 8.9% in 1991. Depreciation expense increased from $54.4 million in 1991 to $63.1 million in 1992 due to the increase in equipment on operating leases which, computed as a monthly average balance, increased 12%. General, operating, and administrative expenses increased 11% over 1991 primarily due to staff-related and other expenses required to service the larger portfolio and expansion into Europe. The Company's full-time employment increased from 310 at the end of 1991 to 324 at December 31, 1992. Provision for credit losses during 1992 increased from $13.2 million in 1991 to $20.4 million in 1992. This increase reflected increased levels of new business and a higher provision taken for the U.S., Australian, and Canadian companies. Receivables, net of recoveries, of $14.3 million were written off against the allowance for credit losses during 1992 compared with $13.0 million during 1991. Receivables past due over 30 days were 2.5% of total receivables at December 31, 1992, compared with 4.0% at December 31, 1991. Past due percentages decreased primarily as a result of increased collection efforts. The allowance for credit losses is monitored to provide for an amount which, in management's judgement, will be adequate to cover uncollectible receivables. At December 31, 1992, the allowance for credit losses was $36.5 million which was 1.4% of finance receivables, net of unearned income, compared with $31.0 million and 1.4% at December 31, 1991, respectively. The effective income tax rate for 1992 and 1991 was 34%. In the fourth quarter of 1992, effective January 1, 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) 109, "Accounting for Income Taxes." SFAS 109 requires changing the method of accounting for income taxes from the deferred method to the liability method. The effect of adopting SFAS 109, as of January 1, 1992, was a benefit of $2.6 million and is excluded from the effective income tax rate calculation. For more information on this accounting change, see Note 8 of the Notes to the Consolidated Financial Statements. Consolidated net income in 1992, excluding the cumulative effect of the change in accounting for income taxes, was $34.0 million, compared with $28.5 million in 1991. The increase in net income generally reflected the increased revenues from a larger portfolio and lower cost of borrowed funds, partially offset by the increase in the provision for credit losses. Capital Resources and Liquidity The Company's operations were primarily funded with a combination of medium-term notes, commercial paper, bank borrowings, retained earnings, and additional equity capital of $30.0 million invested by Caterpillar. Additional short-term funding was available from Caterpillar (see Note 10 of the Notes to the Consolidated Financial Statements); however, no intercompany borrowings were outstanding at December 31, 1993. Total debt outstanding as of December 31, 1993, was $3,041.1 million, an increase of $639.7 million over that at December 31, 1992, and was primarily comprised of $1,854.8 million of medium- term notes, $797.2 million of commercial paper, and $335.7 million of notes payable to banks. Interest rate swaps were contracted in the United States, Australia, Canada, and Germany to reduce the exposure to interest rate fluctuations. See Notes 6 and 7 of the Notes to the Consolidated Financial Statements for more information on short-term and long-term debt. At December 31, 1993, the Company had available in the United States, Australia, Canada, Germany, Sweden, and the United Kingdom a total of $990.7 million of short-term credit lines, which expire at various dates in 1994, and $64.7 million of long- term credit lines, which expire at various dates from January 1996 to May 1996. These credit lines are with a number of banks and are considered support for the Company's outstanding commercial paper, commercial paper guarantees, the discounting of bank and trade bills, and bank borrowings at various interest rates. At December 31, 1993, there were $326.1 million of these lines utilized for bank borrowings in Australia, Germany, Sweden, and the United Kingdom. The Company also has a $455.0 million revolving credit agreement with a group of banks. This agreement is also considered support for the Company's outstanding commercial paper and commercial paper guarantees. The agreement terminates in 1996 and provides for borrowings at interest rates which vary according to LIBOR or money market rates. At December 31, 1993, there were no borrowings under this agreement. The above-mentioned credit agreements require the Company to maintain its consolidated ratio of profit before taxes plus fixed charges to fixed charges at no less than 1.1 to 1 for each quarter; the Company's total liabilities to total stockholder's equity may not exceed 8.0 to 1; and the Company's tangible net worth must be at least $20.0 million. The Company's funding requirements were met primarily through the sale of commercial paper and medium-term notes, discounting of bank and trade bills, and through bank borrowings. During 1993, the average outstanding commercial paper balance, net of discount, was $782.3 million at an average interest rate of 3.7%. At year-end 1993, the face value of commercial paper outstanding was $798.6 million. During 1993, $417.1 million of fixed-rate medium-term notes were sold at an average interest rate of 4.9% and $475.2 million of floating-rate medium-term notes were sold at rates indexed to LIBOR, prime, or commercial paper rates. Medium-term notes outstanding at year-end 1993 were $1,854.8 million. During the year, bank bills totaling $154.4 million and trade bills totaling $184.2 million were discounted at an average interest rate of 5.6% and 8.0%, respectivly. In connection with its match funding objectives, the Company entered into a variety of interest rate contracts including interest rate swap and cap agreements. Interest rate swap agreements totaled $2,047.3 million and interest rate cap agreements totaled $500.0 million at year-end 1993. The Company has entered into forward exchange contracts to hedge its U.S. dollar denominated obligations in Australia and Canada against currency fluctuations. At December 31, 1993, the outstanding forward exchange contracts totaled $146.6 million. On a consolidated basis, equity capital at the end of 1993 was $418.0 million, an increase of $64.0 million during the year. This increase included $30.0 million of additional equity investment made by Caterpillar and $37.8 million of retained earnings from operations. The increase in debt, the equity investment from Caterpillar, and the funds provided by operations were used to finance the increase in the portfolio. The ratio of debt to equity at December 31, 1993 was 7.3 to 1, compared with 6.8 to 1 for 1992 and 6.7 to 1 for 1991. Item 8.

764764

1993

ITEM 6. SELECTED FINANCIAL DATA. The information required by Item 6 is contained on page 27 of this Form 10- K under "Selected Financial Data" and is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information required by Item 7 is contained on pages 28 to 36 of this Form 10-K under "Management Discussion and Analysis" and is incorporated herein by reference. ITEM 8.

717605

1993

ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for the Company. 1993 1992 1991 1990 1989 (dollars in thousands) Electric Operating Revenues $ 837,192 $ 778,303 $ 760,694 $ 735,217 $ 729,861 Net Income 81,876 94,883 96,624 89,713 97,217 Preferred Stock Dividends 3,362 3,445 3,465 3,528 3,528 Net Income for Common Stock 78,514 91,438 93,159 86,185 93,689 Total Assets 1,968,285 1,927,320 1,851,108 1,869,340 1,880,100 Common Stock Equity 645,731 647,217 645,780 641,554 640,169 Preferred Stock Subject to Mandatory Redemption 36,028 37,228 38,416 36,422 36,095 Preferred Stock Not Subject to Mandatory Redemption 16,032 16,032 16,033 14,358 14,309 Long-Term Debt $ 602,065 $ 532,860 $ 573,626 $ 576,095 $ 595,988 Ratio of Earnings to Fixed Charges (SEC Method) 3.34 3.39 3.51 3.03 3.19 Capitalization Ratios: Common Stock Equity 49.7% 52.5% 50.7% 50.6% 49.8% Preferred Stock 4.0 4.3 4.3 4.0 3.9 Long-Term Debt 46.3 43.2 45.0 45.4 46.3 ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Reference is made to the Financial Statements and related Notes to Financial Statements and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis. OVERVIEW The Company's return on average common stock equity decreased 2.4% in 1993 to 12.0% as compared to 14.4% in 1992. A return to normal temperatures in the Company's service territory contributed to a 6.2% increase in revenues from sales to retail customers. However, significant charges associated with restructuring and the adoption of Statement of Financial Accounting Standard (SFAS) No. 112 more than offset the positive effects of the weather and a change in accounting for unbilled revenues. RESTRUCTURING CSW recently announced a management restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable the Electric Operating Companies to focus on and be accountable for serving customers. The initial phase of the restructuring will involve certain changes at CSWS, the mutual service company that serves the CSW System. CSWS will be realigned into two primary units -- Operation Services and Production Services. Operation Services will provide administrative services that can be performed centrally to benefit the CSW System, including the Company. Production Services will focus on consolidated fuel and generation planning for the Electric Operating Companies as well as certain other activities. Certain aspects of the restructuring may be subject to SEC approval. To implement the restructuring program, the CSW System will consolidate and centralize its operation services and production services. The Company, the other Electric Operating Companies and CSW are expected to reduce the size of their work forces and incur costs associated with an early retirement program, severance packages and relocation. The early retirement program has been offered to 181 eligible employees of the Company and 726 employees on a systemwide basis, of which approximately 78% of the eligible employees of the Company and 85% of the total systemwide eligible employees elected the early retirement program. Since the restructuring is not expected to be completed until the end of 1994, it is not possible at this time for the Company to predict the number of its employees who will take the early retirement program, be granted severance packages or be relocated. The Company's share of the total cost of the restructuring was estimated to be $25.2 million before taxes, and was expensed in 1993. The Company's share of the severance and relocation costs will be paid from general corporate funds in 1994 and its share of early retirement costs primarily from pension and postretirement benefit plan trusts. Savings from the restructuring are expected to begin in the second half of 1994. By the end of 1995, initial costs should be fully recovered through operations and maintenance cost savings. CSW established a Business Improvement Plan in 1991 to identify, analyze and implement the best business practices as part of its efforts to align the CSW System strategically to meet competitive forces. The BIP program will be incorporated as part of the restructuring. Any additional costs to the Company are expected to be offset by future savings from the benefits provided through the implementation of BIP recommendations. CONSTRUCTION AND CAPITAL EXPENDITURES The Company's construction and capital expenditures increased 70% in 1993, 30.3% in 1992, and 20.9% in 1991. Included in the expenditures for 1993 was approximately $35 million for the acquisition of BREMCO, a rural electric cooperative with service territory adjacent to the Company's service territory in Louisiana. Construction expenditures during the period 1994-1996 are estimated at $383 million. These expenditures will consist primarily of expansion and improvements to transmission and distribution facilities. The construction program will continue to be reviewed and adjusted for changes affecting the Company's service area. FINANCING AND CAPITAL RESOURCES Internal Generation. Internal sources of funds, consisting of cash flows from operating activities less dividends paid, have provided $148.7 million, $75.4 million, and $104.8 million during 1993, 1992, and 1991. These amounts represented 85%, 78%, and 142% of the total construction expenditures during these periods. Sale of Accounts Receivable. The Company sells its billed and unbilled accounts receivable to CSW Credit, Inc., a wholly owned subsidiary of CSW. These sales provide the Company with cash immediately and reduce working capital and revenue requirements. The monthly average and year end amounts of accounts receivable sold were $64.4 million and $57.1 million in 1993 as compared to $59.4 million and $54.2 million in 1992. Short-Term Financing. The Company traditionally uses short-term debt for interim financing until a marketable amount can be refinanced with first mortgage bonds or preferred stock. The Company, together with other members of the CSW System, has established a System money pool to coordinate short-term borrowings and to make borrowings outside the money pool through the issuance of commercial paper and from bank borrowings. These borrowings are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. The maximum and minimum amounts of borrowings outstanding at month end during 1993 were $53.5 million and zero, and the average amount of borrowings outstanding during the year was $10 million. The weighted average interest rate paid during the year was 3.2%. The maximum borrowing limit through the System money pool authorized by the SEC is $150 million. Long-Term Financing. Long-term financing by the Company involves the sale of first mortgage bonds and preferred stock and the receipt of capital contributions from its parent company or other financing alternatives. The goal of the Company is to maintain a strong capital structure. At December 31, 1993, the capitalization ratios were 50% common stock equity, 4% preferred stock, and 46% long-term debt. External financing will be required in the 1994-1996 time period; however, the timing, nature and extent thereof have not been determined. External financings will be made with capital structure goals and cost of funds in mind. Regulatory Matters. Reference is made to Note 9 of the Notes to Financial Statements for a discussion of regulatory matters. New Accounting Standards. Reference is made to Note 1 of the Notes to Financial Statements-New Accounting Standards for a discussion of SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, SFAS No. 109, Accounting for Income Taxes, SFAS No. 112, Employers' Accounting for Postemployment Benefits, and the Company's change in accounting for Unbilled Revenues. RESULTS OF OPERATIONS Net income for common stockholders decreased 14.1% during 1993 to $78.5 million from $91.4 million in 1992, due primarily to restructuring reserves and the adoption of SFAS 112, offset in part by a change in its accounting method of accounting for unbilled revenues. In 1992, net income decreased 1.8% from $93.2 million in 1991. Electric Operating Revenues. Total electric operating revenues increased 7.6% during 1993, due primarily to higher energy sales which resulted from favorable weather in the Company's service territory, and to a gain in the number of customers served. Approximately 9,400 retail customers were added with the acquisition of BREMCO, a neighboring electric cooperative. Also contributing to the higher total revenues were increased sales of energy for resale, which resulted, in part, from sales to CPL, an affiliate, during an outage at their South Texas Project generating facility. The decline in retail energy sales in 1992 was due to milder temperatures, offset in part by an increase in the number of customers served. Industrial kilowatt-hour sales increased 4.5% in 1993, and 5.9% in 1992. Fuel and Purchased Power. Fuel expense is influenced primarily by two factors, the average unit cost of fuel (price) and the quantity of fuel burned (generation). Fuel expense increased 7.3% in 1993, after increases of 3.9% in 1992 and 6.7% in 1991. The average cost of fuel per million BTU was $1.94, $1.93, and $1.87 during 1993, 1992, and 1991, which amounts to an increase of 0.5% during 1993, 3.2% during 1992, and 2.7% in 1991. The fuel expense increase in 1993 was primarily the result of an 8% increase in generation. Purchased power costs increased $6.5 million in 1993, after an increase of $4.4 million in 1992 and a decrease of $2.2 million in 1991. The increase in 1993 was largely due to scheduled and unscheduled maintenance at the Company's generating facilities and a purchased power contract negotiated as part of the purchase of BREMCO. The increase in 1992 was due largely to a higher amount of energy purchased for resale to neighboring utilities, and the decrease in 1991 resulted primarily from a lower amount of energy purchased for resale. During December 1993 and January 1994, the Company settled two major disputes involving litigation with fuel suppliers. One dispute related to a coal supply contract between the Company and AMAX. The prior contract was replaced in December 1993 with a new coal supply agreement with AMAX as part of the settlement. In January 1994, the Company entered into a settlement of litigation with DELHI regarding a gas supply contract. The settlement provided for termination of the existing gas supply contract, which otherwise would have expired in March 1995, and a new four- year gas supply contract between the parties. Both settlements are expected to result in reduced fuel costs now and in the future, the benefits of which will revert to the Company's customers through fuel cost adjustment mechanisms. Expenses and Taxes. Operation and maintenance expenses increased 41.1% during 1993, primarily the result of restructuring charges and $4.2 million in reserves for certain lignite properties. Also contributing to the increase were higher expenses for outside and legal services, and higher employee benefit expenses. Significantly higher than average maintenance expenditures on the Company's distribution and general facilities resulted in an increase of 19% in maintenance expense for 1993 compared to 1992. Federal income taxes decreased 12% or $3.9 million as a result of lower pre-tax income, which more than offset the increase in the federal income tax rate from 34% to 35%. Taxes other than federal income were 10.4% higher during 1993, primarily due to a Texas tax refund recognized in 1992. The decrease in 1992 was due in part to this refund, and to lower state income taxes. Effects of Inflation. Annual inflation rates, as measured by the national Consumer Price Index, have averaged approximately 3.3% for the three-year period ending December 31, 1993. Inflation at these levels does not materially affect the Company's results of operations or financial condition. Under existing regulatory practice, however, only the historical cost of plant is recoverable from customers. As a result, cash flows designed to provide recovery of historical plant costs may not be adequate to replace plant in future years. Interest and Preferred Stock Dividends. Interest on long-term debt decreased in each of the past three years as a result of reacquisitions and refinancings of long-term debt. OTHER MATTERS Competition and Industry Challenges. The Company's business has been, and will continue to be affected by various challenges that confront the electric utility industry generally. The Company currently faces competition for power sales in the wholesale market. In the future, the Company may face similar competition for retail sales from other utilities, independent power producers or alternative sources of electricity or other energy. To date, the Company has been successful in meeting the competition. In 1993, the Company and PSO filed with the FERC tariffs under which they make generally available firm and non-firm transmission services for other electric utilities on the combined PSO and SWEPCO transmission systems in the Southwest Power Pool. The FERC accepted the tariffs for filing on November 4, 1993. The tariffs will expose the CSW System to some additional risk of loss of load or reduced revenue resulting from competition with alternative suppliers of electric power. Other industry-wide issues confronting the Company include current and proposed stringent environmental and other regulation and deregulation. In addition, the Company is continuing to manage costs and rates and focus on new initiatives in order to maintain its financial strength and reach its financial targets. Environmental. The operations of the Company, like those of other electric utilities, generally involve the use or disposal of substances subject to environmental laws. CERCLA, the federal "Superfund" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs. The Company has been named as a responsible party under federal or state remedial laws four times, and has resolved three of those claims without a material adverse effect on the Company. The Company does not anticipate that resolution of the remaining claim will have a material adverse effect on it. Factors that are the basis for the expectation are the volume and/or type of waste allegedly contributed by the Company, the estimated amount of costs allocated to the Company and the participation of other parties. Contaminated former MGPs are a type of site which utilities, and others, may have to remediate in the future under Superfund or other federal or state remedial programs. Gas was manufactured at MGPs from the mid-1800's to the mid- 1900's. In some cases, utilities and others have faced potential liability for MGPs because they, or their alleged predecessors, owned or operated the plants. In other cases, utilities or others may have been subjected to such liability for MGPs because they acquired MGP sites after gas production ceases. The Company is investigating contamination at a suspected MGP in Marshall, Texas. Although it has not been determined whether a cleanup will be required at the site, preliminary estimates of potential responses indicate that such costs would not be material to the Company. As more information is obtained about the site, and the Company discusses the site with the TNRCC, the preliminary estimates may change. If a cleanup is required, the Company intends to seek contribution from other PRPs. See ITEM 1. ENVIRONMENTAL MATTERS, for further discussion of certain Superfund and MGP sites. The Clean Air Amendments of 1990 direct the EPA to issue regulations governing nitrogen oxide emissions. In addition, these amendments require government studies to determine what controls, if any, should be imposed on utilities to control air toxic emissions. The impact that the nitrogen oxide emission regulations, and the air toxics study, will have on the Company cannot be determined at this time. Research is ongoing whether exposure to EMFs may result in adverse health effects or damage to the environment. Although a few of the studies to date have suggested certain associations between EMFs and some types of adverse health effects, the research to date has not established a cause- and-effect relationship between EMFs and adverse health effects. The Company cannot predict the impact on the CSW System or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems. Cumulative Effect of Changes in Accounting Principles. In 1993, the Company implemented SFAS No. 112, Employers' Accounting for Post Employment Benefits, SFAS No. 109, Accounting for Income Taxes and changed the method of accounting for unbilled revenues. These changes are presented as a net $3.4 million cumulative effect of changes in accounting principles. ITEM 8.

92487

1993

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------- Results of Operations - --------------------- 1993 Compared to 1992 - --------------------- Revenues from the Company's publishing operations in- creased by 0.7% to $54,098,246. Revenues from subscriptions and outside journals increased by 2.4%, primarily attributable to more journal issues being published and higher selling prices, offset by non-renewals of subscriptions partially due to the reduced buying power of libraries. Revenues from book sales decreased by 6.2% primarily due to fewer book titles being published. In December 1993, the Company entered into a Journal Production and Distribution Agreement (the "Distribution Agree- ment") with the Russian Academy of Sciences (the "Academy") and other interested parties pursuant to which the litigation then pending, relating to the translation of Russian scientific journals, was ended, and the Company's role as publisher and distributor of certain of such journals was altered. The Distri- bution Agreement extends from 1994 through 2006. Pursuant to the Distribution Agreement, in 1994 the Company will distribute for MAIK Nauka ("MN"), an entity owned in part by Pleiades Publishing, Inc. and the Academy, 21 Russian scientific journals in English. MN will become the exclusive publisher of such journals. Prior thereto, the Company had translated, published and distributed these journals under a con- tract with the Copyright Agency of the former Soviet government, and under contracts with the individual institutes publishing the journals, and had paid royalties based in part upon the number of subscribers. Under the Distribution Agreement, the Company will continue to promote and distribute these journals throughout the world, and will continue to deal with and collect from subscribers to the journals, retaining a portion of such revenues for performing its function. In 1994, the Company will retain 35% of the revenue, with the amount gradually being reduced to 30% in 1999 and remaining at that level for the balance of the term of the Distribution Agreement. Revenue from such 21 journals in the 1993 journal year constituted 6.7% of the Company's overall journal revenue and 16.2% of its Russian journal revenue. Nine of such journals were being published by both the Company and the predecessor of MN under conflicting contracts and were the subject of the above-mentioned litigation. Under the Distribution Agreement, in 1995 and 1996 MN will undertake the publication of the English translations of 11 additional Russian journals, to be promoted and distributed by the Company, representing a total of an additional 13.7% of the Company's 1993 Russian journal revenue and 5.6% of its total journal revenue. Commencing in such years, MN may elect to publish the English translations of up to 23 additional Russian journals, to be promoted and distributed by the Company. The total revenue from these 23 journals equals 29.2% of the Comp- any's 1993 Russian journal revenue and 11.9% of its total journal revenue. As to each additional journal which is published by MN and distributed by the Company under the Distribution Agreement, the Company will retain 35% of the revenue in the initial year of distribution, with the amount gradually being reduced to 30% over a six-year period. MN intends to cause the above-mentioned journals to be translated and published in the former Soviet Union. The Company will continue its activities in translating, publishing and distributing both the journals subject to the Distribution Agreement until they are published by MN and the approximately 40 English Translation Russian Journals not subject to the Agreement. These activities will be undertaken pursuant to the Company's existing English translation and publication contracts with the individual entities publishing the Russian language journals which generally extend through 2001. Management expects that in 1994 and thereafter, revenues and net income from subscription journals will decrease as a result of the Company's modified relationship to the translation journals covered by the Distribution Agreement, and also as a result of the political and economic situation in Russia and in the other republics of the former Soviet Union. In April 1993, an American learned society with whom the Company had a contract to produce English translations of 11 Russian language journals for publication by that society gave formal notice that they would not exercise the option of renewing the contract beyond the term ending with the 1993 volume year. For fiscal 1993, the amount of revenue generated from the produc- tion of these 11 journals was approximately $1,261,000; however, such revenue will cease during fiscal 1994. The cost of sales as a percentage of revenues increased from 39.82% to 40.08%, primarily due to higher salaries and employee benefit costs, offset by a more favorable mix of reve- nues from subscriptions and outside journals and book sales. The increase in royalty expenses was principally due to increased royalty rates. The decrease in selling, general and administra- tive expenses was primarily attributable to decreased profession- al fees and bad debt expense, offset by higher salaries, employee benefit costs and sales commissions. The decrease in interest income was principally due to lower interest rates and decreased investments in Government securities, time deposits and money market funds, arising in large part because of the decrease in investment assets utilized for redemption of the Company's 6-1/2% Convertible Subordinated Debentures on April 30, 1993. The increase in dividend income resulted from the increase in average investment in marketable securities in 1993. The Company had a net realized gain of $801,387 on marketable securities and recorded a provision of $1,713,197 for net unrealized losses on marketable securities for 1993, as compared to a net realized gain of $2,476,916 on marketable securities for 1992. The decrease in interest expense was primarily due to the redemption of the Debentures. The decrease in net income was principally attributable to the decrease in investment income as discussed in the preceding paragraph and the extraordinary loss from early retirement of 6-1/2% Convertible Subordinated Debentures. The provision for income taxes as a percentage of income decreased in 1993 as compared to 1992 because in 1992 the Company recorded an additional provision for state and local income taxes for assessments of such taxes expected with respect to prior years. 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," effective for fiscal years beginning after December 15, 1993. Under the new rules, which the Company will adopt effective January 1, 1994, the Company will classify its marketable equity securities held as trading securities on the basis of its intent to trade such securities. Accordingly, all marketable equity securities classified as trading securities will be carried at fair market value. Unrealized gains and losses applicable to these securities will be reported as a component of current earnings. Presently, the Company values marketable equity securities as trading securities and reports such securities at the lower of aggregate cost or market, with unrealized losses reported as a component of current earnings. 1992 Compared to 1991 - --------------------- Revenues from the Company's publishing operations increased by 0.7% to $53,725,999. Revenues from subscriptions and outside journals increased by 2.3%, primarily attributable to higher selling prices, offset by non-renewals of subscriptions partially due to the impact of the recession on the buying power of libraries and individuals, and fewer journal issues being published. Revenues from book sales decreased by 5.3% primarily due to fewer book titles being published. Revenues from database products increased by 9.7%, primarily due to increased prices. The cost of sales as a percentage of revenues increased from 39.56% to 39.82%, primarily due to higher salaries and employee benefit costs, offset by a more favorable mix of revenues from subscriptions and outside journals and book sales, and increased prices of database products. The increase in royalty expense was principally due to increased royalty rates and higher costs associated with extended English translation and publication agreements with Institutes publishing scientific journals in Russia. The insignificant decrease in selling, general and administrative expenses was primarily attributable to lower sales commissions, advertising expenditures, computer expenses and mailing expenses, offset by higher salaries and employee benefit costs and increased professional fees. The decrease in interest income was principally due to lower interest rates. The increase in dividend income was due to increased investment in marketable securities. The Company had a net realized gain of $2,476,916 on marketable securities for 1992, as compared to a net realized gain of $19,714 and a reversal of the provision of $6,544,417 for net unrealized loss on marketable securities for 1991. The decrease in interest expense resulted from the repurchase of $6,808,000 of 6 1/2% Convertible Subordinated Debentures due April 15, 2007. The decrease in net income was principally due to the decrease in investment income discussed in the preceding paragraph, decreased income from publishing operations and an increase in the provision for income taxes as a percentage of income, offset by the cumulative effect on prior years of accounting change for deferred income taxes and extraordinary credit arising from the repurchase of 6 1/2% Convertible Subordinated Debentures. The provision for income taxes as a percentage of income increased because the reversal of net unrealized losses on marketable securities in 1991 was exempt from income taxes to the extent that said losses, when incurred in 1990, had no deferred tax benefits recognized, and in 1992 the Company recorded an additional provision for state and local income taxes for assessments of such taxes expected with respect to prior years. Liquidity and Sources of Capital - -------------------------------- The ratio of current assets to current liabilities is 6.3 to 1 at December 31, 1993 compared to 2.1 to 1 at December 31, 1992. Management anticipates that internally generated funds will exceed requirements of the operations of the business. The Company also has funds of approximately $53,855,000 at December 31, 1993 invested in marketable securities and in cash, which are available for corporate purposes. On April 30, 1993 (the "Redemption Date"), pursuant to a notice of election to redeem which had been given to the holders on March 24, 1993, the Company redeemed the Debentures which were outstanding on the Redemption Date. In accordance with the terms of the Debentures and the applicable Trust Indenture, the redemp- tion required a total payment of $40,734,793 (representing the redemption price of 102.60% of the principal amount of outstanding Debentures and accrued interest from April 15 to April 30, 1993). This amount was funded by liquidating a portion of the Company's investments of its excess cash, and from short-term borrowing on the Company's margin account with a broker. Item 8.

79166

1993

ITEM 6. SELECTED FINANCIAL DATA. The information required in response to this Item is incorporated by reference from the disclosure contained under the caption "Selected Financial Data" on page 20 of the Annual Report to Stockholders, which is included as Exhibit 13 hereto. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information required in response to this Item is incorporated by reference from the disclosure contained under the caption "Financial Analysis" on pages 4-19 of the Annual Report to Stockholders, which is included as Exhibit 13 hereto. ITEM 8.

355883

1993

865227

1993

ITEM 6. SELECTED FINANCIAL DATA. This item is omitted pursuant to paragraph (2) of General Instruction "G" -- Information to be Incorporated by Reference. See Summary of Selected Financial Data on Page 2 of the 1993 Annual Report incorporated herein by reference as Exhibit 13. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This item is omitted pursuant to paragraph (2) of General Instruction "G" -- Information to be Incorporated by Reference. See Financial Review on pages 25 through 35 of the 1993 Annual Report incorporated herein by reference as Exhibit 13. Reference is made to page 10 of this report for a discussion of the effects of inflation. ITEM 8.

101320

1993

Item 6. Selected Financial Data See the Financial Statements of the Registrant in Item 8. Item 7.

Item 7. Management's Discussion And Analysis Of Financial Condition and Results Of Operations. General The Company has experienced severe working capital shortages during most of the period since 1976, primarily because of its prolonged experience in its research and development stage and its subsequent inability to obtain delivery of product from its manufactured. The Registrant had been primarily a one product company, engaged in the development of its automated electronic blood pressure measuring device known as the AES Unit. Since February 28, 1985, the Company has had no active business operations of any kind. All risk inherent in new and inexperienced enterprises are inherent the Company's business. The Company has not made a formal study of the economic potential of any business. At the present, the Company has not identified any assets or business opportunities for acquisition. As of February 28, 1993 the Company has no liquidity and no presently available capital resources, such as credit lines, guarantees, etc. and should a merger or acquisition prove unsuccessful, it is possible that the Company may be dissolved by the State of Delaware for failing to file reports, at which point the Company would no longer be a viable corporation under Delaware law and would be unable to function as a legal entity. Should management decide not to further pursue its acquisition activities, management may abandon its activities asked the shares of the Company would become worthless. However, the Company's officers, directors and majority shareholder, have made an oral undertaking to make loans to the Company in amounts sufficient to enable it to satisfy its reporting requirements and other obligations incumbent on it as a public company, and to commence, on a limited basis, the process of investigating possible merger and acquisition candidates. The Company's status as a publicly-held corporation may enhance its ability to locate potential business ventures. The loans will be interest free and are intended to be repaid at a future date, or when the Company shall have received sufficient funds through any business acquisition. The loans are intended to provide for the payment of filing fees, professional fees, printing and copying fees and other miscellaneous fees. Based on current economic and regulatory conditions, Management believes that it is possible. if not probable, for a company like the Company, without assets or liabilities, to negotiate a merger or acquisition with a viable private company. The opportunity arises principally because of the high legal and accounting fees and the length of time associated with the registration process of "going public". However, should any of these conditions change, it is very possible that there would be little or no economic value for anyone taking over control of the Company. ITEM 8.

64605

1993

ITEM 6. Selected Financial Data. Not Applicable. Because of the limited activities of the Trust, the Selected Financial Data required by Item 301 of Regulation S-K does not add relevant information to that provided by the Monthly Reports to Certificateholders, which are filed on a monthly basis on Form 8-K. ITEM 7.

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Not Applicable. The information required by Item 303 of Regulation S-K is inapplicable because the Trust does not have management per se, but rather the Trust has a Trustee who causes the preparation of the Monthly Reports to Certificateholders. The information provided by the Monthly Reports to Certificateholders, which are filed on a monthly basis on Form 8-K, does provide the relevant financial information regarding the financial status of the Trust. ITEM 8.

884033

1993

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS _______ _________________________________________________ The Company's financial condition and results of operations are affected by numerous factors, including the timing and amount of rate relief, the extent of sales growth and the level of operating costs. The following discussion and analysis should be considered in conjunction with the relevant Sections of ITEM 1, "Selected Financial Data" in ITEM 6, and the Company's financial statements appearing in ITEM 8.

17797

1993

ITEM 6. SELECTED FINANCIAL DATA - --------------- * As restated (see Notes to Financial Statements). ** Before the cumulative effect of accounting changes in 1992. *** Excludes effects of Discontinued Operations. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLAR AMOUNTS ARE IN MILLIONS UNLESS OTHERWISE STATED) The task of repositioning the Corporation's businesses which began in 1992 was intensified in 1993 with a number of strategic transactions expected to further the Corporation's goals of improved shareholder value, cash generation and return on equity. A major study designed to improve the effectiveness and productivity of the Corporation's Headquarters functions was completed last fall and will result in reduced overhead costs in 1994 and future years. At ITT Hartford, both revenues and operating income reached record levels in 1993 as the life insurance operations continued to grow through internal expansion and through the assumption of policies from other insurers. Improved underwriting results in the property and casualty business were also a significant contributor to ITT Hartford's performance as the worldwide combined ratio improved to 107.3 percent. ITT Automotive's sales of four-wheel anti-lock brake and traction control systems exceeded $1 billion for the first time in 1993, making it the first automotive parts supplier in the world to reach that level. In June, the sale of ITT Consumer Financial Corporation's domestic unsecured consumer small loan portfolio was completed resulting in a pretax gain of $95 ($63 after tax). Proceeds from the sale allowed ITT Financial to retire higher cost fixed-rate debt, and return capital to the Corporation. An extraordinary pretax loss of $75 ($50 after tax) was recorded on the debt retirement. In September, the Corporation announced the signing of a preliminary agreement to acquire the Motors and Actuators Business Unit of General Motors Automotive Components Group. This acquisition is expected to contribute annual revenues of $900 and add strength to ITT's position as a global leader in the automotive components and systems market. The transaction is expected to close in the first half of 1994. In November, the Corporation entered the U.S. gaming industry with the acquisition of the Desert Inn Properties in Las Vegas which is expected to be developed into a major gaming resort. The acquisition of a full-service resort in Las Vegas, the country's number one destination resort and one of the largest convention cities in the U.S., afforded the Corporation the opportunity to immediately enter the North American land-based gaming industry. ITT Sheraton also plans to open a dockside casino near Memphis by the summer of 1994. The spin-off of ITT Rayonier to the Corporation's shareholders was announced in December and was completed in February, 1994. The spin-off allows Rayonier to better fulfill its long-term strategies and objectives while furthering the Corporation's strategic goals. Rayonier expects to pay a dividend of $.72 per share in 1994, the equivalent of $.18 per share to the Corporation's shareholders. Rayonier has been reflected as a "Discontinued Operation" for all periods presented. These important actions further the Corporation's commitment to improving returns and shareholder value. To that end, additional steps will be taken in 1994, including strategic acquisitions and the continuation of the repurchase of the Corporation's common shares. SALES, REVENUES AND INCOME Worldwide sales and revenues were $22.8 billion in 1993 compared with a restated $23.0 billion and $21.5 billion in 1992 and 1991, respectively. The sales and revenues decrease in 1993 primarily reflects the sale of ITT Financial's domestic unsecured consumer small loan business in June as well as reduced Defense business as several major programs were completed. Excluding the sales of companies included in "Dispositions and Other", sales and revenues increased 2% in 1993 and 8% in 1992. Sales and revenues in all periods have been modified to include 100 percent of the revenues of partially-owned hotel properties and hotel properties under long-term management agreements. The Corporation believes that this presentation better reflects the breadth and control of hotel operations and increased sales and revenues (with no impact on operating income) by $2.4, $2.3 and $2.1 billion in 1993, 1992 and 1991, respectively. Net income for 1993 was $913 or $6.90 per fully diluted share compared with a net loss of $885 or $6.90 per fully diluted share in 1992, which was due primarily to several significant nonrecurring items and accounting changes during 1992. This was compared with net income in 1991 of $749 or $5.49 per fully diluted share. Primary earnings (loss) per share were $7.32 in 1993, $(7.93) in 1992 and $5.84 in 1991. 1993: A number of one-time items are included in net income in 1993 including the gain on the sale of the domestic unsecured consumer small loan portfolio at ITT Financial of $63 after tax, or $.48 per fully diluted share and the related retirement of fixed-rate debt at a premium of $50 after tax, or $.38 per fully diluted share. In addition, results included a $33 after tax or $.25 per fully diluted share provision relating to a program aimed at increasing the effectiveness and productivity at ITT Headquarters and the headquarters of the business segments and a $22 or $.17 per fully diluted share favorable impact of the changes in the United States tax law. Income in future periods will be negatively impacted by the 1% increase in the U.S. Federal tax rate. Further, the year was impacted by $19 after tax or $.15 per fully diluted share for the accelerated write-off of capitalized development expenses at ITT Sheraton; $7 or $.06 per fully diluted share for an after tax gain at ITT Sheraton on its investment in Bally's Las Vegas and $10 after tax or $.08 per fully diluted share for an after tax gain on the sale of ITT Components Distribution. The year also included prior period tax and associated interest charges related to separate decisions by Canadian and California state taxing authorities of $16 after tax or $.12 per fully diluted share and $10 or $.08 per fully diluted share. Extraordinary catastrophe losses at ITT Hartford early in the year negatively impacted earnings by $41 after tax or $.32 per fully diluted share. The catastrophes included the World Trade Center bombing in New York and excessive damage from storms in the Northeastern United States. Portfolio gains at ITT Hartford and ITT Financial in 1993 totalled $98 after tax or $.76 per fully diluted share. Excluding these gains along with the one-time items, net income was $882 or $6.65 per fully diluted share. 1992: The net loss in 1992 included the effects of the Corporation's adoption of Statement of Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions", and SFAS No. 112, "Employers' Accounting for Postemployment Benefits," which were recorded effective January 1, 1992 using the immediate recognition method. These accounting changes resulted in a cumulative catch-up adjustment of $625 after tax, or $4.71 per fully diluted share. These standards required accrual of postretirement and postemployment health care and life insurance benefit costs during the years that an employee provides services to the Corporation rather than on the pay-as-you-go basis previously in effect. There is no cash flow impact of these accounting changes. In July 1992, the Corporation completed the sale of its 30% stake in Alcatel N.V. to its joint venture partner, Alcatel Alsthom, resulting in an after tax gain of $622 or $4.71 per fully diluted share -- see "Alcatel N.V." in Notes to Financial Statements. The Corporation also recorded several one-time items during the year to realign and restructure certain businesses including: -- A $594 after tax charge at ITT Hartford to fund expected loss developments in surplus lines and reinsurance business at its Cameron & Colby unit and $165 after tax for expected legal defense costs associated with environmental-related claims. The total result was a charge of $759 or $5.75 per fully diluted share. Extraordinary catastrophe losses at ITT Hartford in 1992 negatively impacted earnings by $131 after tax or $.99 per fully diluted share. The catastrophes included Hurricanes Andrew and Iniki along with the Los Angeles riots and the Chicago flood. -- A $612 after tax charge or $4.66 per fully diluted share at ITT Financial primarily to strategically transform the consumer finance business by significantly reducing its domestic unsecured consumer small loan business. As a result, ITT Financial established reserves of $693 to cover future unsecured loan losses from the run-off of its existing portfolio, $103 for restructuring, including consolidation of loan offices, and $132 for anticipated losses in the commercial real estate portfolio. The domestic unsecured consumer small loan business has been reflected in "Dispositions and Other" and, as discussed previously, was sold in June 1993. -- Other provisions and reserves of $115 after tax or $.87 per fully diluted share, to cover the loss on the disposal of assets and for closure expenses of ITT Rayonier's Grays Harbor pulp and paper complex. In addition, a $34 after tax, or $.25 per fully diluted share provision to write down hotel investments at ITT Sheraton, and a $33 after tax or $.25 per fully diluted share charge for restructuring in the Components operations of ITT Defense & Electronics were recorded. Portfolio gains at ITT Hartford and ITT Financial in 1992 totalled $337 after tax or $2.56 per fully diluted share. Excluding these gains as well as the one-time items and accounting changes, net income was $465 or $3.31 per fully diluted share. 1991: There were no significant items of an unusual or nonrecurring nature during 1991. Net income was $749 or $5.49 per fully diluted share. Portfolio gains at ITT Hartford and ITT Financial in 1991 totalled $137 or $1.04 per fully diluted share. Excluding these gains, net income was $612 or $4.45 per fully diluted share. CASH FLOW The Corporation generated $1.7 billion of cash from operating activities during 1993, $1.7 billion in 1992 and $2.1 billion in 1991. Additional funds of $2.4 billion were also raised in 1993 from the sale of companies including ITT Financial's domestic unsecured consumer small loan business for $1.5 billion and the collection on a note of $.8 billion from the 1992 sale of Alcatel N.V. Proceeds in 1992 from the Alcatel N.V. sale totalled $1.0 billion. Growth in investment life contracts provided $1.7 billion, compared with $1.6 billion and $1.8 billion in the prior two years. Cash generated was used to fund internal growth, pay dividends, repay debt in 1993 and to repurchase and redeem ITT common and preferred shares in 1993 and 1992. Cash was also reinvested in securities at ITT Hartford and ITT Financial. Additional information on the investment portfolio is included in "Insurance and Finance Investments" in Notes to Financial Statements. Pursuant to the Corporation's share repurchase program announced in May 1992, 3.6 million common shares were repurchased in 1993 at an average price of $86.52 per share for a total of $310 at December 31, 1993. At December 31, 1992, approximately 1.7 million common shares had been repurchased at an average price of $65.63 per share for a total of $109. In addition, the Corporation called for the redemption of all outstanding $4.00 Convertible Series K and $5.00 Convertible Series O Cumulative Preferred Stock at $100 per share plus accrued dividends in June 1992. Redemptions totalled $106, which reduced common equivalent shares by an additional 1.6 million, with the balance converted to 5.8 million shares of common stock. Since the Corporation's stock repurchase programs began in 1987, nearly 40 million equivalent shares have been repurchased and redeemed for approximately $2.3 billion. Dividend payments were $277, $270 and $267 during 1993, 1992 and 1991, including $48 in both 1993 and 1992 and $49 in 1991 related to the ESOP preferred stock. Cash expenditures for plant, property and equipment were $505 in 1993, $549 in 1992 and $658 in 1991 and are expected to approximate $800 in 1994. Acquisitions in 1993 included the Desert Inn Properties in Las Vegas for $160. The planned acquisitions in 1994 in the Automotive and Hotels segments are expected to total approximately $1.0 billion. The Corporation has sufficient cash available, along with debt and equity financing alternatives, to fulfill these and other commitments that may be undertaken during the year. Depreciation in 1993 was $463 compared with $483 in 1992 and $426 in 1991. Accumulated depreciation amounted to 47% of gross plant, property and equipment at year-end 1993 and 1992. Expenditures for research, development and engineering totalled $460 in 1993, $502 in 1992 and $530 in 1991, of which approximately 53% was pursuant to customer contracts. These expenditures have funded numerous product developments such as anti-lock brake systems, and integrated circuits for multimedia applications and digital television, as well as electronic countermeasures and tactical radio communications technology. The Corporation remains financially strong and flexible given the level of cash generated from operations as well as the proceeds received (and expected to be received in 1994) from the sale of investments. Cash at December 31, 1993 totalled $1.1 billion and debt as a percentage of total capital was 33 percent with the Insurance and Finance subsidiaries carried on an equity basis and excluding Discontinued Operations. BUSINESS SEGMENTS Following is a discussion of important factors affecting the sales, revenues and operating income of each Business Segment. INSURANCE Revenues and operating income achieved record levels in 1993. Revenues increased 5 percent despite portfolio gains which were $288 lower than 1992. Portfolio gains included in revenues totalled $155, $443 and $144 in 1993, 1992 and 1991, respectively. Life operations provided much of the revenue growth and contributed 29 percent of the segment revenues in 1993 compared with 24 percent and 21 percent in 1992 and 1991. This increase, 25 percent in 1993, reflects dramatic improvement in account charge revenues from corporate owned life insurance contracts (COLI) combined with continued growth in individual life and annuity lines of business. The assumption and reinsurance of both COLI and annuity policies from Mutual Benefit and Fidelity Bankers were instrumental in the continued growth. Operating income in the life operations contributed 31 percent to the insurance segment in 1993 and increased 30 percent compared with 1992 which, in turn, increased 26 percent over 1991. As with revenues, the effects of the Mutual Benefit and Fidelity Bankers transactions were the largest contributors to the improvement. North American property and casualty underwriting revenues also increased modestly while revenues of the international property and casualty operations were flat compared with 1992. Dramatically improved income performance reflects improved property and casualty underwriting results as reflected in the worldwide combined ratio of 107.3 percent in 1993. Worldwide combined ratios were 133.7 percent in 1992 and 111.3 percent in 1991. Reserves were established in 1992 for expected loss developments in surplus lines and reinsurance at Cameron & Colby ($900) as well as projected legal defense costs associated with environmental-related claims ($250). Excluding the effects of the Cameron & Colby loss developments in surplus lines and reinsurance, the worldwide combined ratios were 105.9 percent in 1993, 114.8 percent in 1992 and 109.1 percent in 1991. In addition, catastrophe losses in 1993 were significantly below the record setting levels of 1992. Adjusted for these unusual items and portfolio gains, 1993 operating income increased significantly. These improvements were partially offset by reduced investment income, the result of lower interest rates and lower portfolio gains in 1993. On the same adjusted basis, 1992 operating income approximated 1991, reflecting a similar trend in domestic property and casualty results, offset by difficult market conditions in the international property and casualty business. Operating results are projected to continue to improve in 1994 due to improvements in worldwide property and casualty underwriting results combined with the effect of the growing life insurance operations. These projections include the benefits of recent restructuring actions designed to increase ITT Hartford's efficiency and competitiveness. FINANCE During 1993, ITT Financial completed a strategic repositioning of the company aimed toward emphasizing the origination and servicing of secured lending assets. Actions during 1993 included the sale of its domestic unsecured consumer small loan portfolio, the start up of ITT Residential Capital Corp. (a fully integrated residential mortgage company) and the repositioning of the domestic home equity business. At year-end 1993, secured funded receivables constituted 88% of total funded receivables as compared to 69% at year-end 1992. Revenues and operating income data have been restated to exclude the results of the domestic unsecured consumer small loan business which is reported in "Dispositions and Other". The benefits of this strategic shift will be reduced operating expenses, dramatically improved credit quality, and improved asset liquidity. ITT Financial plans to leverage these benefits through improved capital efficiency, primarily securitization. During 1993, ITT Financial completed the securitization of $2.4 billion of assets. Finance revenues from ongoing businesses increased in 1993 and 1992 due to increased finance charges and servicing income on higher levels of owned and serviced receivables. The operating income improvement in 1993 reflects the absence of last year's provision of $132 for anticipated losses in the commercial real estate portfolio. When adjusting for that provision, along with the portfolio gains which were significantly lower in 1993 compared with prior years, operating income in 1993 improved over 1992 and approximated 1991 levels. Emphasis on secured lending and asset securitization will remain the focus in 1994. The nature of this strategy is to enhance the Company's risk profile and improve asset quality, although operating income will be somewhat lower. COMMUNICATIONS & INFORMATION SERVICES Both sales and revenues and operating income rose 5 percent in 1993 over 1992 when adjusting for the impact of unfavorable foreign exchange. The increase in all periods reflected improvements in the telephone directory operations in Western Europe as well as an increase in the number of ITT Technical Institutes and student enrollment at those institutes at ITT Educational Services. At ITT World Directories, operating margins are under pressure due to lower advertising volume in a number of units. Modest price increases, coupled with reduced operating costs, have resulted in margins that generally meet or exceed prior year levels. ITT World Directories' operations in the United Kingdom were sold to British Telecom in 1993 prior to the expiration of a directory sales contract. Operations in Turkey were shut down in December 1992 as a result of continuing losses in a difficult economic environment. The operating results of these units are reported in "Dispositions and Other" for all years presented. A shift in the regulatory and competitive structures in the European Community may limit growth of existing operations during 1994. The Company continues to pursue a program of product diversification and geographic expansion. At ITT Educational Services, 20,000 students are enrolled at 48 schools. Five new schools opened during 1993. Operating results at ITT Educational Services are projected to continue to improve in 1994 due to additional school openings and a continuing expansion of curricula and degree offerings. A period of strong growth is expected as a result of ongoing demand for increased technical education of the U.S. work force. AUTOMOTIVE Sales continued to increase in 1993 as in 1992 as a result of increased market penetration of ITT Anti-lock Brake Systems ("ABS"), higher light vehicle production in North America and the continued shift in consumer preference toward light trucks for which ITT Automotive maintains a strong product offering. Tempering the growth in 1993 was the deepening recession in Western Europe which resulted in a decline in Western European car production. Western European sales comprised 57 percent of the total in 1993 compared with 68 percent in 1992 and 70 percent in 1991. Higher operating income in 1993 is largely the result of continued cost reduction efforts partially offset by lower sales prices and higher labor costs. Compared with 1991, the increased operating income was largely attributable to sales growth in addition to cost reduction efforts partially offset by higher labor costs and restructuring actions. ITT Automotive will continue to benefit in 1994 from an anticipated increase in North American light vehicle production, particularly light trucks, as well as continued cost reduction efforts. Additionally, Western European passenger car production is anticipated to stabilize. Anti-lock brake systems remains the largest product line offered by ITT Automotive, comprising 30, 27 and 22 percent of total sales in 1993, 1992 and 1991, respectively. The acquisition of General Motors' motors and actuators business unit is expected to strengthen ITT Automotive's position in a number of product lines, particularly motors and wiper systems for the North American market. DEFENSE & ELECTRONICS The 13 percent sales reduction in 1993 was anticipated and related primarily to the Defense units as the impact of the completion of several major programs and reduced U.S. government defense spending resulted in lower shipments and a decline in operations and maintenance contracts. The sales decrease in 1992 related primarily to the Electronics units due to a worldwide decline in the television market and softness in the connector product line, especially due to lower military related demand. Sales and operating income have been restated in all periods to reflect the December 1993 sale of ITT Components Distribution. The gain on the sale of $13 pretax and the operating results are reflected in "Dispositions and Other." Operating income improved substantially in 1993 reflecting current year cost improvements at several units and favorable margin adjustments on mature military programs along with the absence of a 1992 restructuring charge. The operating loss in 1992 resulted from the $53 million restructuring charge, reduced volume and downward pricing pressures for commercial products. Order backlog was $2.2, $2.3 and $2.2 billion at December 31, 1993, 1992 and 1991, respectively. Sales and operating income in 1994 are expected to approximate 1993 levels. New product development, expanded markets (including international defense opportunities) and the benefits of ongoing restructuring activities provide a basis for future growth. FLUID TECHNOLOGY Sales have remained relatively level in the past several years with the decrease in 1993 due primarily to a stronger U.S. dollar versus many of the European currencies in which Fluid Technology operates. In the past two years, growth in markets including water and wastewater treatment, power generation and exports as well as new products have been largely offset by weak market conditions in such industries as construction, industrial process, oil and gas, mining and leisure marine. Operating income in 1993 benefited from the impact of cost improvement actions taken in 1992, including the consolidation of facilities to reduce excess capacity. In 1992, provisions for restructuring along with the devaluation of the Swedish krona adversely impacted operating income. Slow but steady economic improvement is expected in served markets in 1994. ITT Fluid Technology's position of market leadership, customer-oriented marketing programs, and new products, together with its lower cost structure, should allow the company to resume its profitable growth. HOTELS Sales and revenues have been modified in all periods to include 100 percent of the revenues of the hotels under Sheraton's management. The Corporation believes that such a presentation better reflects the breadth and control of hotel operations and increased sales and revenues (with no impact on operating income) by $2.4, $2.3 and $2.1 billion in 1993, 1992 and 1991, respectively. Sales and revenues increased in 1993 largely due to improvements in the North American region along with the contribution of the Desert Inn which was acquired in late 1993. The increase in 1992 over 1991 was also attributable to the North American region, where room inventory levels were fully restored as renovations were completed at several owned hotels and to higher revenues among Sheraton's managed properties. In 1993, ITT Sheraton continued its focus on upgrading properties and enhancing its image through the completion of renovation work and elimination of properties which do not meet required standards. More than 30.2 million room nights were sold in 1993, an increase of 1.7 million room nights from 1992 for comparable hotels. Operating income in 1993 reflected the accelerated write-off of capitalized development expenses totalling $29 along with an $11 gain on the sale of an investment in Bally's Las Vegas operations. In 1992, a provision of $45 to write down hotel investments resulted in a reported operating loss. When excluding the impacts of these one-time items, operating income rose dramatically in 1993. Total sales and revenues of the Hotels segment, including 100% of unconsolidated revenue generated by franchised hotels, were (in billions) $4.8 in 1993 and 1992 and $4.4 in 1991. Room rates of owned, managed and leased properties averaged $105.48, $107.14 and $104.19 for 1993, 1992 and 1991, respectively, while occupancy rates were 68.5% , 66.4% and 64.9%. The 1993 room rate reduction reflects the stronger U.S. dollar against numerous foreign currencies, particularly in Europe. Total properties numbered 407 in 1993 compared with 426 and 423 in 1992 and 1991, respectively, including franchised properties of 230, 252 and 259 in those years. Operating income is expected to continue to improve in 1994 both from existing hotels as well as from acquisitions. The Gaming division, which will include a full year's results from the Desert Inn and the anticipated contribution from a casino near Memphis opening mid-year, will be a significant focal point. Other anticipated acquisitions are expected to provide Sheraton with an enhanced presence in markets not previously represented. ALCATEL N.V. The Corporation sold its 30 percent interest in Alcatel N.V. to its joint venture partner, Alcatel Alsthom in July, 1992. Proceeds from the sale included $1 billion in cash, two notes payable in 1993 and 1994 totalling $1.6 billion (including interest) and 9.1 million shares in Alcatel Alsthom. The shares, which have a net book value of $.8 billion, have a fair market value of $1.1 billion as of February 28, 1994. The Corporation recognized a pretax gain of $942 ($622 after tax) in 1992 on the transaction. DISPOSITIONS AND OTHER Dispositions and Other includes the sales, operating results and the gain or loss from sale or closedown of units other than "Discontinued Operations," along with the sales and operating results of other non-core businesses. Results for all years presented include sales and operating results of the Corporation's Community Development subsidiary. The domestic unsecured consumer small loan portfolio previously included in the Finance segment is the largest business included in "Dispositions and Other". The operating losses are included in all years presented along with the provision in 1992 to cover future domestic unsecured consumer small loan losses and to restructure the business, including consolidation of consumer loan offices. A $95 pretax gain ($63 after tax) on the sale of this portfolio is included in 1993. Operating results for all periods and associated gains on sale in 1993 as they relate to ITT Components Distribution and World Directories United Kingdom operations are also included. 1992 included provisions for the closedown of World Directories' unit in Turkey ($41 pretax offset with tax benefits of a similar amount included in "Income Taxes") along with respective operating losses in 1992 and 1991. Sales and operating results for 1991 included certain Italian automotive operations sold in 1991. DISCONTINUED OPERATIONS During December, 1993, the Corporation announced its plans to spin-off ITT Rayonier, the Corporation's Forest Products segment to its common and preferred shareholders. The spin-off was completed in February, 1994. Accordingly, the results of ITT Rayonier are reported as "Discontinued Operations" on a one-lined after tax basis. The income (loss) from "Discontinued Operations", net of taxes, were $53, $(72) and $54 in 1993, 1992 and 1991, respectively. The 1992 results included an after tax provision of $115 for the loss on disposal and the estimated closure costs of ITT Rayonier's Grays Harbor pulp and paper complex. INTEREST, TAXES AND OTHER Net interest expense in 1993 decreased due to lower average debt levels and higher average cash invested. Net interest expense in 1992 approximated 1991 levels as interest income earned in the second half of the year from the proceeds of the Alcatel sale offset higher expense from higher average debt levels incurred to support investments, capital programs and working capital requirements. Income taxes of $345 in 1993 were provided on pretax income of $1.3 billion representing a 27 percent effective tax rate. Tax exempt interest earned on invested assets at Insurance and Finance caused the effective rate to be lower than the U.S. statutory rate. Additionally, in 1993, the changes in the United States tax law resulted in a one-time benefit of $32 representing an increase in the Corporation's deferred tax assets at the beginning of the year necessitated by the 1 percent increase in the statutory rate. Partly offsetting this benefit was a $10 increase to the current year tax provision. "Discontinued Operations", "Extraordinary Item" and "Cumulative Effect of Accounting Changes" are all presented on a net of tax basis and accordingly, the associated tax benefits are not included in the provision above. The increase in income taxes over 1992 and 1991 related primarily to the increase in pretax income. In 1992, large provisions in the Insurance and Finance segments resulted in a pretax loss and a corresponding tax benefit. Income taxes paid in 1993, 1992 and 1991 were $337, $202 and $157, respectively. "Other" consists primarily of corporate expenses, minority equity and non-operating income (expense). In 1993, a provision of $50 pretax is included for estimated severance and other costs associated with a program aimed at increasing the effectiveness and productivity at the Corporation's headquarters locations. "Other" expenses increased in 1992 primarily due to higher corporate provisions for divested company exposures and environmental issues. DEBT AND LIQUIDITY Outstanding debt, including Insurance and Finance debt, was $13.9 billion at December 31, 1993. This was a $2.0 billion decrease from 1992, and was primarily due to the application of the proceeds from the sale of ITT Financial's domestic unsecured consumer small loan portfolio and from ITT Financial's receivable securitization. At December 31, 1993 and 1992, debt was 64% and 68% of total capitalization, including finance and insurance subsidiaries debt of $10.4 billion and $12.1 billion, respectively. With insurance and finance subsidiaries carried on an equity basis and excluding Discontinued Operations, debt was 33% of total capitalization at the end of 1993 compared with 37% at the end of 1992. The Corporation remains strong, flexible and well positioned. Future debt needs can be met as required by traditional and emerging channels. Certain subsidiaries are subject to restrictions on transfer of funds to the Corporation, but the restrictions have not affected the Corporation's ability to meet its cash obligations. No change in this condition is anticipated. Stockholders equity increased $403 during 1993 to $7.7 billion mainly as a result of earnings, partly offset by dividends, share repurchases and redemptions and a reduction in the cumulative translation account. The Corporation had cash of $1.1 billion at December 31, 1993, compared with $882 at the end of 1992. The increase is largely the result of cash generated from operations and proceeds from the collection of the Alcatel note, partly offset by share repurchases and acquisitions. Collection of the remaining note received in the Alcatel sale will supplement the Corporation's available cash by $817 in 1994. This cash, along with debt and equity financing alternatives, is available for share repurchases, acquisitions or debt repayment in 1994 and future periods. In February, 1994, the Corporation entered into a new revolving credit agreement with terms ranging from one to five years with 65 domestic and foreign banks providing credit commitments of $7 billion. These commitments were made to the ITT parent company and certain of its subsidiaries for $3 billion and to ITT Financial totalling $4 billion. The credit commitments of the ITT parent company are used to assure working capital needs and to support commercial paper. Commercial paper borrowings totalled $268 at December 31, 1993. ITT's insurance and finance subsidiaries, foreign units and certain other major domestic subsidiaries usually meet their funding requirements on a direct basis and, from time to time, are supplemented through Corporate-established financing vehicles. ITT Financial is a direct issuer of commercial paper. At December 31, 1993, $2.0 billion of commercial paper was outstanding. The Corporation operates in a multinational environment with minimal exposures in hyper-inflationary countries. Thus, inflation has not had a significant impact on the financial position of the Corporation or results of its operations in recent periods, nor is it expected to do so in the near future. The multinational operations of the Corporation also create exposure to foreign currency fluctuation. The Corporation enters into foreign exchange contracts with major financial institutions to reduce such exposure. These agreements are meant to either hedge exchange exposure on the Corporation's net investment in a foreign country or on the Corporation's foreign denominated debt or are meant to hedge a specific transaction. During 1993, consolidated net assets decreased by $114 reflecting the effect of translated local currencies on the Corporation's net foreign investments and was primarily the result of the strengthening of the U.S. dollar against most European currencies. Foreign currency transaction gains or losses were not significant. ITEM 8.

216228

1993

ITEM 6. SELECTED FINANCIAL DATA. SELECTED FINANCIAL INFORMATION The following table sets forth historical financial information of the Partnership for each of the five years ended December 31, 1993. This information should be read in conjunction with the financial statements of the Partnership and related notes included elsewhere in this Report and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Year Ended December 31, ----------------------- 1989 1990 1991 1992 1993 ---- ---- ---- ---- ---- Statements of Operations Data: (dollars in thousands) Revenues: Gaming . . . . . . . . . . . . $306,009 $276,932 $233,265 $265,448 $264,081 Other. . . . . . . . . . . . . 90,680 87,286 66,411 73,270 69,203 Trump Regency. . . . . . . . . - - 11,547 9,465 - -------- ------- -------- -------- ------- Gross revenues . . . . . . . 396,689 364,218 311,223 348,183 333,284 Promotional allowances 42,551 44,281 31,539 34,865 32,793 -------- ------- -------- -------- ------- Net revenues . . . . . . . . . 354,138 319,937 279,684 313,318 300,491 Costs and expenses: Gaming . . . . . . . . . . . . 177,401 178,356 133,547 146,328 136,895 Other . . . . . . . . . . . . 29,158 26,331 23,404 23,670 24,778 General and administrative 71,533 76,057 69,631 75,459 71,624 Depreciation and amortization. 16,906 16,725 16,193 15,842 17,554 Restructuring costs. . . . . . - - 943 5,177 - Trump Regency . . . . . . . . - 3,359 19,879 11,839 - -------- ------- ------- -------- -------- 294,998 300,828 263,597 278,315 250,851 -------- ------- ------- -------- -------- Income from operations 59,140 19,109 16,087 35,003 49,640 -------- ------- ------- -------- -------- Net interest expense . . . . . . 31,988 33,128 33,363 31,356 39,889 Extraordinary (loss) gain - - - (38,205) 4,120 Net income (loss) (1). . . . . . 24,564 (10,591) (29,230) (35,787) 9,338 Balance Sheet Data: Cash and cash equivalents. . . . $11,627 $10,005 $10,474 $18,802 14,393 Property and equipment - net . . 321,391 316,595 306,834 300,266 293,141 Total assets . . . . . . . . . . 406,950 395,775 378,398 370,349 374,498 Total long-term debt - net (2) 273,411 247,048 33,326 249,723 395,948 Preferred Partnership Interest - - - 58,092 - Total capital. . . . . . . . . . 88,481 83,273 54,043 11,362 (54,710) - -------------- (1) Net loss for the year ended December 31, 1990 includes income of $2.4 million resulting from the settlement of a lawsuit relating to a boxing match. Net loss for the year ended December 31, 1991 includes a $10.9 million charge associated with rejection of the Regency Lease and $4.0 million of costs associated with certain litigation. Net income for 1992 includes $1.5 million of costs associated with certain litigation. Net income for 1993 includes $3.9 million of costs associated with the Boardwalk Expansion Site. (2) Long-term debt of $225 million at December 31, 1991 had been classified as a current liability. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. General The Company was incorporated on March 14, 1986 as a New Jersey Corporation, and was originally formed solely to raise funds through the issuance and sale of its debt securities for the benefit of the Partnership. As part of a prepackaged plan of reorganization under chapter 11 of the U.S. Bankruptcy Code consummated on May 29, 1992, the Company became a partner of the Partnership and issued approximately three million Stock Units, each comprised of one share of Preferred Stock and one share of Common Stock. On June 25, 1993 the Company issued and the Partnership guaranteed $330,000,000 of Mortgage Notes (for net proceeds of $325,687,000) and Holding, issued 12,000 Units consisting of an aggregate of $60,000,000 of PIK Notes, together with Warrants to acquire an additional $12,000,000 of PIK Notes at no additional cost. Holding has no other assets or business other than its 99% equity interest in the Partnership. The Company owns the remaining 1% interest in the Partnership. The combined proceeds of the Offerings, together with cash on hand, were used substantially as follows: (i) $225.0 million of such proceeds were used to repay the Partnership's Promissory Note to the Company in the principal amount of $225.0 million, which proceeds were then used by the Company to redeem the Bonds; (ii) $12.0 million was used to repay the Regency Note (see "Item 13. Certain Relationships and Related Transactions -- Trump Regency"); (iii) $40.0 million was distributed to the Company (which used such funds, together with $35.0 million from the Units Offering distributed to Trump and paid to the Company, to redeem its Stock Units); (iv) approximately $17.3 million was used to pay the expenses incurred in connection with the Offerings; and (v) approximately $52.5 million was used to make the Special Distribution to Trump, which was used by Trump primarily to pay certain personal indebtedness. No portion of the net proceeds was retained by Holding, the Company or the Partnership for working capital purposes. The financial information presented below reflects the results of operations of the Partnership. Since the Company and Holding have no business operations other than their interest in the Partnership, their results of operations are not discussed below. Results Of Operations For The Years Ended December 31, 1993 and Gaming revenues were $264.1 million for the year ended December 31, 1993, a decrease of $1.4 million or 0.5% from gaming revenues of $265.4 million in 1992. This decrease in gaming revenues consisted of a reduction in table games revenues, which was partially offset by an increase in slot revenues. These results were impacted by major snow storms during February and March, which severely restricted travel in the region. The decrease in revenues was also attributable, in part, to the revenues derived from "high roller" patrons from the Far East during 1992, which did not recur in 1993, due in part to the decision to de-emphasize marketing efforts directed at "high roller" patrons from the Far East and also to the effects of the adverse economic conditions in that region. Slot revenues were $170.5 million for the year ended December 31, 1993, an increase of $1.0 million or 0.6%, from slot revenues of $169.5 million in 1992. The Partnership elected to discontinue certain progressive slot jackpot programs thereby reversing certain accruals into revenues which had the effect of improving slot revenue by $4.1 million for the year ended December 31, 1992. Excluding the aforementioned adjustment, slot revenues would have resulted in a $5.0 million or 3.0% improvement over 1992. The Partnership believes that its improvement in slot revenues reflects its intensified slot marketing efforts directed towards patrons who tend to wager more per slot play and general growth in the industry. See "Business - -- Business Strategy." Table games revenues were $93.6 million for the year ended December 31, 1993, a decrease of $2.3 million or 2.4% from table games revenues of $95.9 million in 1992. This decrease was primarily due to a reduction in table games drop (i.e., the dollar value of chips purchased) by 9.2% for the year ended December 31, 1993 from 1992, offset by an increase in the table games hold percentage to 14.9% (the percentage of table drop retained by the Partnership) for the year ended December 31, 1993 from 13.9% in 1992. The reduction in table game drop was due to the large dollar amounts wagered during 1992 by certain foreign customers. During the year ended December 31, 1993, gaming credit extended to customers was approximately 18.0% of overall table play. At December 31, 1993, gaming receivables amounted to approximately $16.0 million, with allowances for doubtful gaming receivables of approximately $10.4 million. Other revenues were $69.2 million for the year ended December 31, 1993, a decrease of $4.1 million or 5.6%, from other revenues (excluding revenues from Trump Regency) of $73.3 million in 1992. Other revenues include revenues from rooms, food and beverage and miscellaneous items. The decrease in other revenues primarily reflects a $2.1 million adjustment to the outstanding gaming chip liability in 1992, (this amount had been offset in gaming cost and expenses with a specific reserve provision for casino uncollectible accounts receivable) as well as decreases in food and beverage revenues attendant to reduced levels of gaming activity, and reduced promotional allowances. Promotional allowances were $32.8 million for the year ended December 31, 1993, a decrease of $2.1 million or 5.9%, from promotional allowances of $34.9 million in 1992. This decrease is primarily attributable to a reduction in table gaming activity as well as the Partnership's focusing its marketing efforts during the period towards patrons who tend to wager more frequently and in larger denominations. Gaming costs and expenses were $136.9 million for the year ended December 31, 1993, a decrease of $9.4 million, or 6.4%, from gaming costs and expenses of $146.3 million in 1992. This decrease was primarily due to a $4.8 million decrease in gaming bad debt expense as well as decreased promotional and operating expenses and taxes associated with decreased levels of gaming activity and revenues from 1992. Other costs and expenses were $24.8 million for the year ended December 31, 1993 an increase of $1.1 million or 4.7%, from other costs and expenses of $23.7 million in 1992. General and administrative expenses were $71.6 million for the year ended December 31, 1993, a decrease of $3.8 million, or 5.1%, from general and administrative expenses of $75.5 million in 1992. This decrease resulted primarily from a $2.4 million real estate tax charge resulting from a reassessment by local authorities of prior years' property values incurred during 1992 and overall cost reductions related to cost containment efforts. Income from operations was $49.6 million for the year ended December 31, 1993, an increase of $7.0 million or 16.4% from income from operations (excluding the operations of Trump Regency and before restructuring costs) of $42.6 million for 1992. In addition to the items described above, 1993 costs and expenses were lower as a result of the absence of the Restructuring costs and the expenses associated with the Trump Regency which were incurred in 1992. Net interest expense was $39.9 million for the year ended December 31, 1993, an increase of $8.5 million, or 27.2% from net interest expense of $31.4 million in 1992. This is attributable to the interest expense associated with the Offerings. Other non-operating expenses were $3.9 million for the year ended December 31, 1993, an increase of $2.4 million or 164.9% from non-operating expense of $1.5 million in 1992. This increase is directly attributable to costs associated with the Boardwalk Expansion Site. See "Note 7 to the Financials -- Commitments and Contingent Future Expansions." The Offerings resulted in an extraordinary gain of $4.1 million for the year ended December 31, 1993, which reflects the excess of carrying value of the Regency Hotel obligation over the amount of the settlement payment, net of related prepaid expenses. The Restructuring resulted in an extraordinary loss of $38.2 million for the year ended December 31, 1992 consisting of the effects of stating the Bonds and Preferred Stock issued at fair value and the write off of certain deferred financing charges and costs. Results Of Operations For The Year Ended December 31, 1992 and Gaming revenues were $265.4 million for the year ended December 31, 1992, an increase of $32.1 million, or 13.8%, from gaming revenues of $233.3 million in 1991. This increase in gaming revenues was primarily attributable to an increase in slot revenues which was partially offset by a decline in table game revenues. Slot revenues were $169.5 million for the year ended December 31, 1992, an increase of $35.1 million, or 26.1%, from slot revenues of $134.4 million in 1991. The Partnership believes that its improvement in slot revenues reflects its intensified slot marketing efforts directed towards patrons who tend to wager more per slot play and general growth in the industry. See "Business - Business Strategy". In addition, the Partnership elected to discontinue certain progressive slot jackpot programs, thereby reversing certain accruals into revenues which had the effect of improving slot revenue by $4.1 million for the year ended December 31, 1992. Table game revenues were $95.9 million for the year ended December 31, 1992, a decrease of $3.0 million, or 3.0%, from table game revenues of $98.9 million in 1991. While table game drop (i.e., the dollar value of chips purchased) increased 6.7% for the year ended December 31, 1992 from 1991, the decline in table game revenues was due to a decrease in the table game hold percentage (i.e., the percentage of table game drop retained by the Partnership) to 13.9% for the year ended December 31, 1992 from 15.3% in 1991. The reduction in table game hold percentage was due, in part, to the large dollar amounts wagered by a few patrons, whose individual success at the gaming tables had an impact on the overall table game hold percentage. During the year ended December 31, 1992, gaming credit extended to customers was approximately 27.8% of overall table play. At December 31, 1992, gaming receivables amounted to approximately $20.5 million, with allowances for doubtful gaming receivables of approximately $14.0 million. Other revenues (excluding revenues from Trump Regency) were $73.3 million for the year ended December 31, 1992, an increase of $6.9 million, or 10.4%, from other revenues of $66.4 million in 1991. Other revenues include revenues from rooms, food and beverage and miscellaneous items. This increase in other revenues primarily reflects increases in food and beverage revenues attendant to increased levels of gaming activity. In addition, the Partnership recognized $2.1 million in other revenues during the year ended December 31, 1992 as the result of the cancellation of outstanding chips to offset the debt of a patron who owed in excess of such amounts to the Partnership. The revenue derived from such cancellation, however, was offset by an associated increase in bad debt expense in 1992. Promotional allowances were $34.9 million for the year ended December 31, 1992, an increase of $3.4 million, or 10.8%, from promotional allowances of $31.5 million in 1991. This increase is primarily attributable to the increase in gaming activity during the period. Gaming costs and expenses were $146.3 million for the year ended December 31, 1992, an increase of $12.8 million, or 9.6%, from gaming costs and expenses of $133.5 million in 1991. This increase was primarily due to increased promotional and operating expenses associated with increased slot revenues, increased taxes and increased regulatory expenses. Gaming costs and expenses also increased due to the $2.1 million increase in bad debt expense referred to above. Other costs and expenses were $23.7 million for the year ended December 31, 1992, an increase of $0.3 million, or 1.3%, from other costs and expenses of $23.4 million in 1991. General and administrative expenses were $75.5 million for the year ended December 31, 1992, an increase of $5.9 million, or 8.5%, from general and administrative expenses of $69.6 million in 1991. This increase resulted primarily from a $2.4 million increase in real estate taxes arising from a reassessment by local authorities of prior years property values, as well as increased property insurance and other costs associated with maintaining Trump Plaza. In connection with the Restructuring, the Partnership incurred $5.2 million of non-recurring costs for the year ended December 31, 1992, comprised of professional fees and other costs and expenses of the Restructuring. Pursuant to the terms of the Restructuring, the Partnership ceased operating Trump Regency as of September 30, 1992. For the year ended December 31, 1992, the Partnership realized a net loss of $2.4 million from the operation of Trump Regency, compared to the net loss of $8.3 million in 1991. See "Certain Relationships and Related Transactions." Income from operations (excluding the operations of Trump Regency and before restructuring costs) was $42.6 million for the year ended December 31, 1992, an increase of $17.2 million, or 67.7%, from income from operations of $25.4 million in 1991. Net interest expense was $31.4 million for the year ended December 31, 1992, a decrease of $2.0 million, or 6.0%, from net interest expense of $33.4 million in 1991. The Restructuring resulted in an extraordinary loss of $38.2 million for the year ended December 31, 1992, which reflects a $32.8 million accounting adjustment to carry the Bonds and Preferred Stock issued in the Restructuring on the Partnership's balance sheet at fair market value based upon then current rates of interest. The Partnership also wrote-off certain deferred financing charges and costs of $5.4 million. Net loss was $35.8 million for the year ended December 31, 1992, and increase of $6.6 million, or 22.6%, from the net loss of $29.2 million in 1991. Liquidity and Capital Resources The Partnership. Cash flow from operating activities is the Partnership's principal source of liquidity. For the year ended December 31, 1993, net cash from operating activities was $18.5 million. On June 25, 1993, the date of consummation of the Offerings, the Partnership paid accrued interest on the Bonds. Interest on the Bonds was payable semi-annually on March 15 and September 15, while interest on the Mortgage Notes is payable semi-annually on each June 15 and December 15, commencing December 15, 1993. The decrease of $7.7 million in net cash provided by operating activities as compared to 1992 reflects the aforementioned changes in payments of accrued interest on the Bonds. Capital expenditures of $10.1 million for the year ended December 31, 1993 increased approximately $1.4 million from 1992, and was primarily due to the refurbishment of the casino floor (including new carpeting), the purchase of additional slot machines, the construction of an electronic graphic sign adjacent to the transportation facility and demolition and refurbishing costs associated with the Boardwalk Expansion Site. These expenditures were financed from funds generated from operations. The Boardwalk Expansion (as described below), may require additional borrowings. Capital expenditures for 1992, and 1991 were $8.6 million and $5.5 million, respectively. Previously, the Partnership provided for significant capital expenditures which concentrated on the construction of the Transportation Facility and the renovation of certain restaurants, hotel rooms and the hotel lobby. See "Business -- Facilities and Amenities." At December 31, 1993, the Partnership had a combined working capital deficit totalling $1.5 million, compared to a working capital deficit of $18.2 million at December 31, 1992. In 1993, the Partnership received the approval of the CCC, subject to certain conditions, for the Expansion of its hotel facilities on the Boardwalk Expansion Site upon which there is located an approximately 361-room hotel, which is closed to the public and in need of substantial renovation and repair. On June 25, 1993, the date the Offerings were consummated, Trump transferred title to the Boardwalk Expansion Site to a lender in exchange for a reduction in Trump's indebtedness to such lender in an amount equal to the sum of fair market value of the Boardwalk Expansion Site and all rent payments made to such lender by Trump under the Boardwalk Expansion Site Lease (as defined below). On the date the Offerings were consummated, the lender leased the Boardwalk Expansion Site to Trump for a term of five years, which expires on June 30, 1998, during which time Trump will be obligated to pay the lender $260,000 per month in lease payments. In October 1993, the Partnership assumed the Boardwalk Expansion Site Lease and related expenses. In connection with the Offerings, the Partnership acquired a five-year option to purchase the Boardwalk Expansion Site. Until such time as the Option is exercised or expires, the Partnership will be obligated, from and after the date it entered into the Option, to pay the net expenses associated with the Boardwalk Expansion Site, including, without limitation, current real estate taxes (approximately $1.2 million per year based upon current assessed valuation), $66,000 per month until January 1, 1995 in respect of past due taxes and annual lease payments for the portion of the Boardwalk Expansion Site currently leased by the Partnership from a third party, which lease payments were $86,058 for 1993 and $83,500 for 1992, and increase annually based on the consumer price index. In addition, net expenses include the costs of demolishing certain structures situated on the Boardwalk Expansion Site at a cost of approximately $1.5 million, the redemption in November 1993 of $496,000 in tax sale certificates issued to third parties and $100,000 in annual insurance expense. Under the Option, the Partnership has the right to acquire the Boardwalk Expansion Site for a purchase price of $26.0 million through 1994, increasing by $1.0 million annually thereafter until expiration on June 30, 1998. In addition, the Partnership has a right of first refusal upon any proposed sale of all or any portion of the Boardwalk Expansion Site during the term of the Option. Trump, individually, also has been granted by such lender a right of first refusal upon a proposed sale of all or any portion of the Boardwalk Expansion Site. Trump, has agreed with the Partnership that his right of first refusal will be subject to the Partnership's prior exercise of its right of first refusal (with any decision of the Partnership requiring the approval of the Independent Directors of the Company, acting as the managing general partner of the Partnership). Acquisition of the Boardwalk Expansion Site by the Partnership would under certain circumstances (provided there are no events of default under the Boardwalk Expansion Site Lease or the Option and provided that certain other events had not theretofore or do not thereafter occur) discharge Trump's obligation to such lender in full. Under the terms of the Option, if the Partnership defaults in making payments due under the Option, the Partnership would be liable to the lender for the sum of (a) the present value of all remaining payments to be made by the Partnership pursuant to the Option during the term thereof and (b) the cost of demolition of all improvements then located on the Boardwalk Expansion Site. The Partnership's ability to acquire the Boardwalk Expansion Site pursuant to the Option would be dependent upon its ability to obtain financing to acquire the property. The ability to incur such indebtedness is restricted by the Mortgage Note Indenture and the PIK Note Indenture and requires the consent of certain of Trump's personal creditors. The Partnership's ability to develop the Boardwalk Expansion Site would be dependent upon its ability to use existing cash on hand and generate cash flow from operations sufficient to fund development costs. No assurance can be given that such cash on hand will be available to the Partnership for such purposes or that it will be able to generate sufficient cash flow from operations. In addition, exercise of the Option or the right of first refusal requires the consent of certain of Trump's personal creditors, and there can be no assurance that such consent will be obtained at the time the Partnership desires to exercise the Option or such right. The CCC has required that the Partnership exercise the Option or its right of first refusal therein no later than July 1, 1995. Management has determined to build or refurbish rooms at the Boardwalk Expansion Site. As a result of such expansion, the Partnership will be permitted to increase Trump Plaza's casino floor space by 30,000 square feet. The Partnership plans to add approximately 10,000 square feet in April, 1994 with an additional 5,000 square feet in June, 1994 and 10,000 square feet planned to open in April, 1995. The 5,000 remaining allowable square feet will be added as patron demand warrants. The Partnership has begun construction at such site pursuant to rights granted to the Partnership by the lender under the Boardwalk Expansion Site Lease. Pursuant to the terms of certain personal indebtedness of Trump, the Partnership is restricted from expending more than $15.0 million less any CRDA tax credits for improvements at the Boardwalk Expansion Site prior to such time as it exercises the Option. The Partnership has received approximately $294,000 in CRDA credit as of December 31, 1993. The Partnership's ability to exercise the Option will be restricted by, among other things, the Mortgage Note Indenture, the PIK Note Indenture and the terms of certain indebtedness of Trump, and would require the approval of the CCC. Management does not currently anticipate that it will be in a position to exercise the Option to acquire such site prior to 1995 due, in part, to limitations on its ability to incur additional indebtedness. If the Partnership is unable to finance the purchase price of the Boardwalk Expansion Site pursuant to the Option, any amounts expended with respect to the Boardwalk Expansion Site, including payments under the Option and the Boardwalk Expansion Site lease, if assumed, and any improvements thereon would inure to the benefit of the owner of the Boardwalk Expansion Site and not to the Partnership. In such event, the Partnership might have to close all or a portion of the expanded casino in order to comply with regulatory requirements, which could have a material adverse effect on the results of operations and financial condition of the Partnership. As of December 31, 1993, the Partnership had expended approximately $2.7 million in construction costs related to the Boardwalk Expansion Site. Pursuant to the terms of the Partnership Agreement, prior to amendment on June 25, 1993, the date of the consummation of the Offerings, which eliminated such distribution requirements, the Partnership was required to make certain periodic distributions to the Company and Trump sufficient to pay taxes attributable to distributions received from the Partnership, any amounts required to be paid to directors as fees or pursuant to indemnification obligations, premiums on directors' and officers' liability insurance and other reasonable general and administrative expenses. The Partnership was also required to distribute to the Company, to the extent of cash available therefrom, funds sufficient to enable the Company to pay dividends on, and the redemption price of its Stock Units. For the year ended December 31, 1993, such distributions were approximately $6.3 million. Pursuant to the terms of a Services Agreement with Trump Plaza Management Corp. ("TPM"), a corporation beneficially owned by Trump, in consideration for services provided, the Partnership pays TPM each year an annual fee of $1.0 million in equal monthly installments, and reimburses TPM on a monthly basis for all reasonable out-of-pocket expenses incurred by TPM in performing its obligations under the Services Agreement, up to certain amounts. Under this Agreement, approximately $1.2 million was charged to expense for the year ended December 31, 1993. The Mortgage Note Indenture and the PIK Note Indenture restrict the ability of the Partnership to make distributions to its partners, including restrictions relating to the achievement of certain financial ratios. Subject to the satisfaction of these restrictions, the Partnership may make distributions to its partners with respect to their partnership interests. The Company. The Company's sole source of liquidity is, and will be, payments made by the Partnership in respect of the Partnership Note securing the Company's indebtedness, and distributions from the Partnership, if any, in respect of its Partnership interest. Holding. Holding has no business operations other than that associated with holding its partnership interest in the Partnership and as issuer of the PIK Notes and Warrants. Holding's sole source of liquidity is from distributions in respect of its interest in the Partnership. Prior to the Units Offering, Holding did not have any long-term or short-term indebtedness; upon consummation of the Units Offering on June 25, 1993, Holding issued $72.0 million of indebtedness comprised of $60.0 million of PIK Notes and $12.0 million of deferred warrant obligations. Holding's indebtedness will increase upon exercise of the Warrants and upon the issuance of additional PIK Notes in lieu of cash interest paid on the PIK Notes. On December 15, 1993, the Partnership elected to issue in lieu of cash, an additional $3.6 million in PIK Notes to satisfy its semi-annual PIK Note interest obligation. ITEM 8.

791445

1993

ITEM 6. SELECTED FINANCIAL DATA The following table presents information for Bancshares effective December 31 for the years indicated. (in thousands) (except per share data) 1993 1992 1991 1990 1989 Net Interest & Fee Income $ 10,895 $ 10,389 $ 9,882 $ 9,991 $ 8,901 Gross Interest Income $ 18,156 $ 18,893 $ 21,074 $ 22,261 $ 21,720 Income From Continuing Operations $ 2,638 $ 2,175 $ 1,961 $ 1,314 $ 1,270 Long Term Obligations $ 0 $ 0 $ 0 $ 0 $ 555 Income Per Share from Continuing Operations* $ 3.76 $ 3.39 $ 3.06 $ 2.05 $ 1.98 Net Income per Common Share** $ 3.94 $ 3.39 $ 3.06 $ 2.05 $ 1.98 Cash Dividends Declared per Common Share** $ .99 $ .94 $ .89 $ .88 $ .84 Total Assets at Year End $234,892 $239,897 $227,017 $218,378 $222,296 * Restated to reflect 10% stock dividend on December 15, 1992. ** Restated to reflect 2.5 for 1 Stock Split on October 15, 1993. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS To understand the following analysis, reference should be made to the consolidated financial statements and other selected financial data presented elsewhere in this report. For purposes of the following discussion, net interest income and net interest margins are presented on a fully taxable equivalent basis. Per share data is adjusted to reflect all stock dividends declared through December 31, 1993. The combination of a favorable interest rate environment reduced operating expense and improved asset quality resulted in record earnings for Bancshares for the year just ended. Operating results for 12/31/93 reflect significant improvement when compared to previous years. Net Income for 1993, 1992 and 1991 was $2,638,459, $2,174,710 and $1,961,203 respectively. Earnings per share were $3.94 in 1993 compared to $3.39 in 1992 and $3.06 in 1991. Earnings per share were adjusted in 1993 to reflect a 2.5 for 1 stock split approved by the Board of Directors in September, 1993. Return on average assets for the years ending 12/31/93, 92 and 91 respectively were 1.17%, .95% and .89%. Return on Average Equity was 8.71% in 1993 compared to 8.07% in 1992 and 7.60% in 1991. Improvement reflected in the Return on Average Assets and equity comparisons for the years indicated is due to strategic planning effort to shift the focus from asset growth to improved profitability. Total Assets declined approximately $5 million or 2.13% when comparing 1993 to 1992. This decline is reflective of a run-off in consumer dollars previously invested in CD's into alternative investment sources providing a higher rate of return. In the present low rate environment, customers are willing to sacrifice security in exchange for higher returns. Net Interest Income after the provision for loan losses increased 5.16% and 7.40% in 1993 and 1992. Net Income improved each year under comparison due to (1) a decrease in non-earning assets (Non-Accrual Loans and Other Real Estate Owned), (2) improved income from the Broker Dealer Subsidiary, (3) sale of annuities (a new product offered in 1993), (4) insurance commissions, and (5) increased volume in the loan portfolio. The provision for Loan Losses reflect a continuous decrease for the years under comparison. Net charge-offs at 12/31/93 was $428,000 compared to $644,000 for the same period in 1992. The ratio of net charge-offs to average net loans outstanding was .30%, .48% and .43% for 12/31/93, 92 and 91. Other expenses decreased in 1993 when comparing YTD 1993 to YTD 1992. The decrease is attributed to a reduction of approximately $600,000 in Data Processing expenses. In 1992, a decision was made to terminate the existing Facilities Management Contract with Systematics, Inc. for data processing services. On September 25, 1992, First Citizens converted to an in-house IBM AS/400 and Horizon Software. The change enhanced income significantly in 1993. Salaries and employee benefits increased 5.31% and 6.38% respectively in 1993 and 1992. A further discussion of Salaries and Benefits is included in the discussion of Non-Interest Expense. Purchases of investment securities were limited to those having maturities within guidelines previously established by policy. While longer maturities would afford an immediate increase in investment income, it was determined that the long term risk was unacceptable. Competition in the local market for quality loans led some financial institutions to extend credit at fixed rates for fifteen years and longer. It was determined that transactions of this nature violated sound asset liability management policy and would be entered into on a limited basis, if at all. On March 4, 1993, the Bank entered into an agreement with Southern Data Systems, Roswell, Georgia, to install a platform automation system, "Bank Pro", for deposit and loan document processing. Bank Pro is completely integrated with the central information file of the Bank's host system, as well as deposit and loan accounting systems. Installation is expected to improve customer service as well as stream line loan and deposit operations. "Bank Pro" was successfully installed September 27, 1993. Two changes were made in the composition of the management team during the first quarter of 1993. Until this time the lending function operated under the quidance of both a Loan Administrator and a Senior Commercial Lending Officer. Based on the significant reduction in problem loans, non-accrual loans, and other real estate owned, coupled with the improved quality of new loans placed into the portfolio for the past several years, it was determined that dual leadership was no longer needed. After careful deliberation of the facts, the responsibilities of Loan Administrator were assigned to the Senior Lending Officer. Lending duties once assumed by this individual were delegated to others within the Commercial Lending area. In addition, an analysis of earnings and other factors within the Trust Department led management to recommend a change in leadership of this function. This was also accomplished during the first quarter. In September, 1993, Bank's management accepted the resignation of the Mortgage Loan Department Manager and two other bank officers responsible for originating long term mortgage loans. The position of manager was filled with a qualified individual with extensive experience in mortgage lending. The individuals hired as loan originators are equally qualified. Changes in Financial Accounting Standards Implementation of FASB No. 109 (Accounting for Income Taxes) has been accomplished for years beginning after 12/15/92. A major change in the new statement is the shift to the liability method from the deferred method of accounting for income taxes. Under the liability method, deferred taxes are adjusted for tax rate changes, whereas they are not under the deferred method. Bancshares carries deferred tax assets on its general ledger as of 12/31/93 of $60,000. This asset is primarily the result of a difference in book and tax deductions for loan losses during the year just ended. FASB No. 107 entitled "Disclosures about Fair Value of Financial Instruments" is effective for fiscal years ending after December 15, 1992. This pronouncement requires disclosure of the "fair value" of all financial instruments. The definition of "financial instruments" includes contractual obligations, such as loans and deposits, on which disclosure of fair value has not previously been required. Disclosure of the methods and significant assumptions utilized in determining fair values must also be disclosed. "Fair Value" is defined as "the amount at which the instrument could be exchanged in a current transaction between willing parties. FASB No. 115 (Accounting for certain investments in Debts and Equity Securities) is scheduled to take effect 1/1/94. Subsequent to the effective date, only those securities contained within either the Trading or Held for Sale Accounts will be available for sale. This limitation will alter investment strategy by forcing banks into shorter maturities. Interim purchases intended for resale within a twelve month period will be placed in either the Trading or Held for Sale Account. FASB No. 106 entitled "Employees' Accounting for Postretirement Benefits other than Pensions" is effective for fiscal years ending after December 15, 1992. This standard applies primarily to health care benefits and requires accrual, during the years that the employee renders service, of the expected cost of providing those benefits to an employee and the employee's beneficiaries and covered dependents. FASB No. 106 will have no effect on Bancshares or the Bank since health care benefits are not provided for its employees after retirement. Other changes presently proposed in Financial Accounting Standards will have no direct material effect on the bank. NON-INTEREST INCOME The following table reflects non-interest income for the years ending December 31, 1993, 1992 and 1991: First Citizens consistently outperforms peer group banks in the area of non-interest income. Total Non-Interest Income reflects an increase of 16.03% and 4.10% when reviewing the years under comparison. Non-Interest Income for 1992 includes Securities Gains of $159,820. Without the gains from sale of securities, Non-Interest Income would have increased $116,000 or 7% above the 1991 total. Other income increased due to increased sales in Mortgage Loans, Brokerage Services, Accounts Receivable Factoring and the sale of annuities. Fiduciary income decreased approximately $50,127 when comparing 1992 to 1991. The decrease was due to the loss of a large corporate account. Service charges on Deposit Accounts decreased $35,000 or 7.46% from 1991 to 1992 because of decreased collections of overdraft and business account analysis income. Non- interest income is projected to be more in line with peer banks in 1994 due to a slow down in refinancing of mortgage loans and management's decision to transfer the sale of annuities from the bank's product listing to Financial Plus, Inc., a subsidiary of the bank that offers brokerage services. Offering a new overdraft line of credit product in 1994 is currently being considered to meet customer needs. A decision to add this product to the bank's credit product listing could have a slight impact on fee income. However, Trust Department income is projected to improve over the next three years. Under new management, the potential for increased profits is significant. NON-INTEREST EXPENSE Total Non-Interest Expense increased 7.47% when comparing 1992 to 1991, then leveled off in 1993. Salaries and benefits increased 5.30% in 1993 and 6.39% in 1992. Increases can be attributed to budget based incentive payments totaling approximately $300,000 in 1993, $151,000 in 1992, and $83,000 in 1991. Excluding bonus payments, salaries would have decreased 9.98% in 1993 when compared to 1992. The decrease is reflective not only of the bank's strategic efforts to maintain staffing levels comparable to peer banks, but of efforts made to encourage quality performance rewarded with an annual bonus payment directly related to bank's profitability. In 1993, the budget based incentive program was enhanced to include all employees of the bank. Under the new plan, bonuses are paid based on the bank's ROA ranging from .85% (minimum payment) to 1.15% (maximum payment) and the employees classification level. The prebonus ROA in 1993 was 1.24%. Also included in salaries and benefits for the two current years are retirement benefits totaling $337,500 in 1993 and $318,000 in 1992. Net Occupancy Expense decreased 13.65% in 1992 due to decreased data processing cost. Other Operating Expense increased $386,000 or 10.90% when comparing 1992 to 1991. This can be partially attributed to a $167,000 (74%) increase in FDIC insurance premiums. Total Non-Interest Expense is closely monitored and tightly controlled by management. One measure of efficient staffing in the banking industry is the dollar amount of assets per employee. Peer group banks average $1,900,000. The following table reflects progress made by First Citizens in attempting to achieve this level: (in thousands) December 31 Assets Per Employee 1993 $1,563 1992 $1,643 1991 $1,393 1990 $1,380 1989 $1,408 It is conceivable that our ratios will remain higher than peer group banks because of increased staff necessary to support extended banking hours and non-banking services to our customers. Management's decision to provide customers with more convenient banking hours by opening drive-in windows at 7AM, and certain of our branches on Saturdays, mandates additional staff which would not be necessary for banks operating only during traditional banking hours. Likewise, the Super Money Market Branch located in the Kroger Supermarket allows banking until 8PM on weekdays and 6PM on Saturday. Non-banking services include Trust and Brokerage services. Full time equivalent employees was 149, 146, 163 respectively as of 12/31/93, 92 and 91. The bank's management is making every effort to monitor and control staffing levels. The slight increase in 1993 was a result of management's decision to construct a full service branch bank located at 2211 St. John near the Industrial Park. Two additional staff members were employed as replacement for employees selected to transfer to the branch. COMPOSITION OF DEPOSITS The average daily amounts of deposits and rates paid on such deposits are summarized for the periods indicated: December 31 (in thousands) 1993 1992 1991 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate Non-Interest Bearing Demand Deposits $ 21,922 - $ 18,695 - $ 17,382 - Savings Deposits $ 65,612 2.58% $ 60,006 2.98% $ 52,916 4.37% Time Deposits $104,166 4.70% $111,771 5.42% $117,864 6.90% TOTAL DEPOSITS $191,700 3.44% $190,472 4.12% $188,162 5.55% The preceding table is reflective of customer response to the current low interest rate environment. The reluctance to recommit funds into certificates of deposits had the ultimate effect of reducing time deposits by $13,698,000 or 13.15% since 1991, while increasing savings and time balances by $12,696,000 or 23.99%. One factor which is not evident when reviewing information contained within the table is the growth in "Sweep Account Funds". Large balance customers are offered a service which provides for funds to be automatically swept daily from a demand deposit account into an overnight repurchase agreement. This affords commercial customers the opportunity to earn interest on excess collected funds while providing availability of adequate funds to clear large denomination checks when presented for payment. The sweep balances at December 31, 1993, 1992, and 1991 were $10,022,000, $19,049,000, $7,847,000 respectively. During 1993, approximately $5 million was converted from sweep funds to the bank's Investment Management and Trust Services Division. The Bank's management is continuously monitoring and enhancing the bank's product line to retain funds belonging to its existing customers and to attract new customer relationships. In July, 1993, Generations Gold, a new checking club program was offered that included discounts on travel, food, health services, and other major products, as well as savings on bank services. This account replaced all package accounts previously offered and should serve to ultimately strengthen deposit totals. A time deposit product enhanced to attract funds was the "Sweet Sixteen" Certificate of Deposit offering a 16 month maturity and two rate change options. The average rate paid on deposits in 1993, 1992 and 1991 was 3.44%, 4.12% and 5.55%. A slightly higher rate was paid on deposits when compared to average rates paid in other areas of Tennessee because of competitive pricing in the bank's market place. Pricing of deposit products is based on local market and Treasury Bill rates. MATURITY DISTRIBUTION OF TIME DEPOSITS IN AMOUNTS OF $100,000 AND OVER December 31 (in thousands) 1993 1992 Amount Percent Amount Percent Maturing in: 3 months or less $ 6,770 39.48% $ 8,204 46.20% Over 3 through 6 months $ 5,200 30.32% $ 2,641 14.87% Over 6 through 12 months $ 2,388 13.92% $ 1,737 9.78% Over 12 months $ 2,792 16.28% $ 5,176 29.15% TOTAL $17,150 100.00% $17,758 100.00% SOURCES AND USES OF FUNDS (in thousands) 1993 1992 1991 FUNDING USES Average Increase Average Increase Average Balance (Decrease) % Balance (Decrease) % Balance Amount Amount Amount INTEREST-EARNING ASSETS: Loans (Net of Unearned Discounts & Reserve) $141,664 $ 7,150 5.32% $134,514 $ 284 .21% $134,230 Taxable Investment Securities $ 59,124 $ 614 1.05% $ 58,510 $ 6,590 12.69% $ 51,920 Non-Taxable Investment Securities $ 9,800 $ 3,385 52.77% $ 6,415 $ 637 11.02% $ 5,778 Federal Funds Sold $ 2,387 $(4,632)(65.99%)$ 7,019 $ 74 1.07% $ 6,945 Interest Earning Deposits In Banks $ 198 $ 198 100% $ 0 $ (112) (100%) $ 112 TOTAL INTEREST- EARNING ASSETS $213,173 $ 6,715 3.25% $206,458 $ 7,473 3.76% $198,985 Other Uses $ 20,105 $ (17) (.08%)$ 20,122 $ 105 .52% $ 20,017 TOTAL FUNDING USES $233,278 $ 6,698 2.96% $226,580 $ 7,578 3.34% $219,002 1993 1992 1991 FUNDING SOURCES Average Increase Average Increase Average Balance (Decrease) % Balance (Decrease) % Balance Amount Amount Amount INTEREST-BEARING LIABILITIES: Savings Deposits $ 65,612 $ 5,606 9.34% $ 60,006 $ 7,090 13.40% $ 52,916 Time Deposits $104,166 $ (7,605)(6.80%)$111,771 $ (6,093)(5.17%) $117,864 Federal Funds Purchased and Other Interest Bearing Liabilities $ 21,204 $ 3,418 19.22% $ 17,786 $ 5,097 40.17% $ 12,689 TOTAL INTEREST- BEARING LIABILITIES $190,982 $ 1,419 .75% $189,563 $ 6,094 3.32% $183,469 Demand Deposits $ 21,922 $ 3,227 17.26% $ 18,695 $ 1,313 7.55% $ 17,382 Other Sources $ 20,374 $ 2,052 11.20% $ 18,322 $ 171 .94% $ 18,151 TOTAL FUNDING SOURCES: $233,278 $ 6,698 2.96% $226,580 $ 7,578 3.34% $219,002 SUMMARY - AVERAGE BALANCE SHEET AND NET INTEREST INCOME ANALYSIS (1) Loan totals are shown net of interest collected, not earned and loan loss reserves. (2) Fee Income is included in interest income and the computations of the yield on loans. Overdraft Fee Income is excluded from the totals. (3) Includes loans on nonaccrual status. (4) Interest and rates on securities which are non-taxable for Federal Income Tax purposes are presented on a taxable equivalent basis. (5) Includes Insured Money Fund, NOW, club accounts, and other savings. The preceding table summarizes average interest earning assets and interest bearing liabilities including average yields for each category. Total Interest Earning Assets increased $6,715,000 or 3.25% and $7,473,000 or 3.76% and $4,574,000 or 2.36% when comparing 1993, 1992 and 1991 respectively. Total Interest Bearing Liabilities increased $1,419,000 or .75% and $6,094,000 or 3.32% when analyzing the same time periods. Total Interest Earning Assets averaged $213,173,000 at an average rate of 8.31% in 1993 while Total Interest Bearing Liabilities averaged $190,982,000 at an average rate of 3.80%. Net Yield on Average Earning Assets was 4.91% in 1993, 4.74% in 1992, and 4.67% in 1991. LOAN PORTFOLIO ANALYSIS COMPOSITION OF LOANS December 31 (in thousands) 1993 1992 1991 1990 1989 Real Estate Loans: Construction $ 7,675 $ 5,272 $ 4,879 $ 5,526 $ 6,096 Mortgage $ 84,801 $ 79,376 $76,500 $74,039 $66,696 Commercial, Financial and Agricultural Loans $ 34,547 $ 33,931 $33,089 $29,786 $30,140 Installment Loans to Individuals $ 15,901 $ 15,077 $15,901 $17,130 $16,507 Other Loans $ 6,398 $ 2,005 $ 2,697 $ 3,835 $ 4,060 TOTAL LOANS $149,322 $135,661 $133,066 $130,316 $123,499 CHANGES IN LOAN CATEGORIES December 31, 1993 as compared to December 31, 1992 (in thousands) % of Increase Amount of Increase Loan Category (Decrease) (Decrease) Real Estate 9.25% $ 7,828 Commercial, Financial and Agricultural 1.82% $ 616 Installment Loans to Individuals 5.47% $ 824 Other Loans 219.10% $ 4,393 TOTAL LOANS 10.07% $13,661 Improved earnings resulted from several factors, one of which was the ability to increase loan portfolio totals in excess of $13 million from 1992 to 1993. Low interest rates prompted consumer refinancing of existing mortgages, adding significantly to the mortgage loan portfolio. In addition, commercial customers secured outstanding debt with real estate to take advantage of the lower rates and to provide longer repayment terms. Growth in the loan portfolio exceeded budget projections for 1993. The bank's strategic plan calls for loan officers to aggressively seek quality new loan business. The local economy continues to perform better than other areas in Tennessee as a result of diversification. Several unrelated industries and an excellent agricultural base provide stability not present in less diversified economies. The loan portfolio consists of quality diversified assets with real estate loans comprising 62%, commercial, financial and agricultural 23%, and installment and all others 15%. Total real estate loans outstanding as of 12/31/92 were $84,801,000. Approximately 55% of this total are residential in nature and the remaining 45% are commercial and agricultural property. The average yield on loans of First Citizens National Bank for the years indicated are as follows: 1993 - 9.46% 1992 - 10.05% 1991 - 11.34% 1990 - 12.82% 1989 - 12.76% LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES Due after Due in one one year but Due after year or less within five years five years (in thousands) Real Estate $12,820 $69,110 $10,546 Commercial, Financial and Agricultural $16,324 $16,692 $ 1,531 All Other Loans $ 5,357 $13,331 $ 3,611 TOTALS $34,501 $99,133 $15,688 Loans with Maturities After One Year for which: (in thousands) Interest Rates are Fixed or Predetermined $86,778 Interest Rates are Floating or Adjustable $28,043 Managing interest rate risk is a primary objective of asset-liability management. One tool utilized by First Citizens to ensure market rate return is variable rate loans. Loans totaling $62,544,000 (42% of total portfolio) are subject to repricing within one year or carry a variable interest rate. This total is down approximately $10 million from year end, 1992. Loan maturities in the one to five year category increased from $75,426,000 at 12/31/92 to $99,133,000 at 12/31/93 due to customers demand to lock in fixed interest rates for a longer period of time. While growth in the portfolio is an objective, our first priority is ensuring credit quality. Management considers the portfolio composition to be diversified, with no concentrations in any one industry. NON-PERFORMING LOANS Nonaccrual, Restructured and Past Due Loans and Foreclosed Properties (First Citizens National Bank) December 31 (in thousands) 1993 1992 1991 1990 1989 Nonaccrual Loans $1,079 $1,743 $2,058 $1,958 $ 444 Restructured Loans 0 0 0 0 0 Foreclosed Property Other Real Estate, 98 550 884 1,247 1,597 Other Repossessed Assets 0 0 0 13 24 Total Nonperforming Assets $1,177 $2,293 $2,942 $3,218 $2,065 Loans and leases 90 days Past due and still accruing interest $ 322 $ 176 $1,029 $ 877 $ 673 Nonperforming assets as a percent of loans and leases plus foreclosed property at end of year* .79% 1.71% 2.20% 2.45% 1.65% Allowance as a percent of: Nonperforming assets 142.40% 74.27% 65.81% 59.48% 66.39% Nonperforming assets and loans 90 days past due 111.81% 68.98% 48.76% 46.74% 50.07% Gross Loans 1.12% 1.27% 1.46% 1.47% 1.11% Addition to Reserve as a percent of Net Charge-Offs 93.69% 63.82% 103.86% 142.49% 82.10% Loans and leases 90 days past due as a percent of loans and leases at year end* .22% .13% .78% .67% .54% Recoveries as a percent of Gross Charge-Offs 28.79% 36.17% 26.64% 10.75% 44.01% *Net of unearned income Interest income on loans is recorded on an accrual basis. The accrual of interest is discontinued on all loans, except consumer loans, which become 90 days past due, unless the loan is well secured and in the process of collection. Consumer loans which become past due 90 to 120 days are charged to the allowance for loan losses. The gross interest income that would have been recorded for the twelve months ending 12/31/92 if all loans reported as non-accrual had been current in accordance with their original terms and had been outstanding throughout the period is $102,000. Interest income on loans reported as ninety days past due and on interest accrual status was $30,000 for 1993. Loans on which terms have been modified to provide for a reduction of either principal or interest as a result of deterioration in the financial position of the borrower are considered to be "Restructured Loans". First Citizens has no Restructured Loans for the period being reported. Total Non-Performing Assets have consistently decreased since 1991. As of December, 1993, non-performing loans are at the lowest level since 1985. Total assets in this category as a percent of loans and leases plus foreclosed property was .79% in 1993, 1.71% in 1992, and 2.20% in 1991. Certain loans contained on the bank's Internal Problem Loan List are not included in the listing of non-accrual, past due or restructured loans. Management is confident that, although certain of these loans may pose credit problems, any potential for loss has been provided for by specific allocations to the Loan Loss Reserve Account. Loan officers are required to develop a "Plan of Action" for each problem loan within their portfolio. Adherence to each established plan is monitored by Loan Administration and re-evaluated at regular intervals for effectiveness. LOAN LOSS EXPERIENCE & RESERVE FOR LOAN LOSSES (in thousands) 1993 1992 1991 1990 1989 Average Net Loans Outstanding $141,664 $134,514 $134,230 $126,083 $118,139 Balance of Reserve for Loan Losses at Beginning of Period $ 1,703 $ 1,936 $ 1,914 $ 1,371 $ 1,412 Loan Charge-Offs $ (601) $ (1,009) $ (777) $ (1,432) $ (409) Recovery of Loans Previously Charged Off $ 173 $ 365 $ 207 $ 154 $ 180 Net Loans Charged Off $ (428) $ (644) $ (570) $ (1,278) $ (229) Additions to Reserve Charged to Operating Expense $ 401 $ 411 $ 592 $ 1,821 $ 188 Balance at End of Period $ 1,676 $ 1,703 $ 1,936 $ 1,914 $ 1,371 Ratio of Net Charge- Offs to Average Net Loans Outstanding .30% .48% .43% 1.01% .19% The allowance for possible loan losses is determined by management and approved by the Board based on previous loan loss experience, existing and anticipated economic conditions, composition and volume of the loan portfolio and the level of non-performing assets. A quarterly analysis is presented to the Board in order that a determination may be made concerning the sufficiency of the reserves. The balance of the Loan Loss Reserve account at 12/31/93 was $1,676,000 representing 1.12% of total loans outstanding and a 15.00% decrease from the 1991 account balance. Additions to reserve charged against earnings have reduced significantly since 1990 and are below peer group levels. Management has adequately provided for potential loan losses and risk within the bank's loan portfolio. Internal Loan Review performs an analysis on an annual basis of approximately 75% of the portfolio. Based on this review, each loan is classified as Pass, Substandard, Doubtful or Loss. Loans classified as loss are charged monthly against the Loan Loss Reserve account. Those considered by Loan Review to be Substandard or Doubtful are included on the bank's internal Problem Loan List. Problem Loans, as a percentage of total portfolio were 2.92% at 1993, 4.10% at 12/31/92, and 6.57% at 12/31/91. Quarterly Reports are provided directly to the Board of Directors by the Loan Review Officer which summarize results of the reviews. New classifications are analyzed and discussed in detail. Management estimates the approximate amount of charge-offs for the 12 month period ending 12/31/94 to be as follows: Domestic Amount Commercial, Financial & Agricultural $300,000 Real Estate-Construction 0 Real Estate-Mortgage 50,000 Installment Loans to individuals & credit cards 150,000 Lease financing 0 01/01/94 through 12/31/94 Total $500,000 The following table will identify charge-offs by category for the periods ending December 31 as indicated: Year Ending December 31 (in thousands) 1993 1992 1991 Charge-offs: Domestic: Commercial, Financial & Agricultural $ 415 $ 649 $ 293 Real Estate-Construction 0 0 0 Real Estate-Mortgage 27 115 88 Installment Loans to individuals & credit cards 159 245 396 Lease financing 0 0 0 Total $ 601 $1,009 $ 777 Recoveries: Domestic: Commercial, Financial & Agricultural $ 53 $ 66 $ 97 Real Estate-Construction 0 0 0 Real Estate-Mortgage 11 148 4 Installment Loans to individuals & credit cards 109 151 106 Lease financing 0 0 0 Total $ 173 $ 365 $ 207 Net Charge-offs $ 428 $ 644 $ 570 COMPOSITION OF INVESTMENT SECURITIES December 31 (in thousands) 1993 1992 1991 1990 1989 U. S. Treasury & Government Agencies $42,502 $59,019 $50,919 $43,337 $54,147 State & Political Subdivisions $12,774 $ 9,300 $ 3,239 $ 7,484 $ 7,522 All Others $ 5,471 $ 6,129 $ 4,944 $ 5,251 $ 5,439 TOTALS $60,747 $74,448 $59,102 $56,072 $67,108 MATURITY AND YIELD ON SECURITIES - DECEMBER 31, 1993 (in thousands) Maturing Maturing Maturing Maturing After One Year After Five Years After Within One Year Within Five Years Within Ten Years Ten Years Amount Yield Amount Yield Amount Yield Amount Yield U. S. Treasury and Government Agencies $15,400 6.05% $19,532 5.82% $ 3,135 6.48% $ 4,435 6.08% State and Political Subdivisions* $ 1,653 6.72% $ 9,050 6.73% $ 1,971 6.85% $ 100 6.59% All Others $ 1,900 7.57% $ 3,571 5.31% $ 0 .00% $ 0 .00% TOTALS $18,953 6.26% $32,153 6.02% $ 5,106 6.62% $ 4,535 6.10% *Yields on tax free investments are stated herein on a taxable equivalent basis. The investment securities portfolio is a major component of First Citizens' earning assets. It provides a stable long term income stream and is managed in such a way as to enhance the Company's asset/liability management program. Investment Securities also serve as collateral for government and other public funds deposits. Securities contained within the portfolio consist primarily of U.S. Treasury and other U.S. Government Agency securities and tax-exempt obligations of states and political subdivisions. All other investment securities contained therein comprise approximately 10% of the portfolio. The investment portfolio, when comparing 1993 to 1992 decreased approximately $10 million. Since 1989, deposit and capital growth as well as maturing investments were utilized to fund loan growth. Purchases of Investments during the third quarter consisted primarily of Tax Free Municipal Bonds. A 21% increase in tax free investments from 1992 to 1993 is a conscious effort to reduce tax liability in light of increased earnings. Maturities within the portfolio are made up of 31.19% within one year and 52.92% after one year and within five years. Policy provides for 20% maturities on an annual basis. Management has made a conscious effort to shorten maturities based on the current interest rate environment and mark to market rules scheduled to take effect 1/1/94. Beginning in 1994, the portfolio will be structured to insure that future sales of securities prior to maturity will be accomplished from either the Trading or Held for Sale accounts. During the third quarter of 1993, taxable securities totaling $4,150,000 bearing maturity or call dates in the calendar year 1993 were sold. The sale resulted in gross profits of approximately $22,233. Also sold from the investment portfolio in February, 1993 was a CMO PAC with a par value of $1,022,500 sold with a net loss of $3,280.32. These securities were sold due to interest rate risk in a rising rate environment if held to maturity and to fund loan growth in 1993. For years ending December 31, 1993, 1992 and 1991 there was no activity within the trading account. Interest and dividend income was non- existant for this three year period, with ending balances being zero for all years under comparison. Securities in the Held for Sale Account consisted of 24,000 shares of FHLMC Preferred Stock having a book value of $600,000. Reported in Held for Sale at 6/30/93 was 12,000 shares of FHLMC Preferred stock valued at $300,000. An additional 12,000 shares were purchased and placed in this account during the third quarter 1993. The average and ending balances in the Held for Sale Account for 12/31/93 were $500,000 and $600,000 respectively. During the fourth quarter, 1993, there were no transfers between the Trading, Held for Sale, and Investment Accounts. Gains/Losses reflected in year-end income statements attributable to trading account securities: Year Ended 12/31 Gains Losses Net 1993 $ 0.00 $ 0.00 $ 0.00 1992 $ 0.00 $ 0.00 $ 0.00 1991 $ 3,125.00 $ 0.00 $ 3,125.00 The following table allocates by category unrealized Gains/Losses within the portfolio as of December 31, 1993 (in thousands): UNREALIZED NET GAINS LOSSES GAINS/LOSSES U.S. TREASURY SECURITIES $ 227 $ 0 $ 227 OBLIGATIONS OF U.S. GOVERNMENT AGENCIES AND CORPORATIONS $ 516 $ 35 $ 481 OBLIGATIONS OF STATES AND POLITICAL SUBDIVISIONS $ 205 $ 27 $ 178 FEDERAL RESERVE AND CORPORATE STOCK $ 156 $ 0 $ 156 TOTALS $ 1,104 $ 62 $ 1,042 LIQUIDITY AND INTEREST RATE SENSITIVITY Liquidity is the ability to meet the needs of our customer base for loans and deposit withdrawals by maintaining assets which are convertible to cash equivalents with minimal exposure to interest rate risks. The liquidity ratio which is determined by a comparison of net liquid assets to net liabilities remains between 10% and 15%. The stability of our deposit base, sound asset/liability management, a strong capital base and quality assets assure adequate liquidity. The low interest rate environment has placed pressure on the ability to retain funds in maturing certificates of deposit. Many of our customers are, for the first time, looking outside the traditional bank investment options and investing in annuities, mutual funds and stocks. Deposits of $100,000 and over tend to be much more volatile and interest sensitive than smaller consumer deposits which make up the major portion of our deposit base. Another factor which must be addressed in the current interest rate situation is the inclination of our customers to lock in rates for longer periods of time. In excess of $24,000,000 in loans shifted from less than one year maturity to the one to five year category. Sound asset/liability management principals would dictate that investments should and do follow this trend. To address liquidity concerns, First Citizens became a member of the Federal Home Loan Bank, thereby opening up an additional liquidity source should the need arise. Interest 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 the prime rate are much more sensitive than long-term investment securities and fixed rate loans. The shorter term interest sensitive assets and liabilities are the key to measurement of the interest sensitivity gap. Minimizing this gap is a continual challenge in the present interest rate environment. This is the primary objective of the asset/liability management program. The following condensed gap report provides an analysis of interest rate sensitivity of earning assets and interest bearing liabilities. First Citizens Asset/Liability Management Policy provides that the cumulative gap as a percent of assets shall not exceed 10% for the three to six months, six to twelve months. The Cumulative Gap position in the one to five year category shall not exceed 20%. As evidenced by the following table, our current position is significantly below this level, with annual income exposure determined to be less than $100,000. CONDENSED GAP REPORT 12/31/93 CURRENT BALANCES (in thousands) 1-2 2+ YEARS YEARS CASH AND DUE FROM: CURRENCY AND COIN - 1,880 DUE FROM BANKS - 1,838 CASH ITEMS - 4,724 TOTAL CASH & DUE FROM - 8,442 INVESTMENTS: US TREASURIES 2,000 4,613 US AGENCIES 1,993 14,550 MUNICIPALS 2,305 8,816 HELD FOR SALE - - CORP & OTHERS 1,006 1,341 FEDERAL HOME LOAN BANK - 1,224 TOTAL INVESTMENTS 7,304 30,544 LOANS: COMMERCIAL FIXED 1,593 9,040 COMMERCIAL VARIABLE - - REAL ESTATE-VARIABLE - - REAL ESTATE FIXED 6,204 53,009 HOME EQUITY LOANS - - SEC MORTGAGE - - INSTALLMENT LOANS 3,844 9,497 INSTALLMENT VARIABLE - - FLOOR PLAN - - CREDIT CARDS - - OVERDRAFTS - - NON-ACCRUAL LOANS - 1,079 FHLB LOANS - 2,513 TOTAL LOANS 11,641 75,138 LOAN LOSS RESERVE - 1,676 NET LOANS 11,641 73,462 FED FUNDS SOLD - - TOTAL FED FUNDS SOLD - - TOTAL EARNING ASSETS 18,945 104,006 OTHER ASSETS: BUILDING, F&F & LAND - 7,627 OTHER REAL ESTATE - 98 OTHER ASSETS - 3,062 TOTAL OTHER ASSETS - 10,787 TOTAL ASSETS 18,945 123,235 DEMAND DEPOSITS: BANKS - 39 DEMAND DEPOSITS - 22,392 OFFICIAL CHECKS - 1 TOTAL DEMAND - 22,432 SAVINGS ACCOUNTS: REGULAR SAVINGS - 18,007 NOW ACCOUNT - 27,154 IMF-MMDA - 12,239 HIGH YIELD ACCOUNT - - GENERATIONS GOLD - 5,722 TOTAL SAVINGS - 63,122 CONDENSED GAP REPORT 12/31/93 CURRENT BALANCES (in thousands) 1-2 2+ YEARS YEARS TIME DEPOSITS: FLEX-CD 7,304 6,148 LARGE CD-FLEX 1,342 1,450 IRA-FLOATING - - IRA-FIXED 2,431 6,211 CHRISTMAS CLUB - - TOTAL TIME 11,077 13,809 TOTAL DEPOSITS 11,077 99,363 SHORT TERM BORROWINGS: TT&L - - SECURITIES SOLD-SWEEP - - SECURITIES SOLD-FIXED 600 281 TOTAL SHORT TERM BORR. 600 281 OTHER LIABILITIES: ACCRUED INT. PAYABLE - 1,369 OTHER LIABILITIES - 404 TOTAL OTHER LIABILITIES - 1,773 TOTAL LIABILITIES 11,677 101,417 CAPITAL: COMMON STOCK - 2,000 SURPLUS - 4,000 UNDIVIDED PROFITS - 13,506 TOTAL CAPITAL - 19,506 TOTAL LIAB'S & CAPITAL 11,677 120,923 GAP (SPREAD) 7,268 2,312 GAP % TOTAL ASSETS 3.12 0.99 CUMULATIVE GAP -2,312 - CUM. GAP % TOTAL ASSETS -0.99 - SENSITIVITY RATIO 0.98 1.00 CONDENSED GAP REPORT 12/31/93 CURRENT BALANCES (in thousands) 1-2 2+ YEARS YEARS CASH AND DUE FROM: CURRENCY AND COIN - - DUE FROM BANKS - - CASH ITEMS - - TOTAL CASH & DUE FROM - - INVESTMENTS: US TREASURIES 5.10 5.40 US AGENCIES 5.10 6.12 MUNICIPALS 6.89 6.72 HELD FOR SALE - - CORP & OTHERS 5.16 5.39 FEDERAL HOME LOAN BANK - 5.35 TOTAL INVESTMENTS 5.67 6.12 LOANS: COMMERCIAL FIXED 8.23 7.70 COMMERCIAL VARIABLE - - REAL ESTATE-VARIABLE - - REAL ESTATE FIXED 9.55 8.13 HOME EQUITY LOANS - - SEC MORTGAGE - - INSTALLMENT LOANS 11.57 9.55 INSTALLMENT VARIABLE - - FLOOR PLAN - - CREDIT CARDS - - OVERDRAFTS - - NON-ACCRUAL LOANS - - FHLB LOANS - 7.50 TOTAL LOANS 10.03 8.12 LOAN LOSS RESERVE - - NET LOANS 10.03 8.31 FED FUNDS SOLD - - TOTAL FED FUNDS SOLD - - TOTAL EARNING ASSETS 8.35 7.66 OTHER ASSETS: BUILDING, F&F & LAND - - OTHER REAL ESTATE - - OTHER ASSETS - - TOTAL OTHER ASSETS - - TOTAL ASSETS 8.35 6.47 DEMAND DEPOSITS: BANKS - - DEMAND DEPOSITS - - OFFICIAL CHECKS - - TOTAL DEMAND - - SAVINGS ACCOUNTS: REGULAR SAVINGS - 2.76 NOW ACCOUNT - 2.46 IMF-MMDA - 2.73 HIGH YIELD ACCOUNT - - GENERATIONS GOLD - 2.16 TOTAL SAVINGS - 2.57 CONDENSED GAP REPORT 12/31/93 CURRENT BALANCES (in thousands) 1-2 2+ YEARS YEARS TIME DEPOSITS: FLEX-CD 5.26 5.90 LARGE CD-FLEX 5.35 6.44 IRA-FLOATING - - IRA-FIXED 5.23 5.81 CHRISTMAS CLUB - - TOTAL TIME 5.26 5.92 TOTAL DEPOSITS 5.26 2.45 SHORT TERM BORROWINGS: TT&L - - SECURITIES SOLD-SWEEP - - SECURITIES SOLD-FIXED 5.08 5.80 TOTAL SHORT TERM BORR. 5.08 5.80 OTHER LIABILITIES: ACCRUED INT. PAYABLE - - OTHER LIABILITIES - - TOTAL OTHER LIABILITIES - - TOTAL LIABILITIES 5.25 2.42 CAPITAL: COMMON STOCK - - SURPLUS - - UNDIVIDED PROFITS - - TOTAL CAPITAL - - TOTAL LIAB'S & CAPITAL 5.25 2.03 GAP (SPREAD) 3.10 4.44 GAP % TOTAL ASSETS CUMULATIVE GAP CUM. GAP % TOTAL ASSETS SENSITIVITY RATIO RETURN ON EQUITY AND ASSETS FIRST CITIZENS BANCSHARES, INC. 1993 1992 1991 1990 1989 Percentage of Net Income to: Average Total Assets 1.17% .95% .89% .60% .59% Average Shareholders Equity 13.48% 11.79% 11.65% 8.43% 8.40% Percentage of Dividends Declared Per Common Share to Net Income Per Common Share 25.62% 27.67% 28.86% 42.57% 43.04% Percentage of Average Shareholders' Equity to Average Total Assets 8.71% 8.07% 7.60% 7.27% 7.00% Improved earnings performance is evident when reviewing the following table. The "domino effect" is seen in return on assets and equity, and in improved capital ratios. The company's Strategic Plan addresses objectives to sustain improved earnings, maintain a quality loan portfolio, and to maintain market share by providing quality customer service. Management of the Bank is committed to improving and maintaining earnings that are comparable to peer banks. Ratios comparing net income to average total assets and average shareholders equity indicate improvement from prior years. Return on Assets at 12/31/93 was 1.17%. Total Shareholders' equity (including Loan Loss Reserve) of First Citizens Bancshares as of 12/31/93 was $21,700,477 compared to $19,308,975 at 12/31/92. Total Capital (excluding Reserve for Loan Losses) as a percentage of total assets is presented in the following table for years indicated. CAPITAL RESOURCES/TOTAL ASSETS - YEAR-END TOTALS FIRST CITIZENS BANCSHARES, INC. 1993 1992 1991 1990 1989 9.24% 8.05% 7.75% 7.34% 6.80% Cash Dividends to Shareholders for 1993 and 1992 were $2.10 and $2.30 per share. This compares to dividends of $2.225 in 1990 and $2.10 per share paid each year from 1987 thru 1989. In September, 1993 a 2.5 for 1 stock split on the Common Capital Stock of Bancshares was declared to holders of record as October 15, 1993. The number of shares outstanding increased proportionately with changes to the capital account. In addition, a 10% stock dividend was declared payable December 15, 1992 which provided for the issuance of one share of stock for each 10 shares owned; with payment for fractional shares being made in cash. 25,158 shares were issued as a result of this dividend. In 1989, a stock dividend was declared payable December 15, 1989 which provided for the issuance of one share of stock for each twenty shares owned. Fractional shares were also paid in cash. 11,826 shares were issued as a result. Total shares outstanding were 706,656 at 12/31/93 and 279,247 at 12/31/92. An amendment to the Articles of Association ratified by the Shareholders in April, 1989 approved an increase in the number of shares authorized from 410,000 to 750,000. Risk-based capital focuses primarily on broad categories of credit risk and incorporates elements of transfer, interest rate and market risks. The calculation of risk-based capital ratio is accomplished by dividing qualifying capital by weighted risk assets. Effective January 1, 1993, the minimum risk-based capital ratio increased to 8.00%. At least one-half or 4.00% must consist of core capital (Tier 1), and the remaining 4.00% may be in the form of core (Tier 1) or supplemental capital (Tier 2). Tier 1 capital/core capital consists of common stockholders equity, qualified perpetual stock and minority interests in consolidated subsidiaries. Tier 2 Capital/Supplementary capital consists of the allowance for loan and lease losses, perpetual preferred stock, term subordinated debt, and other debt and stock instruments. Bancshares has historically maintained capital in excess of minimum levels established by the Federal Reserve Board. The risk-based capital ratio for Bancshares and First Citizens National Bank as of 12/31/93 was 13.88 percent and 12.73 percent respectively, significantly above the 8.0 percent level as required by regulation. With the exception of the Reserve for Loan and Lease Losses, all capital is Tier 1 level. Growth in capital will be maintained through retained earnings. There is no reason to assume that income levels will not be sufficient to maintain an adequate capital ratio. ITEM 8.

719264

1993

Item 6. Selected Financial Data PAGE Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations TEN MONTHS ENDED DECEMBER 31, 1993 COMPARED WITH THE TEN MONTHS ENDED DECEMBER 31, 1992 (UNAUDITED) Net sales increased from $22.4 million in the ten months ended December 31, 1992 ("Comparable 1992") to $23.4 million in the ten months ended December 31, 1993 ("Transition 1993") principally as a result of higher volumes of LP gas due to colder weather in the regions serviced by such business in Transition 1993, partially offset by slightly lower average selling prices which resulted from lower product costs. Operating profit decreased from $2.5 million in Comparable 1992 to $1.7 million in Transition 1993 principally due to an increase in selling, general and administrative expenses which resulted from a facilities relocation and corporate restructuring charge of $0.8 million relating to continuing operations (see Note 14 to the consolidated financial statements), partially offset by a slight increase in gross profit. Interest expense was favorably impacted due primarily to the lower debt outstanding and, to a much lesser extent, lower interest rates during Transition 1993. Equity in earnings of affiliates before cumulative effect of changes in accounting principles and extraordinary items of affiliate was unfavorably impacted in Transition 1993 primarily due to the following equity in significant charges of affiliates: (i) a $1.9 million charge recorded in Transition 1993 related to facilities relocation and corporate restructuring, (ii) $0.9 million of estimated cost allocated to the affiliates by Triarc for compensation paid to a special committee relating to the change in control of Triarc and affiliates which took place April 23, 1993, (iii) $1.2 million from the write-off of Graniteville Company's ("Graniteville") investment in Chesapeake Insurance Company Limited ("Chesapeake Insurance") and (iv) $0.5 million from insurance loss reserves recorded by Chesapeake Insurance. Interest income from Triarc was unfavorably impacted due to lower debt outstanding in Transition 1993. SEPSCO also wrote off its $1.5 million investment in Chesapeake Insurance since such investment is no longer deemed recoverable as a result of Chesapeake Insurance reducing its stockholders' equity to a minimal amount following additional provisions for insurance losses of $10.0 million during Transition 1993 and the decision by Triarc effective October 1993 to cease writing new insurance or reinsurance of any kind through Chesapeake Insurance. The benefit from income taxes increased from $0.3 million during Comparable 1992 to $1.2 million in Transition 1993. The Transition 1993 benefit resulted primarily from the equity in earnings of affiliates. Loss from discontinued operations, net of income taxes increased $22.7 million from $0.7 million in Comparable 1992 to $23.4 million in Transition 1993 primarily due to the following reasons: In connection with the consummation of the sales of the tree maintenance services operations and the construction related operations and the letter of intent to sell (and subsequent sale) of the ice operations, SEPSCO reevaluated the estimated gain or loss from the sale of its discontinued operations and provided $13.9 million for the estimated loss on the sale of the discontinued operations during Transition 1993. The revised estimate principally reflects (i) $4.6 million of losses from the sales of the operations comprising the utility and municipal services business segment previously estimated to be approximately break-even, (ii) $6.7 million of losses from the sale of operations comprising the refrigeration business segment previously estimated to be a gain of $1.6 million, (iii) $2.5 million of estimated losses from operations from July 22, 1993 to the actual or estimated disposal dates and (iv) less previously estimated losses of $1.5 million from the sale of the natural gas and oil business segment which now will be sold to Triarc and accounted for as a transfer between entities under common control at net book value. The net loss from the sale of the utility and municipal services business segment reflects a reduction of $1.8 million in the estimated sales price for the construction related operations from previous estimates, a $2.0 million reduction in anticipated proceeds from asset sales by July 22, 1994, and other adjustments in finalizing the loss on the sale of the tree maintenance services operations. The reduction in proceeds from asset sales results from the buyer of such businesses successfully negotiating extensions of certain major contracts with respect to the larger of such businesses and as a result no longer intending to immediately dispose of the major portion of the assets. Should the buyer hold such assets through October 5, 1995, the $2.0 million reduction in proceeds would be effectively realized through the Book Value Adjustment (see subsequent discussion). The $8.2 million change relating to the sales of the refrigeration business segment principally results from (i) a $4.0 million reduction in the sales price for the ice operations and (ii) a $4.0 million reduction in the estimated sales price of the cold storage operations based on preliminary sales discussions and experience with respect to negotiating the sale of the other operations. SEPSCO recorded an $8.0 million write-down relating to the impairment of certain unprofitable properties in Transition 1993. During Transition 1993 SEPSCO was allocated by Triarc as well as directly incurred certain facilities relocation and corporate restructuring charges totaling $4.7 million, of which $3.9 million was allocated to discontinued operations (see Note 14 to the consolidated financial statements for a further discussion). Operating profits of certain business segments through July 22, 1993, exclusive of the above charges, also declined. The tree maintenance activities experienced a decline in earnings due to higher insurance costs, losses on certain contracts and start-up costs on new crews. The flooding conditions experienced during the second quarter of Transition 1993 prevented the generation of revenues by crews added in anticipation of increased workload, whereas the Comparable 1992 period was favorably affected by the additional work in connection with Hurricane Andrew. The construction related activities experienced a decline due to a lower number of contracts in progress and losses experienced on existing contracts. Refrigeration operations had lower margins due to lower revenues from cold storage due to lower occupancy rates and lower margins in the ice operations due to competitive conditions. The above charges were partially offset by the effect of deferring the $3.8 million net loss from discontinued operations subsequent to July 22, 1993, the measurement date, through December 31, 1993 which was considered in the loss on disposal of discontinued operations. SEPSCO expects that such net losses will be offset by seasonal net income of the natural gas and oil operations through its disposal date. Effective March 1, 1993, SEPSCO changed its method of accounting for income taxes when it adopted the provisions of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS 109"). The cumulative effect on prior years of the change in accounting principles decreased the net loss for Transition 1993 by $7.6 million or $.64 per share. Effective March 1, 1992 Graniteville adopted SFAS 109 and Statement of Financial Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits Other than Pensions". The change in accounting principles resulted in charges amounting to $6.0 million, (net of taxes of $0.4 million), or $.51 per share, which was reflected in the consolidated statement of operations in Fiscal 1993. FISCAL 1993 COMPARED WITH FISCAL 1992 Net sales decreased from $29.2 million in Fiscal 1992 to $28.5 million in Fiscal 1993 due to a decrease in the average selling prices, coupled with a slight decrease in volume due to unseasonably warmer weather and increased competitive conditions. Operating profit decreased from $4.6 million in Fiscal 1992 to $3.6 million in Fiscal 1993 principally due to the decrease in sales as explained above, and to a lesser extent higher cost of product. Equity in earnings of affiliates before extraordinary items and cumulative effect of changes in accounting principles increased from $5.2 million in Fiscal 1992 to $12.2 million in Fiscal 1993 due to increased earnings of Graniteville. The gain on sale of marketable security of $6.0 million resulted from the recognition of a gain previously deferred on the sale of the common stock of an unaffiliated company to Triarc which had been previously deferred until collection of a note was assured. As such note was collected in April 1993 prior to the issuance of the Fiscal 1993 consolidated financial statements, the gain was recorded in Fiscal 1993. Gains on repurchase of debentures for sinking fund requirement decreased from $4.0 million in Fiscal 1992 to $0.1 million in Fiscal 1993 due to the market price of the Debentures which increased to above par, and accordingly, since the repurchase of the Debentures was no longer beneficial, the sinking fund requirement was principally made in cash. Other, net decreased from income of $0.4 million in Fiscal 1992 to expense of $1.1 million in Fiscal 1993 principally due to a $1.3 million accrual for the proposed settlement of the Ehrman Litigation in Fiscal 1993. Provision for income taxes as a percentage of income from continuing operations before income taxes for Fiscal 1993 was lower than the statutory rate due to the equity in earnings of affiliates on which income taxes were provided only on the portion remaining after an 80% dividend exclusion. Loss from discontinued operations, net of income taxes, increased from $0.2 million in Fiscal 1992 to $5.5 million in Fiscal 1993 principally due to a $4.7 million reduction in gross profit in the utility and municipal services segment due to competitive conditions experienced principally in the construction related activities and the tree maintenance operations due to intensely competitive bidding in the first quarter of Fiscal 1993 which resulted in losses of certain contracts, most of which were replaced by ones with lower margins and the adjustment of prices to retain certain other existing contracts. Also, the refrigeration operations recorded a $2.1 million accrual before income taxes for potential environmental remediation in Fiscal 1993, whereas Fiscal 1992 included a credit of $1.4 million as proceeds from settlement of certain litigation of the construction operations. These factors were partially offset by a benefit from income taxes of $2.4 million in Fiscal 1993 compared to a benefit from income taxes of $0.3 million in Fiscal 1992. Equity in cumulative effect of changes in accounting principles of affiliate of $6.0 million resulted from Graniteville's adoption of SFAS 109 and SFAS 106 during Fiscal 1993. Equity in extraordinary items of affiliate of $0.3 million in Fiscal 1993 resulted from the early extinguishment of debt by CFC Holdings. LIQUIDITY AND CAPITAL RESOURCES At February 28, 1993 and December 31, 1993 cash and equivalents, excluding restricted cash, amounted to $0.2 million and $33.6 million (including ($10.8 million of marketable securities), respectively. The $22.6 million increase in cash is principally a result of the remaining excess proceeds from the sale of the tree maintenance services operations (see subsequent discussion). Total debt, excluding the debt of the discontinued operations, amounted to $58.3 million and $59.3 million at February 28, 1993 and December 31, 1993, respectively. As previously reported, a change in control of Triarc occurred on April 23, 1993 (the "Closing Date"), which as a result of Triarc's ownership of SEPSCO's voting securities constituted a change in control of SEPSCO. In connection therewith SEPSCO received from Triarc $27.1 million in cash and $3.5 million in the form of an offset of amounts due to Triarc as of April 23, 1993 in connection with the providing by Triarc of certain management services to SEPSCO. The aggregate $30.6 million of payments by Triarc included full payment of $6.8 million (including $0.3 million of accrued interest) on an unsecured promissory note issued to SEPSCO by Triarc in connection with the 1988 sale of an investment and partial payment of $23.8 million (including $1.4 million of accrued interest) on a $49.0 million promissory note due to SEPSCO resulting from the 1986 sale of approximately 51% of Graniteville's common stock to Triarc, as described below. SEPSCO used the $27.1 million of cash proceeds to pay $12.7 million due under its accounts receivable financing arrangement which was then terminated and to pay $14.4 million (including $0.4 million of accrued interest) owed to Chesapeake Insurance Company Limited ("Chesapeake Insurance"). At December 31, 1993 SEPSCO holds a promissory note (the "Note") of $28.0 million (including $1.4 million of accrued interest) from Triarc, which is included in "Due from Triarc Companies, Inc." in the consolidated balance sheet, which had an original face amount of approximately $49.0 million, bearing interest at the annual rate of 13% payable semi-annually. As described above, on the Closing Date, SEPSCO received partial payment of the Note of approximately $23.8 million including $1.4 million of accrued interest from Triarc. The Note, after giving effect to such prepayment, is due in August 1998 and resulted from the 1986 sale of approximately 51% of the outstanding common shares of Graniteville to Triarc and is secured by such shares. The Note is subordinated to senior indebtedness of Triarc to the extent, if any, that the payment of principal and interest thereon is not satisfied out of proceeds of the pledged Graniteville shares. SEPSCO has not received any cash dividends from its investment in Graniteville during Transition 1993 compared with $3.0 million in Fiscal 1993. Under its present credit agreement, Graniteville is permitted to pay dividends or make loans or advances to its stockholders, including SEPSCO in an amount equal to 50% of the net income of Graniteville accumulated from the beginning of the first fiscal year commencing on or after December 20, 1994, provided that the outstanding principal balance of Graniteville's term loan is less than $50.0 million at the time of the payment (the outstanding principal balance was $72.5 million as of December 31, 1993) and certain other conditions are met. Accordingly, Graniteville is unable to pay any dividends or make any loans or advances to SEPSCO prior to December 31, 1995. SEPSCO is required to pay interest on its 11 7/8% Senior Subordinated Debentures due February 1, 1998 (the "Debentures") semi-annually on February 1 and August 1 of each year. Interest payments due February 1, 1994 and August 1, 1994 aggregate $6.9 million. SEPSCO is also required to retire annually, through the operation of a mandatory sinking fund, $9.0 million principal amount of the Debentures on February 1 of each year. The indenture pursuant to which the Debentures were issued (the "Indenture") provides that, in lieu of making such payment in cash, SEPSCO may credit against the mandatory sinking fund requirement the principal amount of Debentures acquired by SEPSCO other than through the sinking fund. On February 1, 1994, SEPSCO satisfied such sinking fund requirement by payment of $9.0 million in cash through cash received from the sale of the tree maintenance services operations rather than through the delivery of Debentures. The indenture contains a provision which limits to $100.0 million the aggregate amount of specified kinds of indebtedness that SEPSCO and its consolidated subsidiaries can incur. At December 31, 1993 such indebtedness was $59.3 million resulting in allowable additional indebtedness, if SEPSCO desired to make such borrowings and if such financing could be obtained, of $40.7 million. On October 18, 1993, Triarc entered into a Settlement Agreement (the "Settlement Agreement") with the plaintiff (the "Plaintiff") in the Ehrman Litigation. The Settlement Agreement provides, among other things, that SEPSCO would be merged into, or otherwise acquired by, Triarc or an affiliate thereof, in a transaction in which each holder of SEPSCO's Common Stock other than Triarc will receive in exchange for each share of SEPSCO's Common Stock, 0.8 shares of Triarc's Class A Common Stock. On November 22, 1993 Triarc and SEPSCO entered into a merger agreement (the"Merger"). The Settlement Agreement was approved by the United States District Court For the Southern District of Florida on January 11, 1994 and the Merger was approved on April 14, 1994 by SEPSCO's stockholders other than Triarc. The Merger was consummated on April 14, 1994 pursuant to which a subsidiary of Triarc was merged into SEPSCO in the manner described in the Settlement Agreement. Following the Merger, Triarc owns 100% of the SEPSCO Common Stock. On July 22, 1993, SEPSCO's Board of Directors authorized the sale or liquidation of the utility and municipal services, refrigeration and natural gas and oil businesses. Accordingly, SEPSCO has retroactively restated the consolidated financial statements for each of the periods shown to reflect all of such businesses as discontinued operations through July 22, 1993. The operating results of the discontinued operations subsequent to July 22, 1993 have been deferred which was anticipated in the loss on disposal of discontinued operations and are included in "Net current liabilities of discontinued operations" in the consolidated balance sheets. In addition, on July 22, 1993 SEPSCO Board of Directors authorized the sale or liquidation of the liquefied petroleum gas business. Sepsco intends to transfer the liquified petroleum gas business to a subsidiary of Triarc and the transfer would be accounted for at net book value. The precise nature of such transfer has not been determined and is expected to occur by July 22, 1994. Based on these facts SEPSCO has continued to reflect the liquified petroleum gas business as a continuing operation. On December 9, 1993 SEPSCO's Board of Directors decided to sell the natural gas and oil business to Triarc following the Merger and the resulting minority interest in SEPSCO rather than selling such business to an independent third party. Such sale will be in the form of a sale of the stock of the entities comprising the natural gas and oil business for cash of $8.5 million which is equal to their fair value and approximately $4.0 million higher than their net book value. On October 15, 1993 SEPSCO sold the assets of its tree maintenance services operations previously included in its utility and municipal services business segment for $69.6 million in cash plus the assumption by the purchaser of $5.0 million in current liabilities resulting in a loss of $4.8 million. The $22.8 million cash balance as of December 31, 1993 is principally a result of such cash proceeds, less the repayment of $24.1 million of capitalized lease obligations relating to the tree maintenance services operations, repayment of $1.1 million of amounts due to Triarc, payment of $2.0 million to the purchasers of the construction related operations (see below) and general operating requirements since October 15, 1993. On October 7, 1993 SEPSCO sold the stock of its two construction related operations previously included in its utility and municipal services business segment for a nominal amount subject to adjustments described below. As the related assets are sold or liquidated the purchasers have agreed to pay, as deferred purchase price, 75% of the net proceeds received therefrom (cash of $1.8 million had been received as of December 31, 1993) plus, in the case of one of the two entities, an amount equal to 1.25 times the adjusted book value of such entity as of October 5, 1995 (the "Book Value Adjustment"). As of October 7, 1993, the adjusted book value of the assets of that entity aggregated approximately $1.6 million. In addition, SEPSCO paid $2.0 million in October and November 1993 to cover the buyer's short-term operating losses and working capital requirements for the construction related operations. SEPSCO currently expects to break-even the sales of the construction related operations excluding any consideration of the potential Book Value Adjustment. On April 8, 1994 SEPSCO sold substantially all of the operating assets of the ice operations of its refrigeration business segment for $5.0 million in cash, a $4.3 million note (discounted value $3.3 million) and the assumption by the buyer of certain current liabilities of up to $1.0 million. While the loss on the sale has not been finalized, SEPSCO currently estimates it will approximate $2,500,000. The note, which bears no interest during the first year and 5% thereafter, would be payable in installments of $120.0 thousand in 1995 through 1998 with the balance of approximately $3.8 million due in 1999. The only remaining discontinued operation to be sold to an independent third party is the cold storage operation of the refrigeration business. The precise timetable for the sale and liquidation of the cold storage operation will depend upon SEPSCO's ability to identify appropriate potential purchasers and to negotiate acceptable terms for the sale of such operation. SEPSCO currently anticipates completion of such sales by July 22, 1994. SEPSCO has $5.3 million of restricted cash and equivalents which support letters of credit which collateralize certain performance and other bonds relating to the utility and municipal services business segment. SEPSCO anticipates that buyers of the segment will provide the collateral for such bonds or that the performance secured by the bond will be completed and the restricted cash will revert to SEPSCO free of restrictions and at that time be used for general corporate purposes. SEPSCO had cash provided by operations of $4.1 million during Transition 1993. Such cash requirements, excluding cash flows from operations, for 1994 will include $3.9 million of capital expenditures, of which SEPSCO intends to seek financing from banks and other sources for $3.2 million, as well as a $9.0 million sinking fund payment on the Debentures (paid February 1, 1994). SEPSCO expects to meet all of its cash requirements during 1994 with the aforementioned financing for capital expenditures and its existing cash balances principally derived from the sale of the tree maintenance services operations. In 1987, Graniteville was notified by the South Carolina Department of Health and Environmental Control ("DHEC") that it discovered certain contamination of Langley Pond near Graniteville, South Carolina and DHEC asserted that Graniteville may be one of the parties responsible for such contamination. Graniteville entered into a consent decree providing for the study and investigation of the alleged pollution and its sources. The study report prepared by Graniteville's environmental consulting firm and filed with DHEC in April 1990, recommended that pond sediments be left undisturbed and in place. DHEC responded by requesting that Graniteville submit additional information concerning potential passive and active remedial alternatives, with accompanying supportive information. In May 1991 Graniteville provided this information to DHEC in a report of Graniteville's environmental consulting firm. The 1990 and 1991 reports concluded that pond sediments should be left undisturbed and in place and that other less passive remediation alternatives either provided no significant additional benefits or themselves involved adverse effects on human health, to existing recreational uses or to the existing biological communities. SEPSCO is unable to predict at this time what further actions, if any, may be required in connection with Langley Pond or what the cost thereof may be. However, given the passage of time since the submission of the two reports by DHEC and the absence of desirable remediation alternatives, other than continuing to leave the Langley Pond sediments in place and undisturbed as described in the reports, SEPSCO believes the ultimate outcome of this matter will not have a material adverse effect on SEPSCO's consolidated results of operations or financial position. As a result of certain environmental audits in 1991, SEPSCO became aware of possible contamination by hydrocarbons and metals at certain sites of SEPSCO's refrigeration operations and has filed appropriate notifications with state environmental authorities and has begun a study of remediation at such sites. SEPSCO has removed certain underground storage and other tanks at certain facilities of its refrigeration operations and has engaged in certain remediation in connection therewith. Such removal and environmental remediation involved a variety of remediation actions at various facilities of SEPSCO located in a number of jurisdictions. Such remediation varied from site to site, ranging from testing of soil and groundwater for contamination, development of remediation plans and removal in certain instances of certain contaminated soils. Based on preliminary information and consultations with, and certain reports of, environmental consultants and others, SEPSCO presently estimates the cost of such remediation and/or removal will approximate $3.7 million, all of which was provided in prior years. In connection therewith, SEPSCO has incurred actual costs through December 31, 1993 of $1.2 million and has a remaining accrual of $2.5 million. SEPSCO believes that after such accrual the ultimate outcome of this matter will not have a material adverse effect on SEPSCO's consolidated results of operations or financial position. PAGE Item 8.

92050

1993

ITEM 6. - SELECTED FINANCIAL DATA - ------ ----------------------- The following table of selected financial data should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein. ITEM 7

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - ----------------------------------------------------------------------- Results of Operations - --------------------- Sales 1993 Increase 1992 Increase 1991 - ---------------------------------------------------------------------- $509.2 3.9% $490.2 11.2% $441.0 Sales increased by almost 4% in 1993 due primarily to strong growth rates in our international export, high school science education (Sargent-Welch division) businesses and the effects of the acquisition of Johns Scientific and the distribution agreement with BDH Ltd. in Canada. Growth in Canada was less than expected. Combining the operations and systems of the three companies proved to be a more complex task than anticipated and we experienced higher costs. In addition, sales of our principal U.S. operating unit (VWR Scientific) lagged behind the market and we missed our internal target. In 1992 each of our areas of business activity gained market share and contributed to our growth from 1991. Sargent-Welch and our international export business sales were very strong. The acquisition of Johns Scientific in the fourth quarter of 1992 for approximately $7.4 million and a large international order in the second half of 1992 accounted for about 1% of the sales growth. Approximately 2% of the sales growth was due to price increases. Gross Margin - ------------- 1993 Increase 1992 Increase 1991 - -------------------------------------------------------------------- Margin $116.3 1.7% $114.4 9.1% $104.9 Percent of Sales 22.8% 23.3% 23.8% Over the three-year period, gross margin as a percent of sales declined primarily as a result of customer mix and competitive price pressures. Operating Expenses Before Restructuring and Other Charges - --------------------------------------------------------- 1993 Increase 1992 Increase 1991 - ---------------------------------------------------------------------- Expenses $101.9 6.7% $95.5 8.2% $88.3 Percent of Sales 20.0% 19.5% 20.0% In 1993 the increase in operating expenses before restructuring and other charges is primarily due to higher personnel costs and transition costs associated with the acquisition of Johns Scientific and the distribution agreement with BDH, Ltd., and our investment in a new direct marketing effort. Excluding the impact from Canadian acquisitions and direct marketing, operating expenses grew approximately 1.4%. Operating expenses grew at a rate slower than sales in 1992. The reasons for the slower growth rate were our continuous emphasis on cost containment and the fact that fixed costs were stable while sales increased. Restructuring and Other Charges - ------------------------------- In the fourth quarter of 1993, the Company made the decision to refocus certain information systems efforts into customer service systems and to take actions that would reduce operating expenses. As a result of this effort, the Company recorded a $3.3 million charge which included non-cash charges of $1.3 million (primarily for software development costs that do not have continuing value) and $2 million related to the consolidation of functions and facilities which consists primarily of severance and personnel-related costs. Approximately $2 million is accrued at December 31, 1993, and is reflected in current liabilities. It is anticipated that the impact of the consolidation of certain functions will result in annualized cost savings of approximately $2 million, beginning in the first half of 1994. Interest Expense - ---------------- 1993 Increase 1992 Decrease 1991 - -------------------------------------------------------------------- Interest $4.5 15.4% $3.9 (7.1)% $4.2 Percent of Sales .9% .8% 1.0% In 1993 interest expense increased due to increased borrowing levels which occurred primarily for the purchase of a new warehouse facility for the Sargent-Welch division, system enhancements, and the 1992 acquisition of Johns Scientific. Interest expense decreased in 1992 primarily as a result of reduced debt levels. Lower debt levels were achieved primarily by improvements in working capital management. Income Taxes - ------------ 1993 Decrease 1992 Increase 1991 - -------------------------------------------------------------------- Taxes $2.7 (52.6)% $5.7 23.9% $4.6 Percent of Sales .5% 1.2% 1.0% Effective tax rate 40.6% 37.5% 37.5% The income taxes footnote to the financial statements describes the difference between the statutory and effective income tax rates. The higher effective tax rate in 1993 reflects the impact of new U.S. federal tax legislation and the carryforward to future years of Canadian tax benefits not recognized currently. In 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109 "Accounting for Income Taxes," which did not have a material effect on the consolidated financial position or results of operations. Income Before Cumulative Effect of Accounting Change and Per Share Data - ----------------------------------------------------------------------- 1993 Decrease 1992 Increase 1991 - -------------------------------------------------------------------- Income $3.9 (58.5)% $9.4 22.1% $7.7 Percent of Sales .8% 1.9% 1.8% Per Share $ .35 $ .85 $ .71 In addition to the impact of the restructuring and other charges, which were $3.3 million pre-tax ($1.9 million net of tax or $.18 per share), income before cumulative effect of accounting change decreased primarily due to decreased operating income from lower than expected sales and margins, and higher operating expenses along with higher interest costs. In 1992 the improvement was the result of sales growth, improved profitability in our newer areas of business activity, expense controls, lower debt levels, and strong asset management. Financial Condition and Liquidity - --------------------------------- The ratio of debt to equity over the past four years is as follows: 1993 1992 1991 1990 - -------------------------------------------------------------- 1.5 1.1 1.3 1.8 The ratio of income before cumulative effect of accounting change, plus depreciation and amortization, to interest expense over the past four years is as follows: 1993 1992 1991 1990 - -------------------------------------------------------------- 2.9 4.6 3.7 2.6 VWR continues to maintain a liquid financial position. VWR's current ratio was 2.7 at December 31, 1993 and accounts receivable and inventory accounted for 63% of total assets. For the year ended December 31, 1993 cash flow from operations of $6.4 million and debt borrowings of $14 million were used to finance investments in property and equipment of $13.4 million and to pay dividends of $4.4 million. The significant investment in property and equipment was due to the purchase of a new warehouse facility for the Sargent- Welch division and system enhancements. Sufficient credit availability existed at December 31, 1993 to provide for the amounts of bank checks outstanding less cash in bank of $1.1 million. Cash requirements reach a low toward the end of each calendar year due to the natural business cycle. The Company has unsecured revolving credit loan agreements, expiring in 1996 which provide for committed facilities of $75 million. The Company is obligated to make available an unsecured subordinated revolving line of credit for approximately $5 million to Momentum Corporation (formerly Momentum Distribution, Inc., the company spun off in 1990) through February 1995. There have been no loans to Momentum Corporation through December 31, 1993. VWR borrows at short-term interest rates. Our credit agreements give us the option to convert up to $37.5 million to a five-year term loan. Interest rate collars effectively establish a minimum and maximum rate on up to $55 million of revolving credit debt. Collars of $25 million will expire in 1994 and are expected to be replaced with interest rate swaps of $10 million at a fixed rate. The remaining collar of $30 million will expire in 1996 and is expected to be replaced at a fixed rate into 1999. On January 1, 1994, the company formed a joint venture with E. Merck of Germany to acquire an interest in Bender & Hobein GmbH, a distributor of laboratory supplies and equipment in Germany. The investment will be accounted for using the cost method of accounting and was funded through the Company's revolving credit line. VWR has been designated by the EPA as a potentially responsible party for various sites. Management believes that any required expenditures would be immaterial to the Company's consolidated financial statements. The Company adopted SFAS No. 106 "Accounting For Postretirement Benefits Other Than Pensions," in 1993, which resulted in a one-time non-cash charge of $1.4 million (net of deferred tax benefit of $.9 million). See notes to the consolidated financial statements for further discussion. Due to declining interest and inflation rates, the Company changed certain pension and retiree medical actuarial assumptions, which included lowering the discount rate to 7.75% and rate of compensation increase to 4%. These changes will not have a material effect on the consolidated financial statements in 1994. As of December 31, 1993 the estimated cost for capital improvement projects is expected to range between $4-$5 million in 1994 related primarily to continued investments in new computer and warehouse systems. Operating Income Return on Average Invested Capital - ----------------------------------------------------- 1993 1992 1991 1990 - --------------------------------------------------------------------- 11.5% 21.8% 19.0% 19.1% 1993 before restructuring charges 14.9% Operating Income to Sales - ------------------------- 1993 1992 1991 1990 - --------------------------------------------------------------------- 2.2% 3.9% 3.8% 3.9% 1993 before restructuring charges 2.8% Average Invested Capital to Sales - --------------------------------- 1993 1992 1991 1990 - --------------------------------------------------------------------- 18.9% 17.7% 19.8% 20.7% Days Sales in Accounts Receivable - --------------------------------- 1993 1992 1991 1990 - --------------------------------------------------------------------- 42.6 41.5 42.1 43.5 Inventory Turnover (Before LIFO) - -------------------------------- 1993 1992 1991 1990 - --------------------------------------------------------------------- 6.9 6.4 6.0 5.6 VWR CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ------------------------------------------ Principles of Consolidation - -------------------- The accompanying consolidated financial statements include the accounts of VWR Corporation (the Company) and all of its subsidiaries (including its wholly owned Canadian subsidiary). All significant intercompany accounts and transactions have been eliminated. Capitalization, Depreciation and Amortization - --------------------------------------- Land, buildings, and equipment are recorded at cost. Depreciation is computed using the straight-line method for financial reporting purposes and, generally, accelerated methods for income tax purposes. Acquisition and development costs for significant business systems and related software for internal use are capitalized on significant projects and amortized over their estimated useful lives of seven years. Interest is capitalized on major construction and development projects while in progress. The Company capitalizes the costs of developing and producing catalogs, which are used by customers for ordering products. Such costs are amortized over the period of use, generally two years. Income Taxes - ------------ In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109 "Accounting for Income Taxes," which supersedes SFAS No. 96 previously followed by the Company. The adoption of SFAS 109 did not have a material effect on the Company's financial position or results of operations. SFAS 109 uses the asset and liability method under which deferred taxes are determined based on the difference between the financial statement amounts and tax bases of assets and liabilities using enacted tax rates. Deferred tax expense is the result of changes in the asset or liability for deferred taxes. Postretirement Benefits - ----------------------- In 1993, the Company adopted SFAS No. 106 "Accounting for Postretirement Benefits Other Than Pensions." This Statement requires the Company to accrue the cost of retiree medical expenses over the period earned by the participants, which is a change from the Company's prior practice of recording these costs when incurred. Earnings Per Share and 1992 Stock Split - ---------------------------------- Earnings per share are based on the weighted average number of shares and dilutive common share equivalents outstanding during the period. On April 20, 1992, the Company's Board of Directors declared a two-for-one stock split in the form of a stock dividend payable to shareholders of record as of May 9, 1992. The aggregate par value, which did not change on a per- share basis, of $5.6 million for the additional shares was transferred from additional paid-in capital to common stock. All share and per-share data in these financial statements have been restated to give effect to the stock split. Segment and Customer Information - -------------------------------- The Company is engaged in one line of business, industrial distribution. No single customer accounts for more than 10% of sales. The majority of the Company's business activity pertains to, and accounts receivable result from, sales of laboratory equipment and supplies to businesses across a wide geographical area in various industries, mainly industrial, governmental, biomedical, and educational. At December 31, 1993, the Company had no significant concentrations of credit risk. Reclassifications - ----------------- Certain prior years' amounts have been reclassified to conform to the current year's presentation. INVENTORIES - ----------- Inventories consist primarily of purchased goods for sale and are valued at the lower of cost (substantially last-in, first-out method) or market. LIFO cost at December 31, 1993, and 1992, was approximately $26.8 million and $25.5 million, respectively, less than current cost. The effect of LIFO layer liquidations decreased the cost of sales by $.6 million in 1993, and $.4 million in 1992 and 1991. Depreciation expense for the years ended December 31, 1993, 1992, and 1991, was $5.4 million, $4.3 million, and $4.0 million, respectively. ACCRUED LIABILITIES - ------------------- Included in accrued liabilities at December 31, 1993, and 1992, is accrued compensation of approximately $4.2 million and $5.2 million respectively. FOREIGN CURRENCY TRANSACTIONS - ------------------------------ The Company has entered into forward exchange contracts to hedge foreign currency transactions with its Canadian subsidiary. As of December 31, 1993, the Company had approximately $3.4 million of forward exchange contracts outstanding. Net transaction gains and losses are not material. At December 31, 1993, the Company had unsecured revolving lines of credit of $75 million. Under the terms of these agreements, which expire in 1996, the Company may borrow U.S. dollars at various rates. In addition, the Company can elect to convert up to $37.5 million of the line into term notes which can extend into the year 2001. Principal amounts due on long-term debt, including assumed conversion in 1995 of the revolving credit agreements to term notes, in each of the five years beginning January 1, 1994, are $.1 million, $3.9 million, $32.1 million, $7.7 million and $7.6 million, respectively. A principal payment of $1.1 million due in 1994 on other debt is expected to be funded from the revolving credit facility and, accordingly, is classified as long-term. For the year ended December 31, 1993, the approximate weighted average interest rate on borrowings made under the unsecured revolving lines was 7.88%, which approximates the year-end rate. The Company has purchased interest rate collars on $55 million, of which $20 million expires on March 27, 1994, $5 million expires on May 3, 1994, and $30 million expires on March 1, 1996. The collars are based on the three-month London Interbank Offered Rate ("LIBOR") and have a floor of 6.75% and a ceiling of 9.5%. The cost of the collars is treated as a reduction of the revolving credit debt and is being amortized as revolving credit interest expense over the terms of the collars. The Company's long-term debt agreement provides for, among other terms, restrictive covenants with respect to working capital, tangible net worth, the current ratio, and the debt-to-equity ratio, which may restrict the Company's ability to declare or pay dividends. Under the most restrictive of these terms, approximately $2 million of retained earnings at December 31, 1993, is available to pay dividends. INCOME TAXES - ------------ During 1993, the Company adopted SFAS No. 109 "Accounting for Income Taxes." The cumulative effect of the accounting change was not material. The income (loss) before income taxes and cumulative effect of accounting change is as follows: The reconciliation of tax computed at the federal statutory tax rates of 35% (1993) and 34% (1992 and 1991) of income before income taxes and cumulative effect of accounting change to the actual income tax provision is as follows: Deferred tax liabilities (assets) as of December 31, 1993 and 1992 are comprised of the following: - ----------------------------------------------------------------------------- (Thousands of dollars) 1993 1992 - ----------------------------------------------------------------------------- Depreciation $6,400 $6,539 Pension 1,918 884 ----- ----- Deferred tax liabilities 8,318 7,423 ----- ----- Postretirement benefits (809) Other benefits (584) (485) Restructuring charges (720) Other-net (363) (578) ----- ----- Deferred tax assets (2,476) (1,063) ------ ------ Net deferred tax liability $5,842 $6,360 ====== ====== Included in other current assets at December 31, 1993 are refundable income taxes of approximately $2.1 Million and $.6 million of net current deferred tax assets. The Company has Canadian tax loss carryforwards of approximately $.9 million which expire at various dates through 2000. SHAREHOLDER RIGHTS AGREEMENT - ---------------------------- On May 20, 1988, the Company established a Shareholder Rights Agreement. The Agreement is designed to deter coercive or unfair takeover tactics that could deprive shareholders of an opportunity to realize the full value of their shares. Under the Agreement, the Company has distributed a dividend of one Right for each outstanding share of the Company's stock. When exercisable, each Right will entitle its holder to buy two shares of the Company's common stock at $45.00 per share. The Rights will become exercisable if a purchaser acquires or makes an offer to acquire 20 percent of the Company's common stock. In the event that a purchaser acquires 20 percent of the common stock, each Right shall entitle the holder, other than the acquirer, to purchase, at the Right's then-current full exercise price, shares of the Company's common stock having a market value of twice the then-current full exercise price of the Right. In the event that, under certain circumstances, the Company is acquired in a merger or transfers 50 percent or more of its assets or earnings to any one entity, each Right entitles the holder to purchase common stock of the surviving or purchasing company having a market value of twice the full exercise price of the Right. The Rights, which expire on May 31, 1998, may be redeemed by the Company at a price of $.005 per Right. STOCK AND INCENTIVE PROGRAMS - ---------------------------- Under the stock option and restricted stock plans, in addition to outstanding options, 235,411 shares were reserved for issuance at December 31, 1993. Restricted Stock Awards - ----------------------- The Company's restricted stock award plan, provides for grants of common stock to certain directors, officers, and managers. The vesting periods range from one to eight years. The fair market value of the stock at the date of grant establishes the compensation amount, which is amortized to operations over the vesting period. During the years ended December 31, 1993, 1992 and 1991, the Company granted 45,219, 7,580 and 15,116 shares, respectively, at fair market values of approximately $.7 million, $.1 million and $.1 million, respectively. Stock Options - ------------- Under the stock option plan, options, which vest over 3 to 10 years, have been granted to certain officers and managers to purchase common stock of the Company at its fair market value at date of grant. Changes in options outstanding were: At December 31, 1993, there were 98,871 options exercisable at an average price of $7.50. Savings Investment Plan - ----------------------- The Company has a savings investment plan whereby it matches 50% of the employee's contribution up to 3% of the employee's pay. For employee contributions between 3% and 7.5% of their pay, the Company will match 50% of the contribution within prescribed limits based on the Company's profitability for the year. All Company contributions are used to buy shares of the Company's stock. Expenses under this plan for the years ended December 31, 1993, 1992, and 1991, were $.5 million, $.6 million and $.4 million, respectively. At December 31, 1993, there were approximately 538,000 shares available for issuance under this Plan. Employee Stock Ownership Plan - ----------------------------- In September, 1990, the Company established an employee stock ownership plan (ESOP) by, in effect, contributing 400,000 shares of treasury stock ($2.9 million fair value) to the ESOP. All full-time and part-time employees, except certain union employees, are eligible to participate in the plan. The ESOP shares will be allocated equally to individual participants' accounts over a period up to ten years. Vesting occurs equally over an employment period of five years at which time the employee is 100% vested in the plan. Expenses are recognized based on shares to be allocated in the subsequent year and are reduced for dividends paid, which approximated $.1 million in 1993, and $.2 million in 1992 and 1991. The net expense for 1993, 1992, and 1991 was approximately $.1 million, $.3 million and $.2 million, respectively. POSTRETIREMENT BENEFITS - ------------------------ Pension Plans: The Company has two defined benefit pension plans covering substantially all of its domestic employees, except for employees covered by independently operated collective bargaining plans. Pension benefits are based on years of credited service and the highest five consecutive years' average compensation. Contributions to the Company plans are based on funding standards established by the Employee Retirement Income Security Act of 1974 (ERISA). The total VWR Corporation plans' funding status and the amounts recognized in the Company's Consolidated Balance Sheets at December 31, 1993, and 1992, are: The assets of the Company plans consist predominantly of undivided interests in several funds structured to duplicate the performance of various stock and bond indexes. Net pension expense under the Company plans includes the following components: The Company maintains a supplemental pension plan for certain senior officers. Expenses incurred under this plan in 1993 were approximately $.3 million. There were no expenses incurred under this plan for 1992 and 1991. Certain employees are covered under union-sponsored, collectively bargained plans. Expenses under these plans for the years ended December 31, 1993, 1992 and 1991, were $.2 million, $.2 million and $.1 million, respectively, as determined in accordance with negotiated labor contracts. Retiree Medical Benefits Program - -------------------------------- The Company provides certain medical benefits for retired employees. In 1993, the Company adopted SFAS No. 106 "Accounting for Postretirement Benefits Other Than Pensions." The Company elected to immediately recognize the calculated liability resulting in a one-time non-cash charge to income of approximately $1.4 million, net of a deferred tax benefit of approximately $.9 million. Employees retired as of December 31, 1992 and active employees who reached age 55 by December 31, 1992 are eligible to participate in the company's retiree health plan (the "plan"). There are also certain provisions for participation by spouses. The plan is contributory, with retiree contributions based on years of service and includes other co-payment and co-insurance provisions. The Company does not fund the plan. The liability of the plan at December 31, 1993 is as follows: (Thousands of dollars) Accumulated postretirement benefit obligation: Retirees $1,604 Eligible active participants 183 Other active participants 21 Unrecognized net gain 266 ----- Accrued postretirement benefit obligation $2,074 ===== The net periodic postretirement benefit cost for 1993 includes the following components: Service cost $ 7 Interest cost 174 ----- $181 ===== The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation is 10% through 1996 and declines 1% per year to a level of 5.4% in 2001 and thereafter. The effect of a 1% annual increase in the assumed cost trend rate would increase the accumulated postretirement benefit obligation by approximately 8%; the annual service and interest cost components in the aggregate would not be materially affected. A 7.75% discount rate was used in determining the accumulated postretirement benefit obligation. Before the adoption of SFAS No. 106, the retiree health care expense was recorded as claims were incurred. The expense for 1992 and 1991 was approximately $.2 million. LEASES - ------ The Company leases office and warehouse space, computer equipment, and automobiles under operating leases with terms ranging up to 15 years, subject to renewal options. Rental expense for continuing operations for the years ended December 31, 1993, 1992, and 1991, was approximately $5.2 million, $4.8 million, and $4.4 million, respectively. Future minimum lease payments as of December 31, 1993, under noncancelable operating leases, having initial lease terms of more than one year are: CONTINGENCIES AND COMMITMENTS - ------------------------------ The Company is involved in various environmental, contractual, warranty, and public liability cases and claims, which are considered routine to the Company's business. In the opinion of management, the potential financial impact of these matters is not material to the consolidated financial statements. As a result of the March, 1990 spin-off of Momentum Corporation, VWR is obligated to make available to the spun-off company, through February 1995, an unsecured subordinated revolving line of credit of $5 million. There have been no loans to Momentum Corporation under this facility. ACQUISITION - ---------- Effective October 5, 1992, the Company, through its wholly owned Canadian subsidiary, acquired certain assets related to the laboratory supply business of Johns Scientific, Inc. of Toronto, Canada for approximately $7.4 million. This acquisition was accounted for under the purchase method of accounting and was funded through the Company's revolving credit line, and a $1.6 million, 8% note payable expected to be refinanced through the revolving line of credit. The acquisition is not material in relation to the Company's consolidated financial statements. The $2.6 million excess purchase price over net assets acquired is being amortized over a 15 year period. RESTRUCTURING AND OTHER CHARGES - ------------------------------- In the fourth quarter of 1993, the Company made the decision to refocus certain information systems efforts into customer service systems and to take actions that would reduce operating expenses. As a result of this effort, the Company recorded a $3.3 million charge which included non-cash charges of $1.3 million (primarily for software development costs that do not have continuing value) and $2 million related to the consolidation of functions and facilities which consists primarily of severance and personnel-related costs. As of December 31, 1993, approximately $2 million of these costs are accrued on the Company's consolidated balance sheet as a current liability. REPORT OF INDEPENDENT AUDITORS - ------------------------------ To The Shareholders of VWR Corporation: We have audited the consolidated balance sheets of VWR Corporation as of December 31, 1993 and 1992, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also include the financial statement schedules listed in the index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates 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 VWR Corporation at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in the notes to the consolidated financial statements (postretirement benefits), in 1993, the Company changed its method of accounting for postretirement benefits other than pensions. BY (SIGNATURE) ERNST & YOUNG Philadelphia, Pennsylvania February 11, 1994 ITEM 9.

788043

1993

Item 6. Selected Financial Data The following table sets forth selected financial data of the Company and should be read in conjunction with the consolidated financial statements which begin on page. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations In 1993, domestic revenues from commissions and fees increased 9 percent. The effect of acquisitions, net of divestitures, accounted for a 4 percent increase. The remaining 5 percent increase was due to net new business gains and higher spending from existing clients. Domestic revenues increased 2 percent in both 1992 and 1991, primarily as a result of net new business gains and higher spending from existing clients. In 1993, international revenues increased 10 percent. The effect of the acquisition of TBWA International B.V. and several marketing services companies in the United Kingdom, net of divestitures, accounted for an 18 percent increase in international revenues. The strengthening of the U.S. dollar against several major international currencies relevant to the Company's non-U.S. operations decreased revenues by 12 percent. The increase in revenues, due to net new business gains and higher spending from existing clients, was 4 percent. In 1992, international revenues increased 25 percent, of which the effect of the acquisition of McKim Baker Lovick BBDO in Canada and the purchase of additional shares in several companies which were previously affiliates of the Company accounted for 14 percent. The remaining increase was due to net new business gains and higher spending from existing clients. The fourth quarter strengthening of the U.S. dollar did not significantly impact the revenues for the year. In 1991, international revenues increased 9 percent, of which the effect of the acquisition of Valin Pollen in the United Kingdom, the purchase of additional shares in several companies which were previously affiliates of the Company, offset by the merger of BBDO's agency in the United Kingdom into Abbott Mead Vickers. BBDO Ltd., accounted for 4 percent. The strengthening of the U.S. dollar decreased international revenues by 3 percent in 1991. The remaining increase was due to net new business gains and higher spending from existing clients. In 1993, worldwide operating expenses increased 9 percent. Acquisitions, net of divestitures during the year, accounted for a 12 percent increase in worldwide operating expenses. The strengthening of the U.S. dollar against several international currencies decreased worldwide operating expenses by 6 percent. The remaining increase was caused by normal salary increases and growth in out-of-pocket expenditures to service the increased revenue base. Net foreign exchange gains did not significantly impact operating expenses for the year. In 1992, worldwide operating expenses, before the special charge, increased 12 percent. Acquisitions, net of divestitures during the year, accounted for 5 percent of the increase. The remaining increase was caused by normal salary increases and growth in out-of-pocket expenditures to service the increased revenue base. Foreign exchange gains did not significantly impact total operating expenses for the year. The ratio of worldwide operating expenses, before the special charge, as a percent of commissions and fees improved slightly over 1991. In 1991, worldwide operating expenses, increased 5 percent over 1990 levels. The ratio of worldwide operating expenses, excluding non-recurring items, as a percent of commissions and fees did not change significantly in 1991. Foreign exchange gains were comparable to those reported in 1990. Gains, net of losses, from the sales of equity interests in certain companies, together with other non-recurring items did not have a significant effect on the 1991 results. Interest expense in 1993 is comparable to 1992. Interest and dividend income decreased in 1993 by $2.2 million. This decrease was primarily due to lower average amounts of cash and marketable securities invested during the year and lower average interest rates on amounts invested. Interest expense in 1992 is comparable to 1991. Interest and dividend income decreased by $1.4 million in 1992. This decrease was primarily due to lower average funds available for investment during the year and declining interest rates in certain countries. Interest expense increased in 1991 by $1.3 million. Interest and dividend income increased by $2.8 million in 1991. This increase was primarily due to an increase of funds available for investment overseas in markets where interest rates were generally above those in the United States. In 1993, the effective tax rate decreased to 42.0%. This decrease primarily reflects a lower international effective tax rate caused by fewer international operating losses with no associated tax benefit, partially offset by an increased domestic federal tax rate. In 1992, the effective tax rate of 43.6% was comparable to the 1991 effective tax rate of 44%. In 1993, consolidated net income increased 23 percent. This increase is the result of revenue growth, margin improvement, an increase in equity income and a decrease in minority interest expense. Operating margin increased to 11.2 percent in 1993 from 11.1 percent in 1992. This increase was the result of greater growth in commission and fee revenue than the growth in operating expenses. The increase in equity income is the result of improved net income at companies which are less than 50 percent owned. The decrease in minority interest expense is primarily due to the acquisition of certain minority interests in 1993 and lower earnings by companies in which minority interests exist. In 1993, the incremental impact of acquisitions, net of divestitures, accounted for 1 percent of the increase in consolidated net income, while the strengthening of the U.S. dollar against several international currencies decreased consolidated net income by 6 percent. Consolidated net income increased 21 percent in 1992. This increase is a result of revenue growth and margin improvement. Operating margin, before the first quarter special charge discussed below, increased to 11.1 percent in 1992 from 10.9 percent in 1991. This increase was the result of greater growth in commissions and fees than the growth in operating expenses. In 1992, the incremental impact of acquisitions, net of divestitures, accounted for 6 percent of the increase in consolidated net income. Consolidated net income increased 10 percent in 1991. This increase is a result of revenue growth, margin improvement, lower net interest costs and a reduction in the effective tax rate. Operating margin, which excludes net interest expense, increased to 10.9 percent in 1991 from 10.8 percent in 1990, reflecting the greater growth of commissions and fees as compared to operating expenses. The reduction in net interest expense also contributed to an increase in the Net Income Before Tax margin from 8.7 percent to 9.1 percent. The impact of net non-recurring items in 1991 did not contribute towards net income growth. In 1991, the incremental effect of acquisitions net of dispositions had an adverse effect of 5 percent on net income. At December 31, 1993, accounts payable increased by $131.3 million from December 31, 1992. This increase was primarily due to an increased volume of activity resulting from business growth and acquisitions during the year and differences in the dates on which payments to media and other suppliers became due in 1993 compared to 1992. In 1992, the Company adopted two new accounting principles which had a net favorable cumulative after tax effect of $3.8 million. At the same time, the Company recorded a special charge to provide for future losses related to certain leased property. The combination of the favorable impact of the adoption of the new accounting principles and the after tax impact of the special charge had no effect on 1992 consolidated net income. Effective January 1, 1994, the Company will adopt Statement of Financial Accounting Standards No. 112 "Employers' Accounting for Postemployment Benefits" ("SFAS No. 112"). The Company estimates that the adoption of SFAS No. 112 will result in an unfavorable after tax effect on net income of approximately $27 million. The current economic conditions in the Company's major markets would indicate varying growth rates in advertising expenditures in 1994. The Company anticipates slow growth rates in certain European economies and improved growth rates in the United States, the United Kingdom and Australia. However, the Company believes that it is properly positioned should the anticipated improved growth rates not occur. Capital Resources and Liquidity Cash and cash equivalents increased $62 million during 1993 to $175 million at December 31, 1993. The Company's positive net cash flow provided by operating activities was enhanced by an improvement in the relationship between the collection of accounts receivable and the payment of obligations to media and other suppliers. After annual cash outlays for dividends paid to shareholders and minority interests and the repurchase of the Company's common stock for employee programs, the balance of the cash flow was used to fund acquisitions, make capital expenditures, repay debt obligations and invest in marketable securities. Cash was also raised from the issuance of $144 million of 4.5%/6.25% Step-Up Convertible Subordinated Debentures due 2000, the net proceeds of which were used for general corporate purposes, including, to reduce borrowings under the Company's commercial paper program. On August 9, 1993, the Company issued a Notice of Redemption for the outstanding $85 million of its 7% Convertible Subordinated Debentures due 2013. Prior to the October 8, 1993 redemption date, debenture holders elected to convert all of their outstanding debentures into common stock of the Company at a conversion price of $25.75 per common share. The Company maintains relationships with a number of banks worldwide, which have extended unsecured committed lines of credit in amounts sufficient to meet the Company's cash needs. At December 31, 1993, the Company had $359 million in committed lines of credit, comprised of a $200 million, two and one-half year revolving credit agreement and $159 million in unsecured credit lines, principally outside of the United States. Of the $359 million in committed lines, $27 million were used at December 31, 1993. Management believes the aggregate lines of credit available to the Company are adequate to support its short-term cash requirements for dividends, capital expenditures and maintenance of working capital. The Company anticipates that the year end cash position, together with the future cash flows from operations and funds available under existing credit facilities will be adequate to meet its long-term cash requirements as presently contemplated. Item 8.

29989

1993

Item 6 - Selected Financial Data Citizens responds to this item by incorporating by reference the material under the caption "Comparison of Selected Data" on pages 34 and 35 of Citizens' 1993 Annual Report to Shareholders. Item 7

Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations Citizens responds to this item by incorporating by reference the material under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 24 through 33 of Citizens' 1993 Annual Report to Shareholders. Item 8

702163

1993

Item 6. Selected Financial Data The information required under this item is contained in the 1993 Annual Report under the heading "Selected Financial Data" on pages 18 and 19 and is incorporated by reference herein. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information required under this item is contained in the 1993 Annual Report under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition" on pages 18 through 21 and is incorporated by reference herein. Item 8.

75252

1993

65660

1993

ITEM 6. SELECTED FINANCIAL DATA Incorporated by reference from page 13 of the 1993 Annual Report. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference from the 1993 Annual Report, pages 14 through 17. ITEM 8.

108721

1993

37748

1993

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDI- TION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations presented below relates to the Consoli- dated Financial Statements of USAir Group, Inc. ("USAir Group" or the "Company") presented in Item 8A. Consolidated Financial Statements for USAir, Inc. ("USAir"), the Company's principal subsidiary, are presented in Item 8B. USAir's operating revenue accounted for more than 93% of the Company's operating revenue in each of the last three years. USAir Group also owns three commuter airline subsidiaries, which accounted for more than 5% of the Company's operating revenue in each of the last three years. Therefore, the following discussion and analysis of results of operations relates principally to the operations of USAir and to the airline industry. The following general factors are among those that influence USAir's financial results and its future prospects: 1. General economic conditions and industry capacity. 2. A decline in the proportion of passengers paying higher yield "business fares" to passengers paying lower yield fares. 3. The emergence and growth of low cost, low fare airlines and USAir's high cost structure. 4. The trend toward globalization in the airline industry and related regulatory limitations. These and other factors are discussed in the following sections. General Economic Conditions and Industry Capacity Historically, demand for air transportation has tended to mirror general economic conditions. Economic conditions in the United States and fare competition in the domestic airline industry continued to be major factors affecting the financial condition of USAir and the airline industry in 1993. In recent years, the change in industry capacity has failed to mirror the reduction in demand for domestic air transportation due primarily to continued delivery of new aircraft and, secondarily, to the operation of certain major U.S. carriers under the protection of Chapter 11 of the Bankruptcy Code for extended periods. While industry capacity has leveled off and the general economy has shown signs of improvement, the Company expects that the airline industry will remain extremely competitive for the foreseeable future. See the discussion of low cost, low fare airlines below. During the recent economic recession, some observers of the travel industry speculated that the business traveler became less reliant on air transportation as teleconferencing, telecopying and other technological developments gained wider acceptance. In addition, some observers have speculated that corporate restructur- ing and furloughs in the U.S. have reduced the number of business travelers and that the leisure traveler has become conditioned to waiting for promotional fares before making travel plans. The Company is unable to determine whether these structural changes have occurred in the air transportation market or if these changes have occurred, how long-lived these trends will be. However, the Company believes that for the foreseeable future the demand for higher yield "business fares" will remain essentially flat and relatively inelastic while the lower yield "leisure" market will continue to grow with the general economy. This trend could make it more difficult for the domestic airlines, including USAir, to sustain meaningful yield increases in the future. Financial circumstances have compelled certain bankrupt or financially weakened carriers to sell assets, including foreign routes, gates and take-off and landing slots at capacity con- strained airports. Proceeds from asset sales provide cash infusions to weaker carriers, but also augment the route systems and market presence of the stronger carriers. Although USAir has completed route and other asset purchases from a number of weaker carriers, the purchases illustrate a trend of consolidation of strategic assets and financial strength within the industry which appears to benefit the three largest U.S. carriers in the long- term. In the short-term, however, these carriers have suffered from the cost of integrating these assets into their systems and from the incremental capacity which has been exacerbated by declines in passenger travel and fare wars. As a result, these carriers have taken or announced actions including reduction in workforce and salary and other employee benefits, concessions from unionized employees, deferral of new aircraft deliveries, early retirement of inefficient aircraft types, and termination of unprofitable service. USAir implemented similar measures during 1990-1993, including a workforce reduction of 2,500 full-time positions between November 1993 and the first quarter of 1994, which, along with other measures, is expected to save the Company approximately $200 million in 1994. USAir will pursue additional measures in 1994 to reduce further its operating costs. See Item 1. "Business - Significant Impact of Low Cost, Low Fare Competi- tion" and "-British Airways Announcement Regarding Additional Investment in the Company; Code Sharing." In 1993, USAir reached an agreement with the Boeing Company ("Boeing") to, among other things, exercise options to purchase additional B757-200 aircraft on an accelerated basis and to cancel and reschedule the delivery of certain Boeing 737 aircraft on order into the future. This agreement reduced USAir's capital expendi tures by more than $880 million between 1993 and 1996. USAir is currently in negotiations with Boeing regarding, among other things, the current schedule of new aircraft deliveries. Each major airline has developed a frequent traveler program that offers its passengers incentives to maximize travel on that particular carrier. Participants in such programs typically earn "mileage credits" for every trip they fly that can be redeemed for airline travel or, in some cases, for other benefits. Under USAir's Frequent Traveler Program ("FTP"), participants receive mileage credits equal to the greater of actual miles flown or 750 miles for each paid flight on USAir or USAir Express, or actual miles flown on one of USAir's FTP airline partners. Participants flying on first or business class tickets receive additional credits. Participants may also earn mileage credits by staying at participating hotels or by renting cars from participating car rental companies within 24 hours of a flight. Mileage credits can be redeemed for certificates for various travel awards, including fare discounts, first class upgrades and tickets on USAir or other airlines participating in USAir's FTP. Certain awards also include hotel and car rental awards. Award certificates may not be brokered, bartered or sold, and have no cash value. USAir and its airline partners limit the number of seats allocated per flight for award recipients. The number of seats varies depending upon flight, day, season and destination. Award travel is not permitted on blackout dates, which generally correspond to certain holiday periods in the United States or peak travel dates to foreign destinations. Hotel awards are valid at participating hotels and are subject to room availability, which is limited. Car rental awards are valid only at participating locations. The number of cars available for award usage is limited, and no cars are available for award usage on blackout dates. USAir reserves the right to terminate the FTP or portions of the program at any time, and the FTP's official rules, partners, special offers, blackout dates, awards and mileage levels are subject to change with or without prior notice. USAir accounts for its FTP under the incremental cost method, whereby travel awards are valued at the incremental cost of carrying one additional passenger. Such costs are accrued when FTP participants accumulate sufficient miles to be entitled to claim award certificates. No value is assigned to airline, hotel or car rental award certificates that are to be honored by other parties. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, liability insurance and denied boarding compensation expenses expected to be incurred on a per passenger basis. No profit or overhead margin is included in the accrual for incremental costs. FTP participants had accumulated mileage credits for approxi- mately 3,896,000 awards (at the 20,000 mile level required for a free domestic flight on USAir) at December 31, 1993, compared with 3,199,000 awards at December 31, 1992. However, because USAir expects that some award certificates will be redeemed by other airlines participating in USAir's FTP, that some certificates will expire, and that some accumulated mileage credits will never be applied towards award certificates, the calculations of the accrued liability for incremental costs at December 31, 1993 and 1992 were based on approximately 88% and 86%, respectively, of the accumulat- ed credits. Mileage for FTP participants who have accumulated less than the minimum number of mileage credits necessary to claim an award is excluded from the calculation of the accrual. Most participants belong to more than one frequent traveler program and it is not possible to project when or if participants will accrue additional mileage credits required to earn an award. Incremental changes in the liability resulting from additional mileage credits are recorded as part of the regular review process. Effective January 1, 1995, USAir will increase the minimum mileage level required for a free domestic flight from 20,000 to 25,000. USAir's customers redeemed approximately 841,000, 626,000 and 654,000 awards for free travel on USAir in 1993, 1992 and 1991, respectively, representing approximately 8.0%, 4.9% and 5.3% of USAir's revenue passenger miles ("RPMs") in those years, respec- tively. During 1993, two "free ticket for segments flown" promotions were completed which increased the number of awards used for free travel on USAir. These promotions were offered in response to similar promotions offered by USAir's competitors. USAir does not believe that usage of FTP awards results in any significant displacement of revenue passengers. USAir has the ability, through its inventory management system, to identify markets and flights expected to have high load factors and, through capacity controls, to maximize use of FTP awards on flights with lower demand and available seats. Also, blackout dates forestall the usage of awards on peak travel days. Furthermore, USAir's exposure to the displacement of revenue passengers is not signifi- cant, as the number of USAir flights that depart 100% full is minimal. In the third quarter of 1993 (the third quarter being the period of the year when USAir generally experiences its highest load factor and expects the usage of FTP awards to be highest), for example, fewer than 2.2% of USAir's flights departed 100% full. During this same quarterly period, only approximately 1.9% of USAir's flights departed 100% full and also had one or more passengers on board who were traveling on FTP award tickets. Airlines often use other competitive promotions, such as offering extra credits or reduced award thresholds under certain conditions, as incentives to stimulate travel. USAir reviews these promotions to determine the proper accounting treatment for each one. To the extent these promotions are determined to be an integral part of the FTP, they are accounted for in the same manner as free travel earned through mileage credits. Low Cost, Low Fare Competition In September 1993, Southwest Airlines, Inc. ("Southwest"), a low cost, low fare, "no frills" air carrier which had not previous- ly provided service to or in the eastern U.S., inaugurated service to Chicago and Cleveland from Baltimore/ Washington International Airport ("BWI") at fares substantially below those previously offered by USAir and other airlines in the same markets. BWI is one of USAir's hub airports. Unlike the other major U.S. air carriers, Southwest does not structure its operations around connecting hub airports, relying instead on high frequency point- to-point service. USAir responded by matching most of Southwest's fares and increasing the frequency of service in related markets. On March 22, 1994, Southwest announced that on May 26, 1994, and June 6, 1994, it will expand service between BWI and Chicago. Southwest also announced that on May 26, 1994, it will initiate its low fare service between BWI and St. Louis, and on July 8, 1994, between BWI and Birmingham, Alabama and Louisville, Kentucky. At this time, USAir has not determined its response to the Southwest announcement. In October 1993, Continental Airlines ("Continental"), which had reorganized under bankruptcy proceedings earlier in 1993, inaugurated low fare service on certain routes in the eastern U.S. USAir is a competitor in most of the markets served by these routes. While Continental initiated service to certain cities, such as Charleston, South Carolina; Greensboro, North Carolina; and Jacksonville, Florida; most of the markets included as part of its new program (for example, Baltimore) were previously served by Continental through its hubs at Newark, Cleveland, and Houston. However, under its new program, Continental linked certain of these cities independently of its hubs while continuing to provide many of the same services that are available on its hub flights, including advance seat assignment, frequent traveler mileage credits and interline connections. Under its new program, Continental served approximately 80 city pair markets, from which USAir has historically realized approximately 4% of its total passenger revenue. When Continental started the new program it was uncertain whether the program was an experiment or a beachhead from which Continental planned to expand further. USAir, therefore, made a measured response by matching most of the low fares offered by Continental. On January 31, 1994, Continental increased its competitive threat. It announced that by March 9, 1994, it would expand the low fare program to approximately 356 city pair markets, most of which USAir served and from which USAir has historically realized approximately 8% of its passenger revenue. Moreover, if secondary markets within a 90-mile radius, or a reasonable driving distance, were viewed as being included in Continental's new program, markets from which USAir has historically realized approximately 36% of its passenger revenue were affected. Contemporaneously, Continental announced that it would substantially reduce service at its Denver hub and redeploy significant aircraft and personnel resources to the eastern U.S. Although Continental's balance sheet continues to have significant leverage following its bankruptcy reorganization, its liquidity position improved substantially as a result of equity and debt infusions completed as part of that reorganization. Moreover, Continental completed a common stock offering in December 1993, which may indicate the market's receptivity to its efforts to raise additional funds. Continental has operating (including labor) costs that are substantially lower than those of USAir and the other major air carriers. On February 8, 1994, in response to the expansion of Continen- tal and to avoid loss of market share in the eastern U.S., USAir lowered in primary and secondary markets affected by the Continen- tal expansion, by as much as 50%, the fares most commonly used by business travelers on many east coast routes. In addition, USAir lowered leisure fares by as much as 70% in the same markets. In many of the markets, free companion fares are available with business fares. These reduced fares have no expiration date. However, USAir could adjust the fares at some time in the future. Increases in traffic which are stimulated by the lower fares offered by Southwest, Continental and USAir will not offset USAir's reduced revenue resulting from lower yields in these markets. USAir believes that Southwest, Continental or other low cost carriers with a significant cost advantage over USAir likely will expand their operations to additional markets. For example, in December 1993, Southwest completed its acquisition of Morris Air, a regional air carrier with operations concentrated in the western U.S. This acquisition could enable Southwest to divert resources to expand its operations in the eastern U.S. Furthermore, media reports indicate that Southwest has entered into a long-term agreement for the use of four additional gates at BWI, where it currently operates from two gates. On March 4, 1994, Continental further escalated prospective competition by announcing that it will further reduce operations at its Denver, Colorado hub and establish a flight crew base at Greensboro, North Carolina. These measures are likely to increase losses at USAir because they could enable Continental, which has significantly lower costs than USAir, to expand further its high frequency, low fare service described above in additional short-haul markets served by USAir with substantial detriment to USAir. In addition, other low cost carriers may enter other USAir markets. For example, America West announced on February 15, 1994 that it will commence service on April 18, 1994 between Columbus, Ohio where it operates a hub and Philadelphia, where USAir has a hub operation. Other carriers, including some of the larger carriers, have also indicated their intent to develop similar low-fare short-haul service. Unless USAir is able to reduce its operating costs, present and increasing competition from low cost, low fare airlines in USAir's markets could have a material adverse impact on USAir's cash position and therefore, its ability to sustain operations. In March 1994, USAir announced that it had initiated discussions with the leadership of its unionized employees regarding wage reduc- tions, improved productivity and other cost savings. The outcome of these negotiations is uncertain, but if timely agreements are not reached, the Company may seek other restructuring alternatives. See Item 1. "Business - Significant Impact of Low Fare, Low Cost Competition". In 1993, Northwest Airlines, Inc. ("Northwest") and Trans World Airlines, Inc. ("TWA") sought and obtained from unionized employees substantial concessions and productivity improvements. In exchange, these employees have received ownership interests in those companies. In December 1993, United Airlines, Inc. ("Unit- ed") announced that it had reached agreement with two of its unions to trade concessions for a substantial ownership stake by all employees, subject to approval by United's stockholders. The memberships of these two unions have ratified the agreement. The stated intent and purpose of these labor concessions are to enable these carriers to lower their operating costs. At this time, it is uncertain whether the United transaction will be consummated and whether these events constitute isolated incidents or a trend of employee ownership in the airline industry. As an airline with relatively high labor costs and a route system with a significant percentage of short-haul flying, USAir is considering additional ways to reduce these costs which could involve an exchange of employee concessions for an ownership interest in the Company. USAir is currently engaged in discussions with the leaders of its unionized employees regarding efforts to reduce costs, including reductions in wages, improvements in productivity and other cost savings. The outcome of these discussions is uncertain. See Item 1. "Business - Significant Impact of Low Fare, Low Cost Competi- tion." USAir has been examining various ways to restructure its operations to increase efficiency and lower unit costs in markets of approximately 500 miles or less in distance. Certain carriers, such as Southwest and Continental, have a substantial cost advantage over USAir in these short-haul markets. In addition, consumers appear to be increasingly price conscious, particularly for short distance flights. In February 1994, USAir implemented the first phase of the introduction of a new short-haul product in 18 city-pair markets of approximately 500 miles or less, resulting in increased utilization and productivity of aircraft, personnel, and ground facilities in these markets by decreasing the amount of time that aircraft spend on the ground between flights from an average of 45 minutes to approximately 25 minutes. Initiation of the first phase of this service did not involve any immediate pricing changes or new personnel. Ultimately, USAir anticipates that enhancements to the short-haul product will be completed in summer 1994, and that long-haul and transatlantic service will be redesigned later in 1994. USAir plans to expand this higher frequency service to additional short-haul and other markets in July 1994, with a total fleet of approximately 100 aircraft. Although USAir expects this higher frequency operation will result in reduced unit costs in relevant markets, certain variable costs generally associated with providing the incremental flights, including jet fuel, landing fees and labor, will increase. There can be no assurance, therefore, that the changes will result in improved financial results for USAir. If USAir cannot find ways to compete effectively with low cost carriers by lowering its operating costs, and to generate sufficient additional passengers to offset the effect of sharply reduced fares, USAir's revenue and results of operations will continue to be materially and adversely affected. Industry Globalization and Regulation The trend toward globalization of the airline industry has accelerated in recent years as the three largest U.S. carriers have initiated foreign service and purchased the foreign routes of financially distressed or bankrupt U.S. carriers. In addition, certain foreign carriers have made substantial investments in U.S. carriers which have frequently been tied to marketing alliances or, less frequently, reciprocal investments by the U.S. carrier in its foreign partner. In August 1993, Continental announced that it had reached agreement with Air France on a joint marketing agreement. Earlier in the year, Air Canada made a substantial equity invest- ment in Continental in connection with Continental's bankruptcy reorganization. In October 1993, United and Lufthansa German Airlines announced that they had reached an agreement to implement code sharing to link some of their flights. Continuing privatiza- tion of sovereign carriers and foreign airline deregulation may encourage further foreign investment. Foreign investment in U.S. air carriers is restricted by statute and may be subject to review by the U.S. Department of Transportation ("DOT") and, on antitrust grounds, by the U.S. Department of Justice ("DOJ"). On January 21, 1993, USAir Group and British Airways Plc ("BA") entered into an Investment Agreement ("Investment Agree- ment") under which a wholly-owned subsidiary of BA has purchased certain preferred stock of the Company for $400.7 million. On March 7, 1994, BA announced that it would not make any additional investments in the Company under current circumstances. See "Liquidity and Capital Resources" and Item 1. "Business - British Airways Announcement Regarding Additional Investments in the Company; Code Sharing" and "- British Airways Investment Agreement" for additional information related to the investment. Under the Investment Agreement, USAir and BA have entered into a code sharing arrangement under which certain domestic USAir flights, connecting to certain BA transatlantic flights, may be listed on computerized reservation systems either under USAir's or BA's two letter designation code, subject to authorization by the DOT. As of March 1, 1994, USAir and BA offered code share service to and from 34 of the 65 airports authorized by the DOT. On March 17, 1994, the DOT issued an order renewing for one year the existing code sharing authority. In January 1994, USAir and BA filed applica- tions with the DOT to code share to 65 additional domestic and seven additional foreign destinations. The DOT did not act on these applications in its March 17, 1994 order. See Item 1. "Business - British Airways Announcement Regarding Additional Investments in the Company; Code Sharing" and "-British Airways Investment Agreement". USAir and BA are in the process of expanding their code sharing arrangement. USAir believes that it will have greater access to international traffic and that its and BA's customers will benefit from better on-line connections as well as coordinated check-in and baggage checking procedures. USAir also believes that the code sharing arrangement will generate increased revenues, the magnitude of which cannot be reasonably estimated at this time. The DOT may continue to link further renewals of the code share authorization to the United Kingdom's ("U.K.") liberalization of U.S. air carrier access to the U.K. markets. However, the code sharing arrangement is expressly permitted under the bilateral air services agreement between the U.S. and U.K. USAir expects that the authorization will be renewed in the future; however, there can be no assurance that this will occur. USAir does not believe that the DOT's failure to renew the code share authorization or grant the pending application would result in a material adverse change in its financial condition. However, further investment in the Company by BA, as contemplated in the Investment Agreement, may be less likely. See Item 1. "Business - British Airways Announcement Regarding Additional Investments in the Company; Code Sharing" and "-British Airways Investment Agreement." Current U.S. law provides that foreign ownership or control of the voting interest in a certificated U.S. air carrier may not exceed 25%, non-U.S. citizens may not constitute more than a third of the board of directors and managing officers of the air carrier and the president of the air carrier must be a U.S. citizen. Over the years in the context of "fitness" reviews to determine whether air carriers could be issued, or continue to hold, operating certificates, the DOT has also issued interpretations regarding whether investments by, or other arrangements with, foreign investors constitute de facto control over a U.S. air carrier. Although the Company believes the policy has no basis in law, recently and particularly during 1992 and 1993, the DOT has linked its review of foreign investment in, and foreign alliances with, U.S. air carriers to the status of the bilateral air transportation treaty between the U.S. and the country of origin of the foreign airline. The willingness of the DOT to allow proposed foreign investments, alliances and participation in corporate governance has been linked to its perception of the liberality of the relevant treaty with respect to the right of U.S. air carriers to operate to, from and beyond the foreign country. For example, the Netherlands entered into a new bilateral treaty with the U.S. in 1992 which permitted "open skies", or unrestricted access to the Netherlands by U.S. air carriers. As a result, in 1992 the DOT approved Northwest's proposal to integrate its operations with those of KLM Royal Dutch Airlines, an airline based in that nation. However, the DOT has refused to allow USAir and BA to proceed with the second and third phases of their Investment Agreement, which calls for an additional investment of $450 million by BA, unless and until the U.K. government agrees to amend its bilateral air services agreement with the U.S. to permit new services by U.S. carriers to the U.K. and particularly to London's Heathrow Airport. The U.S. and U.K. governments held several negotiating sessions during the past year and have exchanged proposals to amend the bilateral agreement, but to date the two governments have failed to resolve their differences. As a result, USAir and BA were unable to proceed with the second and third phases of the Investment Agreement in 1993. In any event, on March 7, 1994, BA announced that it would not make any additional investments in the Company under current circumstances. See Item 1. "Business - British Airways Announcement Regarding Additional Investment in the Company; Code Sharing" and "-British Airways Investment Agreement." The National Commission to Ensure a Strong Competitive Airline Industry ("Airline Commission") issued its report in August 1993. The Airline Commission was a presidentially-appointed committee with the task of analyzing the condition of the U.S. airline industry and reporting to the Clinton Administration its findings and recommendations. Among other things, the Airline Commission recommended that: (i) the air traffic control system be modernized and the Federal Aviation Administration's ("FAA") air traffic control functions be performed by an independent federal corpora- tion; (ii) the federal regulatory burden be reduced; (iii) the airlines be granted certain tax relief; and (iv) the bankruptcy process be shortened. The Airline Commission also favored raising the statutory limit on foreign ownership of voting securities in the U.S. airlines to 49 percent under certain circumstances. It further urged that the current international system of bilateral agreements be replaced with multilateral arrangements. In addition, the Airline Commission recommended that the DOT review the airlines' business, capital or financial plans with the assistance of a presidentially-appointed advisory committee and, if an airline repeatedly failed to heed warnings or concerns of the DOT Secretary, the DOT could "exercise its existing authority", among other things, to revoke an airline's operating certificate. In January 1994, the Clinton Administration issued a report which described its program to implement certain of the Airline Commission's recommendations. Among other things, the Administra- tion stated that it supported the recommendation described above regarding the FAA, supported increasing to 49 percent the foreign ownership restrictions provided there are reciprocal opportunities for U.S. airlines and investors abroad, and opposed the recommenda- tions regarding tax relief and the appointment of the advisory committee discussed above. At this time, it is impossible to predict whether any of the Airline Commission's recommendations will be enacted and, if enacted, their effect on USAir. It is also difficult to anticipate whether the Congress will act in the near term on any of the proposals requiring legislation. As part of its initiative in the transportation industry, the Clinton Administration also indicated that the DOT has begun a comprehensive examination of the "high density rule" which limits airline operations at Chicago O'Hare, New York's LaGuardia ("LaGuardia") and John F. Kennedy International, and Washington National ("National") Airports by restricting the number of takeoff and landing slots. As part of its study, the DOT will determine whether the operating limitations imposed by the rule can be eliminated or modified to better utilize available capacity at these airports. USAir holds a substantial number of slots at LaGuardia and National, including those assigned a value when the Company acquired Piedmont Aviation, Inc. Any DOT action which would eliminate those slots or compel USAir to transfer those slots could have a material adverse effect on USAir's operations and financial position. Revision of the high density rule at National, however, would require legislation by the Congress. The DOT has indicated that it expects to complete its study by late 1994. RESULTS OF OPERATIONS 1993 Compared with 1992 The Company recorded a net loss of $393.1 million on revenue of $7.1 billion, in 1993 compared with the 1992 net loss of $1.2 billion on revenue of $6.7 billion. Several non-recurring items, which include the cumulative effect of accounting changes, make it difficult to compare these results. After excluding the effect of certain non-recurring items discussed below, which amount to $153.2 million and $759.3 million in 1993 and 1992, respectively, the net loss would have been $239.9 million in 1993 ($5.69 per common share after preferred dividend requirement) compared with a loss of $469.6 million in 1992 ($11.09 per common share after preferred dividend requirement). The Company's 1993 financial results contain $153.2 million of non-recurring items, including (i) $68.8 million for severance, early retirement and other personnel-related expenses recorded in connection with a workforce reduction of approximately 2,500 full- time positions between November 1993 and the first half of 1994; (ii) $43.7 million for the cumulative effect of an accounting change, as required by Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" ("FAS 112"), which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (iii) $36.8 million based on a projection of the repayment of certain employee pay reductions; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reservations system; and (vi) an $18.4 million credit related to non-operating aircraft. The Company's 1992 financial results contain $759.3 million of non-recurring items, including (i) $628.1 million for the cumula- tive effect of an accounting change, as required by Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"); (ii) $107.4 million related to aircraft which have been withdrawn from service; (iii) $34.1 million loss related to the sale of ten McDonnell Douglas 82 ("MD-82") aircraft which USAir had on order but eliminated from its fleet plan; and (iv) $10.3 million gain resulting from the sale of three of the Company's subsidiaries during 1992. Operating Revenue - The Company's Passenger Transportation Revenue increased by $356.5 million (5.8%) in 1993 compared with 1992, primarily due to the $296.0 million (5.1%) increase at USAir. USAir's capacity, as measured by available seat miles ("ASM" - one ASM is equal to one seat flown one mile), decreased by 0.3% in 1993 compared with 1992, its passenger revenue per ASM increased by 5.4% to 10.22 cents and its passenger load factor, a measure of capacity utilization, increased by 0.4 points to 59.2%. The increase in passenger revenue per ASM is largely attributed to the lower level of discounting in 1993 versus 1992. The Company expects that it will experience a 1 - 2% increase in ASMs (including the effect of weather-related cancellations) in 1994 compared with 1993. Continued fare discounting and low fares offered by USAir to compete with low cost, low fare carriers discussed above, are expected to have a negative impact on the Company's passenger revenue. It is not expected that the resulting decrease in revenue per ASM will be totally offset by additional passengers. The severe winter weather conditions in the U.S. during the early part of 1994 have caused a reduction in revenue which the Company estimates at approximately $50 million. In March 1993, USAir and five other U.S. air carriers entered into a settlement in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir has estimated that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. See Note 4 to the Company's Consolidated Financial Statements for additional information. The Company's Other Revenue increased by $38.8 million (12.3%) in 1993. USAir's increase of $90.5 million (32.3%) was partially offset at the Company level by a decrease in non-airline subsidiary revenue resulting from the sale of three wholly-owned subsidiaries in July 1992. USAir's 32.3% improvement resulted from increased passenger cancellation and rebooking fees, frequent traveler participation fees, and various other sources. Expense - The Company's total operating expenses increased $141.7 million (2.0%) in 1993 compared with 1992. The Company's Personnel Costs increased by $217.7 million (8.3%), $205.6 million of which is attributable to USAir. USAir's increase includes (i) $65.6 million of the $68.8 million non-recurring charge related to a workforce reduction of 2,500 full-time positions; and (ii) the $36.8 million charge based on an estimate of the repayment of certain employee pay reductions, both discussed above. Without the effect of these non-recurring charges, USAir experienced an increase in employee salaries of $91.4 million (4.7%) and an increase in employee benefits of $11.8 million (2.1%). The increase in employee salaries is generally due to contractual and general salary increases which occurred during 1993. The amount saved as a result of the 12-month salary reduction program was approximately the same in 1993 and 1992. USAir expects that due to scheduled contractual increases and the effect of the expiration of the 12-month salary reduction program, employee salaries will increase in 1994 to the extent that the reduction of 2,500 full- time positions and any other possible measures do not offset the increases. See Item 1. "Business - Significant Impact of Low Fare, Low Cost Competition" and "- Employees" for information related to the possible unionization of additional employee groups. The $11.8 million increase in employee benefits is the result of increased pension expense, offset partially by a decrease in other postretir- ement benefit expense. The increased pension expense in 1993 resulted from the establishment of a defined contribution pension plan for USAir's non-contract employees on January 1, 1993. The defined benefit plan for these employees was frozen at December 31, 1991. Because of the interest rates on long-term, high quality corporate bonds which prevailed at December 31, 1993, the Company has lowered its discount rate used to calculate the actuarial present value of its pension and postretirement obligations. This action will cause an increase in the Company's pension and other postretirement benefits expense in 1994 of approximately $70 million over 1993. See Note 11 to the Company's Consolidated Financial Statements. The Company's Aviation Fuel Expense decreased $43.2 million (5.7%) as a result of a lower cost per gallon and decreased consumption. In early August 1993, the Clinton Administration's budget package was enacted. The budget package included a 4.3 cent per gallon tax on transportation fuels beginning October 1, 1993. The airline industry is exempt from the tax until October 1, 1995. See Item 1. "Business - Jet Fuel" and Note 1 to the Company's Consolidated Financial Statements. Commissions increased by $27.2 million (4.8%) as a result of the 5.8% increase in Passenger Transportation Revenue. The Company's Other Rent and Landing Fees increased $64.3 million (15.8%) primarily due to an increase in USAir's facility rental expense following the opening of the new terminal at Pittsburgh in October 1992, and the $8.9 million of non-recurring expense recorded for certain airport facilities, discussed above. The Company's Aircraft Rent Expense included a $72.4 million non- recurring charge in 1992 (part of the $107.4 million discussed above). Without this charge, aircraft rent expense increased $15.0 million (3.3%) due to the addition of new leased aircraft in 1993. Excluding the effect of non-recurring items in 1992 and 1993, Aircraft Maintenance Expense increased by $37.6 million (10.6%) resulting from the timing of aircraft maintenance cycles. Other Operating Expense decreased by $58.0 million (4.0%), reflecting a $25.0 million (1.8%) decrease at USAir and a $58.4 million decrease which resulted from the sale of three wholly-owned subsidiaries in July 1992, offset by increases at the Company's other wholly-owned subsidiaries. The Company's Interest Capitalized decreased $10.0 million (36.1%) as the level of outstanding purchase deposits decreased with the delivery of new aircraft and changes in delivery sched- ules. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", ("FAS 109"). The adoption of FAS 109 resulted in no cumulative adjustment. Results for 1993 do not include any income tax credit due to the FAS 109 limitations in recognizing a current benefit for net operating losses. See Note 6 to the Company's Consolidated Financial Statements for additional information. 1992 Compared With 1991 The Company recorded a net loss of $1.2 billion on revenue of $6.7 billion in 1992, compared with the 1991 net loss of $305.3 million on revenue of $6.5 billion. Several non-recurring items, which include the cumulative effect of an accounting change, make it difficult to compare these results. In addition, the Company recorded no tax credit in 1992. After excluding the effect of certain non-recurring items which amount to a net charge of $759.3 million and a net gain of $45.9 million in 1992 and 1991, respec- tively, the pre-tax loss would have been $469.6 million in 1992 ($11.09 per common share after preferred dividend requirement) compared with a pre-tax loss of $460.7 million in 1991 ($11.01 per common share after preferred dividend requirement). This compari- son does not consider the ongoing effect to the Company's operating expenses which result from the adoption of FAS 106, the freezing of the pension plan for non-contract employees, or other changes. The Company's 1992 financial results contained $759.3 million of non-recurring items, detailed above. Operating results for 1991 included (i) $107 million pre-tax gain related to the freeze of the fully funded pension plan for USAir's non-contract employees; (ii) a $21 million pre-tax charge related to USAir's parked British Aerospace BAe-146 ("BAe-146") fleet; (iii) $21.6 million pre-tax expense related to early retirement incentives; and (iv) $18.5 million, net, in miscellaneous non-recurring charges. On October 5, 1992, the International Association of Machin- ists ("IAM"), which represents USAir's mechanics and related employees, commenced a strike against USAir. At that time, USAir implemented a reduced flight schedule equal to approximately 60% of the normal flight schedule. On October 8, 1992, USAir reached agreement with the IAM on a new collective bargaining agreement which becomes amendable in October 1995. Following ratification of the agreement by the IAM-represented employees, USAir resumed full service on October 12, 1992. USAir immediately offered various incentives including bonus frequent traveler miles and relaxed advance purchase restrictions in an effort to attract passengers following the disruption of service. The Company estimates that the IAM strike had a negative effect on results of approximately $45 million for the year. Operating Revenue - The Company's Passenger Transportation Revenue increased $164.6 million (2.7%) in 1992, reflecting a $97.9 million increase in USAir passenger transportation revenue and a $66.7 million increase in commuter airline passenger revenue. USAir's ASMs increased by 2.4% in 1992, its passenger revenue per ASM decreased by 0.7% to 9.7 cents, and its passenger load factor increased by 0.2 points to 58.8%. USAir's average 1992 passenger revenue per ASM was adversely affected by widespread fare promo- tions. The improvement in commuter airline passenger revenue is attributed to increased traffic made possible by 20.1% increase in capacity during 1992 over 1991, as measured by ASMs, at the Company's commuter airline subsidiaries. USAir's Other Revenue increased $81.3 million (40.9%) in 1992 as compared with 1991, due to increases in revenue generated by passenger cancellation and re-booking fees, fees received from commuter affiliates for handling certain of their flights, and other miscellaneous sources. Operating Expenses - The Company's Personnel Costs increased $102.5 million (4.1%) in 1992 compared with 1991, driven by USAir's increase in personnel costs of $99.7 million (4.2%). Personnel Costs are comprised of two components: (i) employee wages and salaries; and (ii) employee benefits. USAir's wage and salary expense decreased $21.9 million (1.1%) during 1992 as a result of partial-year wage concessions on the part of pilots, non-contract employees and mechanics, all of which ended in 1993. USAir's employee benefit expense increased $121.6 million (27.8%) in 1992 resulting from the adoption of FAS 106 in 1992, and the 1991 freeze of the fully-funded pension plan for non-contract employees. The 1991 pension freeze resulted in a $107 million gain. The Company estimates that USAir's pension expense was approximately $40 million lower in 1992 than would have been the case if the freeze had not occurred. Expense for postretirement medical and death benefits, calculated in accordance with FAS 106, was $114.7 million in 1992, compared with approximately $8 million cash-basis expense in 1991. USAir's medical and dental benefit expense for active employees decreased $26.7 million (14.2%) in 1992 compared with 1991 as a result of a contributory managed care program that was implemented during 1992 for most employee groups. Excluding the effects of FAS 106 and the pension freeze, USAir employee benefit expense decreased approximately $48 million, or 8.8%, in 1992 compared with 1991. The Company's Aviation Fuel Expense decreased $45.8 million (5.7%) during 1992 compared with 1991 as a result of lower cost per gallon, partially offset by an increase in consumption. The price of fuel was inflated during early 1991 as a result of the Iraqi invasion of Kuwait and ensuing Desert Storm operation in August 1990 - January 1991, and did not return to pre-invasion levels until the second quarter of 1991. Commissions increased $29.6 million (5.5%) as a result of the 2.7% increase in passenger transportation revenue and the mix of travel agency sales versus total sales. Other Rent and Landing Fees Expense for the Company increased $56.6 million (16.2%) during 1992. This increase was largely due to increased expense at LaGuardia which resulted from USAir's assumption of Continental's leasehold obligations associated with the East End Terminal there in January, 1992 and the increased operation at LaGuardia during the year using the take-off and landing slots acquired from Continental. Also contributing to the increase was the October 1992 opening of the new terminal at the Pittsburgh International Airport, USAir's largest hub. The Company's Aircraft Rent Expense increased $152.3 million (40.3%) during 1992. A charge related to USAir's grounded BAe-146 fleet accounted for $81 million of the increase. The remainder of the increase was caused by additional leased aircraft both at USAir and the commuter airline subsidiar- ies. The Company's Aircraft Maintenance Expense decreased $33.9 million (8.2%) during 1992. This decrease reflects USAir's decrease in aircraft maintenance of $43.4 million, or 12.0%, and an increase of $9.5 million at the Company's commuter airline subsidiaries during the same period. The improvement in USAir's aircraft maintenance expense is largely attributable to the grounding of its BAe-146 fleet in May 1991, the shifting of certain aircraft engine repairs in-house from outside vendors and the negotiation of a new vendor repair contract in 1991 for certain aircraft engines. The increase in maintenance expense at the commuter airline subsidiaries is due primarily to an increased fleet size in 1992. Maintenance expense for 1992 and 1991 includes charges of $25.0 million and $25.5 million, respectively, related to grounded aircraft. The Company's Other Operating Expense, Net increased $63.6 million (4.6%) in 1992 compared with 1991. Expense for 1992 includes $25 million related to an employee suggestion program which netted estimated savings of $22 million in 1992 and $110 million in 1993. The remainder of the increase is attributable to changes in various smaller expense categories. USAir Group's Interest Income decreased $8.7 million (46.9%) during 1992 due to a lower average level of short-term investments during 1992 coupled with lower interest rates in 1992. Both USAir's interest income and expense include intercompany amounts which have been eliminated in the USAir Group consolidation process. The Company's Interest Expense decreased $10.4 million (4.0%) in 1992 due to a lower average level of debt outstanding related to USAir Group's revolving bank credit agreement, partially offset by additional interest associated with higher levels of aircraft-related debt in 1992. Interest Capitalized decreased $7.8 million (21.8%) as a result of a lower level of outstanding equipment deposits coupled with a lower capitalized interest rate. The Company's Other Non-Operating Expense, Net increased $17.0 million, or 40.2%, during 1992. In 1992, this category included a gain of $10.3 million from the sale of three wholly-owned subsid- iaries and a $34.1 million loss related to the sale of ten MD-82 aircraft discussed above. In 1991, this category included a $12.5 million loss incurred in conjunction with the sale of nine Boeing B727-200 aircraft which had been previously retired from service. All of the Company's remaining available tax credit, or $117.6 million, was recognized upon the adoption of FAS 106 on January 1, 1992. The Company could not recognize any tax credit associated with the 1992 results due to limitations under Accounting Princi- ples Board Opinion No. 11. Inflation and Changing Prices Inflation and changing prices do not have a significant effect on the Company's operating revenues, operating expenses, and operating income because such revenues and expenses, other than depreciation and amortization, generally reflect current price levels. Depreciation and amortization expense is based on historical cost. For assets acquired through the purchase of Pacific Southwest Airlines, USAir's historical cost is based on fair market value of the assets on May 29, 1987. In the case of Piedmont Aviation, Inc., USAir's historical cost is based on the fair market value of the assets on November 5, 1987, reduced by the tax effect of that portion of fair market value not deductible for tax purposes in the form of depreciation and amortization. Therefore, aggregate depreciation and amortization is lower than if this expense reflected today's replacement costs for existing productive assets. In evaluating how inflation would increase depreciation expense, however, consideration should also be given to the reduction in other operating expenses, such as aircraft maintenance and aviation fuel, that would be achieved from the operating efficiencies of newer, more technologically advanced productive assets. LIQUIDITY AND CAPITAL RESOURCES Cash used by operations was $21.3 million during 1993, including a $220.0 million payment under USAir's revolving accounts receivable sale program ("Receivables Agreement"). At December 31, 1993, cash and cash equivalents totaled approximately $368.3 million, excluding $163.7 million which was deposited in trust accounts to collateralize letters of credit or workers compensation policies and classified as "Other Assets" on the Company's balance sheet. Although not currently available (see below), at Decem- ber 31, 1993, USAir Group had $300 million in commitments available for borrowing under its revolving credit agreement with a group of banks ("Credit Agreement") and no outstanding loans thereunder, and USAir had approximately $141 million of available funds under its Receivables Agreement. At February 28, 1994, cash and cash equivalents totaled approximately $363.5 million. Funds under the Credit Agreement and Receivables Agreement are not available to the Company and USAir because of violations of minimum net worth covenants in those agreements. On March 14, 1994, the Company and USAir announced that they are seeking waivers of compliance with the minimum net worth covenant and other anticipated covenant violations. There can be no assurance that the Company or USAir will be able to obtain the waivers or arrange replacement facilities. The Company and USAir are highly leveraged. In order to meet debt service, lease and other obligations and to finance daily operations, the Company and USAir require substantial liquidity and working capital. In addition, developments may occur which are beyond the control of the Company and USAir, including intensified fare wars or substantial increases in jet fuel prices, which could have a material adverse effect on the Company's prospects and financial condition. The Company and USAir have unencumbered assets, particularly if the Credit Agreement is terminated and the mortgage of aircraft equipment related thereto is released. The Company expects that it could use these unencumbered assets to raise funds to provide an infusion of liquidity. In addition, the second and third quarters of the year historically have been characterized by higher revenues and working capital than in the first and fourth quarters. Moreover, USAir is seeking in discus- sions with the leadership of its unionized employees substantial wage reductions, improved productivity and other cost savings. However, if unforeseen adverse developments occur, if the Company and USAir are unable to finance unencumbered assets, or if timely agreements with the employees are not reached, the Company and USAir may pursue other restructuring alternatives. See Item 1. "Business - Significant Impact of Low Fare, Low Cost Competition" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Low Cost, Low Fare Competi- tion." During 1993, the Company's investment in new aircraft acquisitions and purchase deposits totaled $545.3 million. USAir took delivery of 11 Boeing 757-200, one Boeing 767-200, and six MD- 82 aircraft during the year. The MD-82s were immediately sold to a third party. In addition, USAir sold two other MD-82 aircraft which had been delivered in the fourth quarter of 1992. Proceeds from the sale of the MD-82s approximated $168 million. The Company has completed financing arrangements for, including the $337.7 million issue of Pass Through Certificates ("Certificates") which USAir sold through an underwritten public offering on November 1, 1993, or internally funded, all of its 1993 aircraft expenditures. See Note 4(d) to the Company's Consolidated Financial Statements for the projected cash flows associated with aircraft orders and other contractual capital commitments. The Company has arranged committed financing for 100% of its 1994 and 1995 aircraft deliveries. On January 21, 1993, a wholly-owned subsidiary of BA purchased 30,000 shares of the 7% Series F Cumulative Convertible Senior Preferred Stock ("Series F Preferred Stock"), for $300 million. Substantially all of the $300 million received by the Company from the sale of the Series F Preferred Stock was used to pay down debt under the Company's Credit Agreement. The Series F Preferred Stock is subject to mandatory redemption on January 15, 2008. On May 4, 1993, the Company sold 11.5 million shares of $1 par value Common Stock at $20.75 per share which netted proceeds of approximately $231 million. BA partially exercised its preemptive right to maintain its proportionate ownership percentage by purchasing, on June 10, 1993, 9,919.8 shares of redeemable Series T-2 Cumulative Exchangeable Senior Preferred Stock ("Series T-2 Preferred Stock") for approximately $99.2 million. For additional information, see Note 8 to the Company's Consolidated Financial Statements. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of measures by the Company to reduce costs and improve financial results is known. On July 8, 1993, USAir sold $300 million principal amount of 10% Senior Notes due 2003 (the "10% Notes") through an underwritten public offering. The offering netted proceeds of approximately $294 million. The 10% Notes are unconditionally guaranteed by the Company. On February 2, 1994, USAir sold $175 million principal amount of 9 5/8% Senior Notes due 2001 (the "9 5/8% Notes") through an underwritten public offering. The offering netted proceeds of approximately $172 million. The 9 5/8% Notes are unconditionally guaranteed by the Company. The 9 5/8% Notes are not reflected in the Company's December 31, 1993 balance sheet because they were issued after that time. All net proceeds received by USAir or the Company from the Common Stock offering, the sale to BA of the Series T-2 Preferred Stock, the sale of the 10% Notes and 9 5/8% Notes were added to the working capital of the Company for general corporate purposes, including the possible early repayment of certain outstanding debt with high interest rates. USAir and the Company have filed with the Securities and Exchange Commission ("SEC") a shelf registration for $700 million of various debt and equity securities. Approximately $187 million of securities remain available for sale on the shelf registration following the sale of the 9 5/8% Notes and may be sold from time- to-time depending on market conditions. The Company will continue to evaluate opportunities in the financial markets. On September 29, 1993, the maximum commitment available under the Credit Agreement decreased to $300 million from $600 million in accordance with the terms of the agreement. The Credit Agreement is due to expire on September 30, 1994. In September 1993, USAir Group obtained a waiver of compliance with the coverage ratio test required to be maintained as part of the Credit Agreement, for the period July 1 through September 30, 1993. Without this waiver, USAir Group would have violated this test on September 30, 1993. As of September 30, 1993, USAir Group was in compliance with the other financial covenants required to be maintained as part of the Credit Agreement. Moreover, in December 1993, USAir Group obtained an additional waiver under the Credit Agreement of compliance during the period October 1 through December 31, 1993 with the coverage ratio test. Without this waiver, USAir Group would have violated this test on December 31, 1993. The Company is currently unable to borrow under the Credit Agreement because it is in violation of a minimum net worth covenant thereunder. In addition, based on current projections of its results for 1994, USAir Group expects that it will not be in compliance with the coverage ratio test and possibly other financial covenants at March 31, 1994 and during the remainder of the year. There can be no assurance that USAir Group will be able to obtain a waiver of compliance with these covenants or to arrange a replacement facility. In September 1993 and December 1993, USAir obtained waivers of the coverage ratio test under the Receivables Agreement on the same terms as described above with respect to the Credit Agreement. At December 31, 1993, USAir was in compliance with the other financial covenants and had no amounts outstanding under the Receivables Agreement. The maximum amount of receivables which USAir may sell under the Receivables Agreement was $240 million at December 31, 1993 and will be adjusted downward to $190 million on June 30, 1994 if the Company's consolidated net worth does not exceed $1.5 billion. For purposes of this net worth comparison, the Company's actual net worth is adjusted to add back the initial and ongoing impact of adopting FAS 106 and certain other accounting pronounce- ments. USAir is currently unable to sell receivables under the Receivables Agreement because it is in violation of a minimum net worth covenant thereunder. In addition, based on current projec- tions of its results for 1994, USAir expects that it will not be in compliance with the coverage ratio test and possibly other financial covenants at March 31, 1994 and during the remainder of the year. There can be no assurance that USAir will be able to obtain a waiver of compliance with these covenants or to arrange a replacement facility. The Company's and USAir's debt and equity securities are presently rated below investment grade by Standard and Poor's Corporation ("S&P") and Moody's Investors Service, Inc. ("Moo- dy's"). Following the January 21, 1993 transaction in which a subsidiary of BA purchased $300 million of the Company's Series F Preferred Stock, Moody's placed the ratings on watch for possible upgrade. On March 19, 1993, Moody's confirmed its ratings of USAir Group and USAir securities. Following DOT approval of the purchase of the Series F Preferred Stock and the code sharing and wet lease relationship between USAir and BA, S&P affirmed its ratings of USAir Group and USAir securities, stating its ratings outlook was positive. In December 1993, S&P affirmed its ratings of USAir Group and USAir securities. However, the agency revised the ratings outlook to negative, citing, among other considerations, the status of the negotiations on a revised U.S.-U.K. bilateral air services agreement and the entrance and possible expansion of the operations of low fare, low cost air carriers into USAir's markets. In February 1994, as a result of USAir's low fare initiative in certain markets and its high cost structure, S&P and Moody's placed the securities of the Company and USAir on watch with negative implications. On March 24, 1994, S&P further downgraded the Company's and USAir's securities. This downgrade will make it more difficult for the Company and USAir to effect additional financing. In addition, the Company's and USAir's securities remain on watch with negative implications at S&P. In 1992, the Company's investment in new aircraft acquisitions and purchase deposits, net of deposits refunded, totaled $458.7 million. The Company purchased eight Fokker and four deHavilland Dash 8 aircraft during 1992. The acquisition of these aircraft was financed through a combination of secured debt financings and interim debt financings. In addition, USAir took delivery of four MD-82s, two of which were immediately sold to a third party. The remaining two aircraft delivered in 1992 were sold to a third party in early 1993. Cash outflows for other property during the period totaled $277.2 million, which includes $61 million paid to Continental for landing and take-off slots at LaGuardia and Washington National Airports and $50 million paid to TWA for London routes from BWI and Philadelphia International Airports. See Item 1. "Business - British Airways Investment Agreement - U.S.-U.K. Routes." Proceeds from disposition of assets of $429.5 million were realized during the year, primarily from sale-leaseback transactions, the sale of the two MD-82 aircraft, and the sale of three wholly-owned subsidiaries. During 1991, acquisition of new aircraft and purchase deposit payments amounted to $345 million. During 1991, USAir took delivery of two Boeing 767-200ER, nine Boeing 737-400, 12 Fokker 100, and five deHavilland Dash 8 aircraft. The acquisition of these aircraft was financed through a combination of sale-leaseback transactions, secured debt financings and interim debt financings. Expenditures for other property, consisting primarily of ground support equipment, leasehold improvements, and major aircraft components, totaled $97 million. Proceeds from disposition of property of $286 million were realized during 1991, primarily as a result of aircraft sale-leaseback transactions. In May 1991, USAir Group sold 4,263,050 Depositary Shares, each representing 1/100 of a share of $437.50 Series B Cumulative Convertible Preferred Stock, without par value, for net proceeds of $207.8 million. Such proceeds were used to repay indebtedness under USAir Group's Credit Agreement. At December 31, 1993, USAir Group's ratio of current assets to current liabilities was 0.53 to 1 and the debt component of USAir Group's capitalization structure was approximately 82% (100% if the redeemable Series A Cumulative Convertible Preferred Stock, the Series F Preferred Stock and the redeemable Series T Cumulative Convertible Exchangeable Senior Preferred Stock are considered to be debt). Item 8A. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION USAir Group, Inc. Independent Auditors' Report The Stockholders and Board of Directors USAir Group, Inc.: We have audited the accompanying consolidated balance sheets of USAir Group, Inc. and subsidiaries ("Group") as of December 31, 1993 and 1992, and the related consolidated statements of opera- tions, cash flows, and changes in stockholders' equity (deficit) for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibil- ity of Group's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of USAir Group, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles. As discussed in Note 11 to the consolidated financial statements, effective January 1, 1993, Group changed its method of accounting for postemployment benefits and effective January 1, 1992, Group changed its method of accounting for postretirement benefits other than pensions. KPMG PEAT MARWICK Washington, D. C. February 25, 1994 See accompanying Notes to Consolidated Financial Statements. See accompanying Notes to Consolidated Financial Statements. See accompanying Notes to Consolidated Financial Statements. USAir Group, Inc. Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The accompanying consolidated financial statements include the accounts of USAir Group, Inc. ("USAir Group" or the "Company") and its wholly-owned subsidiaries USAir, Inc. ("USAir"), Piedmont Airlines, Inc. ("Piedmont") (formerly Henson Aviation, Inc.), Jetstream International Airlines, Inc. ("Jetstream"), Pennsylvania Commuter Airlines, Inc. ("PCA"), USAir Leasing and Services, Inc. ("Leasing"), USAir Fuel Corporation and Material Services Company, Inc. All significant intercompany accounts and transactions have been eliminated. At December 31, 1992, USAM Corp. ("USAM"), a subsidiary of USAir, owned 11% of the Covia Partnership ("Covia") which owned and operated a computerized reservation system ("CRS"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided CRS services to travel agent subscribers in Europe. Covia was then separated into three new entities. As a result, at December 31, 1993, USAM owns 11% of the Galileo International Partnership which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan, and approximately 21% of the Apollo Travel Services Partnership which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method. On August 1, 1992, two wholly-owned USAir Group's commuter airline subsidiaries, Allegheny Commuter Airlines, Inc. and PCA, merged. PCA, the surviving entity, operates under the name of Allegheny Commuter Airlines, with headquarters in Middletown, Pennsylvania. On July 15, 1992, USAir Group completed the sale of three of its wholly-owned subsidiaries: Piedmont Aviation Services, Inc., Air Service, Inc. and Aviation Supply Corporation. The Company realized a gain of $10.3 million as a result of the sale. The three former subsidiaries engaged in fixed base operations and the sale and repair of aircraft and aircraft components. These subsidiaries were included in the accounts until their sale. On October 9, 1991, USAir reached agreement for the sale of certain assets of its wholly-owned subsidiary Pacific Southwest Airmotive ("Airmotive"). Airmotive discontinued operations in the third quarter of 1991. USAir did not realize any material gain or loss on the sale and discontinuance of Airmotive's operations. USAir Group's principal operating subsidiary, USAir, and its three commuter airline subsidiaries, Piedmont, Jetstream and PCA, operate within one industry (air transportation); therefore, no segment information is provided. Certain 1992 and 1991 amounts have been reclassified to conform with 1993 classifications. (b) Cash and Cash Equivalents For financial statement purposes, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. (c) Materials and Supplies Inventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts. (d) Property and Equipment Property and equipment is stated at cost or, if acquired under capital leases, at the lower of the present value of minimum lease payments or fair market value at the inception of the lease. Maintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows: Property acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to depreciation expense. (e) Goodwill, Other Intangibles and Other Assets Goodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years as other non-operating expense. Accumulated amortization at December 31, 1993 and 1992 was $98 million and $82 million, respectively. Intangible assets consist of purchased operating rights at various airports, purchased route authorities, and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from Piedmont Aviation, Inc. ("Piedmont Avia- tion") or Pacific Southwest Airlines ("PSA"), are being amortized over periods ranging from ten to 25 years as Other Rent and Landing Fees Expense. The purchased route authorities are amortized over periods of 25 years as other operating expense. Accumulated amortization at December 31, 1993 and 1992 was $72 million and $65 million, respectively. The decrease in Other Intangibles, net in 1993 is primarily attributable to the $47 million reclassification of two London routes to Other Assets as a result of USAir's relinquishment of these routes as contemplated by the January 21, 1993 Investment Agreement ("Investment Agreement") between the Company and British Airways Plc ("BA"). USAir relinquished its Charlotte to London route authority in January 1994. In addition, takeoff and landing slots at Washington National Airport were purchased from Northwest Airlines, Inc. ("Northwest") for $10 million during 1993. (f) Restricted Cash and Investments Restricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies and short-term investments restricted for specified construction projects. These amounts are classified as Other Assets on the accompanying balance sheets. (g) Deferred Gains on Sale and Leaseback Transactions Gains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense. (h) Passenger Revenue Recognition Passenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger. (i) Frequent Traveler Awards USAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program. (j) Investment Tax Credit Investment tax credit benefits are recorded using the "flow- through" method as a reduction of the Federal income tax provision. (k) Earnings Per Share Earnings per share is computed by dividing net loss, after deducting preferred stock dividend requirements, by the weighted average number of shares of Common Stock outstanding, net of treasury stock. USAir Group's outstanding redeemable Series A Cumulative Convertible Preferred Stock ("Series A Preferred Stock"), Series B Cumulative Convertible Preferred Stock ("Series B Preferred Stock"), redeemable Series F Cumulative Senior Preferred Stock ("Series F Preferred Stock"), redeemable Series T Cumulative Convertible Exchangeable Senior Preferred Stock ("Series T Preferred Stock) and common stock equivalents are anti-dilutive. (l) Swap Agreements USAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. USAir is party to such hedging arrangements with several entities. Under these arrangements, the Company's maximum commitments, which are offset by amounts received under the arrangements, totaled approximately $100.3 million and $158.7 million at December 31, 1993 and 1992, respectively. Although the agreements expose the Company to credit loss in the event of nonperformance by the other parties to the agreements, the Company does not anticipate such nonperformance. The Company has entered into interest rate swap transactions to manage interest rate exposure. Net settlements are recorded as an adjustment to interest expense. The Company is party to such interest rate swap agreements with banks and other financial institutions. The notional principal amounts of these agreements were $150 million and $400 million at December 31, 1993 and 1992, respectively. Under these swap agreements, the Company pays interest at fixed rates averaging 9.8% and 9.7% at December 31, 1993 and 1992, respectively, and receives floating rate interest payments based on three-month LIBOR. Although the agreements, which expire in 1995, expose the Company to credit loss in the event of non-performance by the other parties to the agreements, the Company does not anticipate such non-performance. (2) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Unless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. The Company has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining maturities. The estimated fair values of the Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock are obtained by consulting with an independent external valuation source. The fair values of interest rate swap agreements, energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount the Company would receive or pay to terminate such agreements. The estimated fair values of the Company's financial instru- ments are summarized as follows: (3) LONG-TERM DEBT Details of long-term debt are as follows: Maturities of long-term debt and debt under capital leases for the next five years are as follows: (in thousands) 1994 $ 87,833 1995 75,344 1996 73,464 1997 84,027 1998 152,180 Thereafter 2,059,002 In addition to the varying interest rate on Credit Agreement borrowings as described below, interest rates on $239 million principal amount of long-term debt at December 31, 1993 are subject to adjustment to reflect prime rate and other rate changes. The Company and a group of banks are parties to a Credit Agreement dated as of March 30, 1987, as amended (the "Credit Agreement") which makes a $300 million revolving credit facility available to the Company as of December 31, 1993. The Credit Agreement expires on September 30, 1994. At December 31, 1993, loans under the Credit Agreement, at the option of the Company, would have borne interest at a reference rate, a Eurodollar rate plus 2.50% - 2.65% per annum, determined by the Company's coverage ratio discussed below, or a bid rate if offered by a lending bank. During 1993, 1992 and 1991, the maximum amount of credit agreement borrowings outstanding at any month end was $250 million, $450 million and $733 million, respectively. All outstanding Credit Agreement borrowings were paid off in May 1993 and no other funds were borrowed during the remainder of 1993. The average amount of Credit Agreement borrowings outstanding and weighted average interest rate for 1993 were $37 million and 5.8%, respectively. The average amount of Credit Agreement borrowings outstanding and the weighted average interest rate for 1992 were $174 million and 6.2%, respectively. The average amount of Credit Agreement borrowings and the weighted average interest rate for 1991 were $510 million and 8.3%, respectively. On June 21, 1993, USAir Group entered into the Seventh Amendment to the Credit Agreement. The Seventh Amendment increased the limit of unsecured debt of subsidiaries to $300 million from $200 million. On December 21, 1993, the Company obtained a waiver under the Credit Agreement which further increased the limit of unsecured debt of subsidiaries to $620 million for the period commencing December 21, 1993 and ending on the final annual reduction date of September 30, 1994. This waiver also exempted the Company from compliance, for the quarter ended December 31, 1993, with the coverage ratio test which must be maintained as part of the Credit Agreement. The Company would not otherwise have complied with this test as of December 31, 1993 but was in compliance with the other financial covenants required to be maintained as part of the Credit Agreement. USAir Group is currently unable to borrow under the Credit Agreement because it is in violation of a minimum net worth covenant thereunder. In addition, based on current projections of its results for 1994, USAir Group expects that it will not be in compliance with the coverage ratio test and possibly other financial covenants at March 31, 1994 and during the remainder of the year. There can be no assurance that USAir Group will be able to obtain a waiver of compliance with these covenants or arrange a replacement facility. Certain USAir, Piedmont and PCA aircraft and engines with a net book value of $247 million at December 31, 1993 secure the Credit Agreement. Equipment financings totaling $2.0 billion are collateralized by aircraft and engines with a net book value of $2.2 billion at December 31, 1993. An aggregate of $32 million of future principal payments of the Equipment Financing Agreements are payable in Japanese Yen. This foreign currency exposure has been hedged to maturity. Although the Company is exposed to credit loss in the event of non- performance by the counterparty to the hedge agreement, the Company does not anticipate such non-performance. On February 2, 1994, USAir sold $175 million principal amount of 9 5/8% Senior Notes ("9 5/8% Senior Notes") which are uncondi- tionally guaranteed by the Company. The 9 5/8% Senior Notes are not reflected in the above table because they were sold after December 31, 1993. (4) COMMITMENTS AND CONTINGENCIES (a) Operating Environment The economic conditions in the United States, fare competition and the emergence and growth of lower cost, lower fare carriers in the domestic airline industry are factors affecting the financial condition of USAir Group. Industry capacity has recently failed to mirror changes in demand due primarily to the continued delivery of new aircraft and secondarily, to the prolonged operation of certain major U.S. carriers under the protection of Chapter 11 of the Bankruptcy Code. USAir competes with at least one major airline on most of its routes between major cities. Although the economy generally has shown signs of improvement, the Company expects that the competitive environment in the airline industry, the entry of low cost, low fare carriers into USAir's markets, and the excess capacity in the domestic airline industry will continue to have an adverse effect on USAir's passenger revenue for the foreseeable future. The extent or duration of these conditions cannot be reasonably determined at this time. (b) Lease Commitments The Company's airline subsidiaries lease certain aircraft, engines, computer and ground equipment, in addition to the majority of their ground facilities. Ground facilities include executive offices, overhaul and maintenance bases and ticket and administra- tive offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options. The following amounts applicable to capital leases are included in property and equipment: At December 31, 1993, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows: Rental expense under operating leases for 1993, 1992 and 1991 was $781 million, $707 million and $605 million, respectively. Rental expense for 1993 excludes a charge of $9 million related to certain airport facilities where USAir has, among other things, discontinued or reduced its service. Rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe- 146 fleet. Rental expense for 1991 excludes a credit of $9 million for the BAe-146 fleet. (c) Legal Proceedings The Company and various subsidiaries have been named as defendants in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unsettled. For these reasons the outcome of these suits and proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations. In 1989 and 1990, a number of U.S. air carriers, including USAir, received two Civil Investigative Demands ("CIDs") from the U.S. Department of Justice ("DOJ") (a CID is a request for information in the course of an antitrust investigation and does not constitute the institution of a civil or criminal action) related to investigations of price fixing in the domestic airline industry. The investigations by the DOJ culminated in the filing of a lawsuit against Airline Tariff Publishing Company ("ATPCo") and eight major air carriers, including USAir, alleging that the defendants had agreed to fix prices in violation of Section 1 of the Sherman Act through the methods used to disseminate fare data to ATPCo, an airline-owned fare publishing service. To avoid the costs associated with protracted litigation and an uncertain outcome, USAir and another carrier decided to settle the lawsuit by entering into a consent decree to modify their fare-filing practices in certain respects and to implement compliance programs that would include education of employees regarding the carriers' responsibilities under the consent decree. Accordingly, the consent decree and the U.S. Government's complaint were filed contemporaneously in the U.S. District Court for the District of Columbia in December 1992. Due to certain legal requirements associated with the settlement of government antitrust suits, the consent decree could not be entered until a notice and comment period had expired. On November 1, 1993, after it had reviewed the comments, the Court entered the consent decree. USAir does not believe that the fare-filing practices reflected in the consent decree will have a material adverse effect on its financial condition or on its ability to compete. In March 1994, the remaining six air carrier defendants agreed to the entry of a separate consent decree to settle the lawsuit. This consent decree cannot be entered by the Court until a notice and comment period has expired. When that consent decree is entered, USAir can petition the Court to have its consent decree amended to conform with the other settlement and the Court will enter the amended consent decree. On March 19, 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit. The class action suit, which was filed in July 1990, alleged that the airlines used ATPCo to signal and communicate carrier pricing intentions and otherwise limit price competition for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers will pay $45 million in cash and issue $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. USAir's share of the cash portion of the settlement, $5 million, was recorded in results of operations for the second quarter of 1992. The certificates provide a dollar-for-dollar discount against the cost of a ticket generally of up to a maximum of 10% per ticket, depending on the cost of the ticket. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir has employed the incremental cost method to estimate a range of costs attributable to the exercise of the certificates, based on the assumption that the estimated maximum number of certificates to be redeemed for travel on USAir will be related to USAir's market share relative to the total market share of the six carriers involved in the settlement. USAir's estimated percentage of such market share is less than 9%. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, liability insurance, and denied boarding compensation expenses expected to be incurred on a per passenger basis. USAir has estimated that its incremental cost will not be material based on the equivalent free trips associated with the settlement. The Attorney General of the State of Florida and the Attorneys General of several other states are investigating whether several major airlines, including USAir, have engaged in price fixing and other unlawful restraints of trade. Certain of these Attorneys General have issued document requests to USAir and several other airlines requiring them to provide certain information and documents. At this time, USAir cannot predict the manner in which these investigations will be resolved and if the resolution will have an adverse effect on USAir's results of operations or financial position. (d) Aircraft Commitments At December 31, 1993 USAir's new aircraft on firm order, options for new aircraft and scheduled payments for new aircraft orders (including progress payments, buyer furnished equipment, spares, and capitalized interest) were: USAir may elect, under certain circumstances, to convert Boeing 737 Series and Boeing 767 Series firm order or option deliveries to Boeing 757-200 deliveries. If USAir were to elect such a substitution, the payments presented in the table above would change. USAir is currently in negotiations with Boeing regarding, among other things, the above schedule of new aircraft deliveries. In addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration ("FAA") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $29.1 million - 1994; $12.0 million - 1995; $42.3 million - 1996; $43.4 million - 1997; $44.0 million - 1998; and $30.8 million thereafter. (e) Concentration of Credit Risk USAir Group does not believe it is subject to any significant concentration of credit risk. At December 31, 1993, most of the Company's receivables related to tickets sold to individual passengers through the use of major credit cards (48%) or to tickets sold by other airlines (17%) and used by passengers on USAir or the commuter subsidiaries. These receivables are short- term, generally being settled shortly after sale or in the month following usage. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts. (f) Guarantees At December 31, 1993, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $16 million. (5) SALE OF RECEIVABLES USAir is party to an agreement ("Receivables Agreement") to sell, on a revolving basis, undivided interest of up to $240 million in a pool of designated receivables. Approximately $141 million was available for sale at December 31, 1993 based on receivable balances at that date. The maximum amount available under the Receivables Agreement to be sold gradually reduces from $240 million at December 31, 1993, to $190 million on June 30, 1994. The Receivables Agreement expires on December 21, 1994. USAir had no outstanding amounts due under the Receivable Agreement at December 31, 1993. The net amounts sold reduce receivables in the accompanying balance sheet by $220 million and $188 million at December 31, 1992 and 1991, respectively. Included in the accounts payable balances at December 31, 1992 and 1991, are $74 million and $64 million, respectively, which represent funds held by USAir related to previously sold receivables that had been collected. USAir obtained a waiver from the purchaser of the receivables and its operating agent, exempting USAir from compliance with the coverage ratio financial covenant in the Receivables Agreement for the quarter ended December 31, 1993. USAir is currently unable to sell receivables under the Receivables Agreement because it is in violation of a minimum net worth covenant thereunder. In addition, based on current projections of its results for 1994, USAir expects that it will not be in compliance with the coverage ratio test and possibly other financial covenants at March 31, 1994 and during the remainder of the year. There can be no assurance that USAir will be able to obtain a waiver of compliance with these covenants or to arrange a replacement facility. (6) INCOME TAXES Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the year ended December 31, 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating losses. The Company files a consolidated Federal income tax return with its wholly-owned subsidiaries. The components of the provision (credit) for income taxes are as follows: The significant components of deferred income tax expense/- (benefit) for the year ended December 31, 1993, are as follows: Deferred tax benefit (exclusive of the other components listed below) $(136,191) Adjustments to deferred tax assets and liabilities for enacted changes in tax laws and rates (8,880) Increase for the year in the valuation allowance for deferred tax assets 145,071 -------- Total $ 0 ======== For the years ended December 31, 1992 and 1991 deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: A reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows: The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993 are presented below: (in thousands) Deferred tax assets: Leasing transactions $ 132,551 Tax benefits purchased/sold 79,434 Gain on sale and leaseback transactions 164,613 Employee benefits 430,257 Net operating loss carryforwards 557,494 Alternative minimum tax credit carryforwards 21,146 Investment tax credit carryforwards 49,802 Other deferred tax assets 62,615 --------- Total gross deferred tax assets 1,497,912 Less valuation allowance (564,838) --------- Net deferred tax assets 933,074 Deferred tax liabilities: Equipment depreciation and amortization (874,640) Other deferred tax liabilities (58,434) --------- Net deferred tax liabilities (933,074) --------- Net deferred taxes $ 0 ========= The valuation allowance for deferred tax assets as of January 1, 1993, was $420 million. The increase in the valuation allowance during 1993 was $145 million. At December 31, 1993, the Company had unused net operating losses of $1.5 billion for Federal tax purposes, which expire in the years 2005-2008. The Company also has available, to reduce future taxes payable, $460 million alternative minimum tax net operating losses expiring in 2007 and 2008, $50 million of investment tax credits expiring in 2002 and 2003, and $21 million of minimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service. (7) BRITISH AIRWAYS PLC INVESTMENT On January 21, 1993, USAir Group and BA entered into the Investment Agreement under which a wholly-owned subsidiary of BA purchased certain series of convertible preferred stock during 1993 (see Note 8 - Redeemable Preferred Stock) and BA entered into code sharing and wet lease arrangements with USAir contemplated by the Investment Agreement. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of measures by the Company to reduce its costs and improve its financial results is known. At December 31, 1993, the preferred stock held by BA con- stituted approximately 22% of the total voting interest in the Company. To the extent permitted by foreign ownership restrictions which are applicable by statute regulations or interpretation by regulatory authorities, including the U.S. Department of Transpor- tation ("DOT") ("Foreign Ownership Restrictions"), the preferred stock owned by BA votes on all matters presented to the Company's stockholders for a vote and has voting power equal to the underly- ing shares of Common Stock. Under the Investment Agreement, on January 21, 1993, BA designated three of its officers to serve on the Company's Board of Directors. The Company has agreed to use its best efforts to place these designees on the slate of nominees for election as Directors of the Company. In addition to BA's holdings of the Company's preferred stock at December 31, 1993, BA has the option, which it has announced it will not exercise under current circumstances, to purchase, at a minimum, an additional $450 million of the Company's preferred stock. Under certain circumstances, BA is entitled, at its option, to purchase, on or prior to January 21, 1996, 50,000 shares of Series C Cumulative Convertible Senior Preferred Stock ("Series C Preferred Stock") resulting in an additional cash investment in the Company of $200 million, and, on or prior to January 21, 1998, 25,000 shares of Series E Cumulative Convertible Senior Preferred Stock ("Series E Preferred Stock") resulting in an additional cash investment in the Company of $250 million. If the DOT approves all the transactions and acts contemplated by the Investment Agreement, at the election of either BA or the Company on or prior to January 21, 1998, BA's purchase of the Series C Preferred Stock (unless previously consummated) and BA's purchase of the Series E Preferred Stock must be consummated under certain circumstances. On March 15, 1993, the DOT issued an order ("DOT Order") stating, among other things, that BA's initial investment does not impair USAir's citizenship under current U.S. Foreign Ownership Restrictions. However, the DOT instituted a proceeding to consider whether USAir will remain a U.S. citizen if the transactions and acts contemplated by the Investment Agreement, including the possible sale of Series C Preferred Stock and Series E Preferred Stock, to BA, are consummated. The DOT has indefinitely suspended the period for comments from interested parties pending its resolution of requests by other airlines for production of additional documents from USAir. The DOT Order states that the DOT expects and advises USAir and BA not to proceed with the closing of the purchase of the Series C Preferred Stock or the Series E Preferred Stock until the DOT has completed its review of USAir's citizenship. In any event, on March 7, 1994, BA announced it would not make any additional investments in the Company under current circumstances. USAir cannot predict the outcome of the proceedings or if further transactions contemplated under the Investment Agreement, including the sale of Series C and Series E Preferred Stock to BA, will be consummated. The sale of additional preferred stock to BA on June 10, 1993 (see Note 8(c)), did not result in BA's ownership of voting stock in the Company exceeding applicable foreign ownership restrictions and therefore does not affect the Company's U.S. citizenship under those restrictions. (8) REDEEMABLE PREFERRED STOCK (a) Series A Preferred Stock At December 31, 1993, the Company had 358,000 shares of its 9 1/4% Series A Cumulative Convertible Redeemable Preferred Stock ("Series A Preferred Stock"), without par value, outstanding which was convertible into 9,239,944 shares of the Company's Common Stock at a conversion price of approximately $38.74 per share. The Series A Preferred Stock ranks pari passu with the Series F Cumulative Convertible Senior Preferred Stock ("Series F Preferred Stock"), without par value, and Series T-_ Cumulative Convertible Exchangeable Senior Preferred Stock ("Series T Preferred Stock"), without par value, and senior to the Series B Cumulative Convert- ible Preferred Stock ("Series B Preferred Stock"), without par value, Junior Participating Preferred Stock, Series D ("Series D Preferred Stock"), without par value, and the Common Stock, with respect to dividend payments and the distribution of assets. At December 31, 1993, the Series A Preferred Stock is entitled to approximately 25.81 votes per share (determined by dividing the $1,000 liquidation preference per share of Series F Preferred Stock by the $38.74 conversion price), or a total of 9,239,944 votes, and votes together with the Series F Preferred Stock, the Series T Preferred Stock and the Common Stock, on all matters submitted to a vote of stockholders of the Company. The Series A Preferred Stock is redeemable on August 7, 1999 at $1,000 per share. The Company has the right to redeem the stock at a 10% premium until that time. The agreement relating to the sale of the Series A Preferred Stock imposes certain restrictions on the purchaser's ability to increase its ownership of, and to transfer, its stock in USAir Group. There have been no changes in the balance sheet value of the Series A Preferred Stock since its issuance in 1989. (b) Series F Preferred Stock At December 31, 1993, the Company had outstanding 30,000 shares of its 7% Series F Preferred Stock which was convertible into 15,458,658 shares of the Company's Common Stock at a conver- sion price of approximately $19.41 per share. The Series F Preferred Stock ranks pari passu with the Series A Preferred Stock and Series T Preferred Stock and senior to the Series B Preferred Stock, Series D Preferred Stock, and the Common Stock, with respect to dividend payments and the distribution of assets. At December 31, 1993, each share of Series F Preferred Stock was entitled to approximately 515.29 votes per share to the extent permitted by the existing Foreign Ownership Restrictions and votes with the Company's Series A Preferred Stock, the Series T Preferred Stock and the Company's Common Stock as a single class. Under Foreign Ownership Restrictions, no more than 25% of the Company's voting interest may be held by persons other than U.S. citizens. In accordance with the terms of any preferred stock held by BA, conversion rights and voting rights may not be exercised to the extent that doing so would result in a loss of the Company's or any of its subsidiaries' operating certificates and authorities under Foreign Ownership Restrictions, and it is assumed for this purpose that Series F Preferred Stock will be fully converted before any other preferred stock held by BA. The Series F Preferred Stock is convertible at any time on or after January 21, 1997 to the extent that such conversion would not violate U.S. Foreign Ownership Restrictions. Series F Preferred Stock may be converted at the option of the Company at any time after January 21, 1998 if the average composite closing market price of Common Stock during any 30-day calendar period is at least 133% of the conversion price. The Series F Preferred Stock is mandatorily redeemable on January 21, 2008. If BA has not purchased the Series C Preferred Stock by January 21, 1996, then the Company may at its option redeem, in whole or in part, Series F Preferred Stock at the higher of market value or the price of $10,000 per share, plus accrued dividends. The Series F Certifi- cate provides that if on any one occasion on or prior to Janu- ary 21, 1996, any court or regulatory authority issues a final order that any material part of the Investment Agreement is unenforceable (except pursuant to bankruptcy or like event), then the conversion price of Series F Preferred Stock shall be reduced by 10.2564%. There have been no changes in the balance sheet value of the Series F Preferred Stock since its issuance in 1993. (c) Series T Preferred Stock Under the Investment Agreement, BA has preemptive and optional purchase rights to maintain its proportionate ownership of the Company's Common Stock and convertible securities, measured in terms of the BA Percentage ("BA Percentage") which approximates BA's fully diluted ownership percentage based on BA's current and potential holdings in the Company. The BA Percentage is calculated without regard to Foreign Ownership Restrictions at the time of the calculation. BA may exercise such preemptive or optional purchase rights by purchasing, from time-to-time, a series of Series T Preferred Stock. At December 31, 1993, the Company had two series of the Series T Preferred Stock outstanding. On June 10, 1993, BA exercised its preemptive purchase right by purchasing 9,919.8 shares of a series of the Series T Preferred Stock ("Series T-2 Preferred Stock") for approximately $99.2 million and exercised its optional purchase right by purchasing 152.1 shares of a series of Series T Preferred Stock ("T-1 Preferred Stock") for approximately $1.5 million. BA's preemptive right was triggered by the issuance of Common Stock, as described in Note 8 - Stockholders' Equity, and BA's optional purchase rights were triggered by the Company's issuance of additional shares of Common Stock through the exercise of options under various employee stock option plans and through the sale of shares to certain defined contribution plans during the period from January 21, 1993 to March 31, 1993. On March 7, 1994, BA advised the Company that it would not exercise its optional purchase rights to buy three additional series of Series T Preferred Stock triggered by the Company's issuance of common stock pursuant to certain employee benefit plans during the second, third and fourth quarters of 1993. There have been no changes in the balance sheet value of the Series T-1 Preferred Stock and Series T-2 Preferred Stock since their issuance in 1993. The terms of all series of the Series T Preferred Stock are substantially similar to those of the Series F Preferred Stock except as noted. Each share of Series T-2 Preferred Stock carries a conversion price of $26.40 and is convertible into approximately 378.79 shares of Common Stock or Non-Voting Class ET stock. Each share of Series T-1 Preferred Stock has a conversion price of $20.50 and is convertible into approximately 487.80 shares of Common Stock or Non-Voting Class ET stock. With respect to the Series T Preferred Stock, dividends are payable quarterly in arrears, at 50 basis points over the three-month LIBOR rate. Any shares of the Series T Preferred Stock held by any person other than BA or its subsidiaries may be redeemed for cash at any time at the option of the Company at $10,000 plus accrued dividends plus a redemption premium equal to $700 from the date of issue until the first anniversary thereof and reduced by $46.67 on each anniversary thereafter. The Series T Preferred Stock is exchangeable, at the option of the Company, for that principal amount of floating rate convertible subordinated notes of the Company ("T Notes") equal to the liquidation preference of the shares to be exchanged and bearing interest at the dividend rate. Any accrued dividends on the Series T Preferred Stock to be exchanged will be treated as accrued interest on the T Notes. Each $10,000 aggregate principal amount of such T Notes will be entitled to a number of votes equal to the number of votes to which each share of Series T Preferred Stock was entitled at the time of its exchange for T Notes, subject to adjustment. If issued, T Notes will have terms otherwise consis- tent with the terms of the Series T Preferred Stock. (9) STOCKHOLDERS' EQUITY (a) Common Stock The Company had 150,000,000 and 100,000,000 authorized shares of Common Stock, par value $1, at December 31, 1993 and 1992, respectively. If BA purchases the Series C Preferred Stock (see Note 6 - British Airways Plc Investment), the number of authorized shares of various classes of Common Stock will increase to 300,000,000. BA has indicated, however, that it will not make any additional investments in the Company under current circumstances. At December 31, 1993, approximately 52,618,000 shares were reserved for issuance upon the conversion of preferred stock and for offerings under employee stock purchase, stock option and stock incentive plans. On May 4, 1993, the Company sold 11.5 million shares of previously unissued Common Stock at $20.75 per share through a public, underwritten offering. The offering netted proceeds of approximately $231 million. (b) Preferred Stock and Senior Preferred Stock At December 31, 1993, the Company had 5,000,000 authorized shares of preferred stock, without nominal or par value, of which 358,000 shares were issued as Series A Preferred Stock, 43,000 shares were issued as Series B Preferred Stock and 1,035,000 shares were reserved as Series D Preferred Stock. Also, at December 31, 1993, the Company had 3,000,000 authorized shares of Senior Preferred Stock, without nominal or par value, of which 30,000 shares were issued as Series F Preferred Stock and approximately 10,000 were issued as Series T Preferred Stock. (c) Series B Preferred Stock At December 31, 1993, the Company had 4,263,050 Depositary Shares, representing 42,630.5 shares of its $437.50 Series B Preferred Stock outstanding. Each Depositary Share represents 1/100 of a share of the Series B Preferred Stock. The Series B Preferred Stock is convertible at any time, at the option of the holder, at the rate of 249.25 shares of Common Stock of the Company per preferred share, or 2.4925 shares of Common Stock per De- positary Share. The Series B Preferred Stock ranks junior to the Company's Series A Preferred Stock, the Series F Preferred Stock and the Series T Preferred Stock and senior to the Series D Preferred Stock and the Common Stock with respect to dividend payments and the distribution of assets, whether upon liquidation or otherwise. Except under certain circumstances, the holders of Series B Preferred Stock have no voting rights. The Series B Preferred Stock is not redeemable prior to May 15, 1994. The Series B Preferred Stock is redeemable, at the option of the Company and with consent of the holders of Series F Preferred Stock, on or after May 15, 1994, (i) in whole but not in part, only in certain circumstances, for so long as any shares of Series A Preferred Stock are outstanding; and (ii) in whole or in part if no shares of Series A Preferred Stock are outstanding, in each case initially at a redemption price of approximately $53.06 per 1/100 of a share and thereafter at prices declining to $50 per 1/100 of a share (equivalent to $5,000 per share of Series B Preferred Stock) on or after May 15, 2001, plus dividends accrued and accumulated but unpaid to the redemption date. (d) Preferred Stock Purchase Rights Each outstanding share of Common Stock is accompanied by one Preferred Share Purchase Right ("Right") and each outstanding share of Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock is accompanied by a Right for each share into which it is convertible. Each Right entitles the holder to buy 1/100th of a share of Series D Preferred Stock at an exercise price of $175 per Right. The Rights expire on June 29, 1996. As long as the Rights remain outstanding, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any preferred stock into, or the exercise of any options for, Common Stock, as long as such preferred stock or options were outstanding prior to the Rights becoming exercisable. Generally, the Rights become exercisable only if a party other than, under certain circumstances, BA acquires 20% or more of the Company's Common Stock or announces a tender offer for 20% or more of the Common Stock. The Rights are redeemable at $.03 per Right at any time before 20% or more of the Company's Common Stock has been acquired. If at any time after the Rights become exercisable and before they have been redeemed the Company is involved in a merger or other business combination transaction, the Rights will automatically entitle a holder, other than a holder of 20% or more of the Company's Common Stock, to receive, upon exercise of each Right, a number of shares of Common Stock, or a number of common shares of the acquiring company, as the case may be, having a market value of two times the exercise price of each Right. In addition, at any time after the acquisition of 30% or more of the Common Stock by any person and prior to the acquisition by such person of 50% or more of the Common Stock, the Board of Directors of the Company may exchange the Rights (other than Rights owned by such person which have become void), in whole or in part, at an exchange ratio of one share of Common Stock, or 1/100th of a share of Series D Preferred Stock, per Right. Until the first to occur of the redemption or expiration of the Rights, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any securities into, or the exercise of any options or warrants for, Common Stock if such securities, options or warrants were outstanding prior to when Rights became exercisable. (e) Treasury Stock In 1989, the Company's Board of Directors authorized the repurchase from time-to-time of up to 9.4 million shares of its Common Stock in open market transactions. In 1989, approximately 2.1 million shares were repurchased. The Company sold approximate- ly 500,000 shares and approximately 390,000 shares of its treasury stock during 1993 and 1992, respectively. The remaining shares are carried on the accompanying balance sheet at the average acquisi- tion cost. (f) Employee Stock Option and Purchase Plans During 1992, the Company's stockholders approved the 1992 Stock Option Plan ("1992 Plan") which allows for the issuance of stock options to purchase up to 8,125,000 shares of USAir Group Common Stock to USAir employees who participate in the previously announced cost reduction program. Under the stock option program, employees whose pay was or is currently being reduced receive options to purchase 50 shares of Common Stock at a price not less than $15 per share for each $1,000 of salary reduction. The Company will grant stock options under the 1992 Plan only in connection with salary reductions. Participating employees have five years from the grant date to exercise such options. Options, with an exercise price of $15, have been granted to purchase ap- proximately five million shares of Common Stock in conjunction with salary reductions. The Company plans to seek authority from its stockholders at its 1994 Annual Meeting to reduce the number of shares reserved for this plan. At December 31, 1993, 5.3 million shares of Common Stock are reserved for the granting of stock options or restricted stock under the Company's 1984 Stock Option and Stock Appreciation Rights ("SARs") Plan and 1988 Stock Incentive Plan. These plans provide that options may be granted as either nonqualified or incentive stock options. Options awarded prior to 1991, except for those that reverted, have vested. Options awarded during 1991, 1992 and 1993, except under the 1992 Plan, become exercisable generally within three years from date of grant. Optionees may also receive SARs which permit them to receive, in lieu of the right to exercise the stock option, an amount equivalent to the difference between the stock option price and the fair market value of the Common Stock on the date of exercising the right. This amount may be paid in stock, in cash, or in any combination of the two. Also, restricted stock award grants for 57,000 shares and 111,600 shares were outstanding at December 31, 1993 and 1992, respectively. Deferred compensation related to the restricted stock, which vests over periods of up to five years, amounted to $.3 million and $ .6 million at December 31, 1993 and 1992, respectively. As of December 31, 1993, options to acquire approximately 9 million shares under all three plans, including 85,000 SARs, were outstanding at a weighted average exercise price of $18.77. Of those outstanding, approximately six million options were exercis- able at December 31, 1993. Options were exercised to purchase approximately 33,500 and 6,000 shares of Common Stock at average exercise prices of $17.24 and $10.44 during 1993 and 1992, respectively. (g) Dividend Restrictions The Company's Credit Agreement does not contain specific provisions which restrict the payment of dividends by USAir Group. The amount of dividends, however, is indirectly restricted through the existence of certain covenants contained in the Credit Agreement. At December 31, 1993, under the most restrictive of these provisions, the Company's ability to pay dividends is limited to approximately $77 million. (10) EMPLOYEE STOCK OWNERSHIP PLAN In August 1989, USAir established an Employee Stock Ownership Plan ("ESOP"). The Company sold 2,200,000 shares of Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. The amount of dividends used for debt service by the ESOP was $127,000 in 1991. As the loan is repaid over time, participating employees receive allocations of the Common Stock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if the Company's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in 1993, 1992 and 1991. The interest portion of these contributions was $10.5 million in 1993, $10.6 million in 1992 and $10.7 million in 1991. Approximately 366,000 shares of Common Stock have been allocated to employees. USAir recognized approximately $4 million of compensation expense related to the ESOP in each of 1993, 1992 and 1991 based on shares allocated to employees (the "shares allocated" method). Deferred compensation related to the ESOP amounted to approximately $95 million, $98 million and $102 million at December 31, 1993, 1992 and 1991, respectively. (11) EMPLOYEE BENEFIT PLANS (a) Pension Plans The Company's subsidiaries have several pension plans in effect covering substantially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensa- tion. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974. The defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993. The funded status of the qualified defined benefit plans at December 31, 1993 and 1992 was as follows: Approximately 97% of the accumulated benefit obligation was vested at December 31, 1993 and 1992. Unrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 7.6% and 8.75% as of December 31, 1993 and 1992, respectively. The expected long-term rate of return on plan assets used in 1993 and 1992 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1993, plan assets consisted of approxi- mately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other invest- ments. At December 31, 1992, plan assets consisted of approximate- ly 4% in cash equivalents and short-term debt investments, 70% in equity investments, and 26% in fixed income and other investments. The following items are the components of the net pension cost for the qualified defined benefit plans: Net pension cost for 1993 and 1991 presented above excludes a settlement charge of approximately $33.9 million and $21.6 million, respectively, related to "early-out" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1992. Non-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from the Company's funds so that total pension payments equal amounts that would have been payable from the Company's principal pension plans if it were not for limitations imposed by income tax regulations. The following table sets forth the non-qualified plans' status at December 31, 1993 and 1992: Net supplementary pension cost for the two years included the following components: The discount rate used to determine the actuarial present value of the projected benefit obligation was 7.5% and 8.75% as of December 31, 1993 and 1992, respectively. Rates of 3% to 6% were used to estimate future salary levels. In addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. Company contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. The Company's contribution expense was $42 million for 1993. The Company recognized no such expense in 1992 or 1991. (b) Postretirement Benefits Other Than Pensions USAir offers medical and life insurance benefits to employees who retire from the Company and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with the Company. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis. USAir adopted Statement of Financial Accounting Standards No. 106 ("FAS 106") during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation ("APBO") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.7 million ($628.1 million net of tax benefit). The following table sets forth the financial status of the plans as of December 31, 1993 and 1992: The components of net periodic postretirement benefit cost are as follows: The postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to "early out" programs offered to a limited number of employees during the year. No such charges were incurred in 1992 or 1991. The discount rate used to determine the APBO was 7.75% and 8.75% at December 31, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 10.5% in 1993 and 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by one percentage point, the APBO at December 31, 1993 would be increased by 10% and 1993 periodic postretirement benefit cost would increase 13%. Prior to the adoption of FAS 106, USAir recognized expense for retiree health care at an estimated monthly rate (based on payments) and recognized expense for death benefits when paid. The expense using this methodology was approximately $8 million for 1991. (c) Postemployment Benefits USAir adopted Statement of Financial Accounting Standards No. 112, "Employer's Accounting for Postemployment Benefits" ("FAS 112"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million. (12) SUPPLEMENTAL BALANCE SHEET INFORMATION The components of certain accounts in the accompanying balance sheets are as follows: (13) NON-RECURRING AND UNUSUAL ITEMS (a) 1993 The Company's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full- time positions between November 1993 and the first half of 1994; (iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership which operates a computerized reserva- tions system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft recorded in the second quarter of 1993. (b) 1992 The Company's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992; and (iv) a $10.3 million gain on the sale of three wholly-owned subsidiaries, recorded in the third quarter of 1992 (see Note (1)). (c) 1991 The Company's results for 1991 include (i) a $107 million pre- tax gain related to freezing of the fully funded non-contract employee pension plan; (ii) a $21.6 million pre-tax expense related to early retirement incentives offered to certain employees during 1991; (iii) a $21 million pre-tax charge to establish an additional reserve for USAir's grounded BAe-146 fleet; and (iv) $18.5 million, net, in miscellaneous non-recurring charges. (14) SELECTED QUARTERLY FINANCIAL DATA (Unaudited) The following table presents selected quarterly financial data for 1993 and 1992: Item 8B. FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION USAir, Inc. Independent Auditors' Report The Stockholder and Board of Directors USAir, Inc.: We have audited the accompanying consolidated balance sheets of USAir, Inc. and subsidiaries ("USAir") as of December 31, 1993 and 1992, and the related consolidated statements of operations, cash flows, and changes in stockholder's equity for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of USAir's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. 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 USAir, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993 in conformity with generally accepted accounting principles. As discussed in Note 9 to the consolidated financial state- ments, effective January 1, 1993, USAir changed its method of accounting for postemployment benefits and effective January 1, 1992, USAir changed its method of accounting for postretirement benefits other than pensions. KPMG PEAT MARWICK Washington, D. C. February 25, 1994 (PAGE> USAir, Inc. Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) Basis of Presentation The accompanying consolidated financial statements include the accounts of USAir, Inc. ("USAir") and its wholly-owned subsidiary USAM Corp. ("USAM"). USAir is a wholly-owned subsidiary of USAir Group, Inc. ("USAir Group" or "the Company"). All significant intercompany accounts and transactions have been eliminated. At December 31, 1992, USAM owned 11% of the Covia Partnership ("Covia") which owned and operated a computerized reservation system ("CRS"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided services to travel agent subscribers in Europe. Covia was then separated into three new entities. As a result, at Decem- ber 31, 1993, USAM owns 11% of the Galileo International Partner- ship which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan and approximately 21% of the Apollo Travel Services Partner- ship which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method. On October 9, 1991, USAir reached agreement for the sale of certain assets of its wholly-owned subsidiary Pacific Southwest Airmotive ("Airmotive"). Airmotive discontinued operations in the third quarter of 1991. USAir did not realize any material gain or loss on the sale and discontinuance of Airmotive's operations. Certain 1992 and 1991 amounts have been reclassified to conform with 1993 classifications. (b) Cash and Cash Equivalents For financial statement purposes, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. (c) Materials and Supplies Inventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts. (d) Property and Equipment Property and equipment is stated at cost or, if acquired under capital leases, at the lower of the present value of minimum lease payments or fair market value at the inception of the lease. Maintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows: Property acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to depreciation expense. (e) Goodwill, Other Intangibles and Other Assets Goodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years as other non-operating expense. Accumulated amortization at December 31, 1993 and 1992 was $98 million and $82 million, respectively. Intangible assets consist of purchased operating rights at various airports, purchased route authorities, and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from Piedmont Aviation, Inc. ("Piedmont Avia- tion") or Pacific Southwest Airlines ("PSA"), are being amortized over periods ranging from ten to 25 years as Other Rent and Landing Fees Expense. The purchased route authorities are amortized over periods of 25 years as other operating expense. Accumulated amortization at December 31, 1993 and 1992 was $72 million and $64 million, respectively. The decrease in Other Intangibles, net in 1993 is primarily attributable to the $47 million reclassification of two London routes to Other Assets as a result of USAir's relinquishment of these routes as contemplated by the January 21, 1993 Investment Agreement ("Investment Agreement") between the Company and British Airways Plc ("BA"). USAir relinquished its Charlotte to London route authority in January 1994. In addition, takeoff and landing slots at Washington National Airport were purchased from Northwest Airlines, Inc. ("Northwest") for $10 million during 1993. (f) Restricted Cash and Investments Restricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies and short-term investments restricted for specified construction projects. These amounts are classified as Other Assets on the accompanying balance sheets. (g) Deferred Gains on Sale and Leaseback Transactions Gains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense. (h) Passenger Revenue Recognition Passenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger. Approximately $29 million and $28 million of amounts owed to wholly-owned subsidiaries of USAir Group for passenger transportation revenue are included in Traffic Balances Payable and Unused Tickets at December 31, 1993 and 1992, respectively. (i) Frequent Traveler Awards USAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program. (j) Investment Tax Credit Investment tax credit benefits are recorded using the "flow- through" method as a reduction of the Federal income tax provision. (k) Swap Agreements USAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. USAir is party to such hedging arrangements with several entities. Under these arrangements, the Company's maximum commitments, which are offset by amounts received under the arrangements, totaled approximately $100.3 million and $158.7 million at December 31, 1993 and 1992, respectively. Although the agreements expose the Company to credit loss in the event of nonperformance by the other parties to the agreements, the Company does not anticipate such nonperformance. (2) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS Unless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. USAir has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining maturities. The fair values of energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount USAir would receive or pay to terminate such agreements. The estimated fair values of USAir's financial instruments are summarized as follows: (3) LONG-TERM DEBT Details of long-term debt are as follows: Maturities of long-term debt and debt under capital leases for the next five years are as follows: (in thousands) 1994 $ 85,715 1995 75,691 1996 75,715 1997 86,496 1998 155,234 Thereafter 2,153,879 Interest rates on $239 million principal amount of long-term debt at December 31, 1993 are subject to adjustment to reflect prime rate and other rate changes. Equipment financings totaling $2.1 billion are collateralized by aircraft and engines with a net book value of $2.2 billion at December 31, 1993. In addition, certain USAir aircraft and engines with a net book value of $162 million collateralize USAir Group's Credit Agreement borrowings. An aggregate of $32 million of future principal payments of the Equipment Financing Agreements are payable in Japanese Yen. This foreign currency exposure has been hedged to maturity. Although the Company is exposed to credit loss in the event of non- performance by the counterparty to the hedge agreement, the Company does not anticipate such non-performance. On February 2, 1994, USAir sold $175 million principal amount of 9 5/8% Senior Notes ("9 5/8% Senior Notes") which are uncondi- tionally guaranteed by the Company. The 9 5/8% Senior Notes are not reflected in the above table because they were sold after December 31, 1993. (4) COMMITMENTS AND CONTINGENCIES (a) Operating Environment The economic conditions in the United States, fare competition and the emergence and growth of low cost, low fare carriers in the domestic airline industry are factors affecting the financial condition of USAir. Industry capacity has recently failed to mirror changes in demand due primarily to the continued delivery of new aircraft and secondarily, to the prolonged operation of certain major U.S. carriers under the protection of Chapter 11 of the Bankruptcy Code. USAir competes with at least one major airline on most of its routes between major cities. Although the economy generally has shown signs of improvement, the Company expects that the competitive environment in the airline industry, the entry of low cost, low fare carriers into USAir's markets, and the excess capacity in the domestic airline industry will continue to have an adverse effect on USAir's passenger revenue for the foreseeable future. The extent or duration of these conditions cannot be reasonably determined at this time. (b) Lease Commitments USAir leases certain aircraft, engines, computer and ground equipment, in addition to the majority of its ground facilities. Ground facilities include executive offices, overhaul and mainte- nance bases and ticket and administrative offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options. The following amounts applicable to capital leases are included in property and equipment: At December 31, 1993, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows: Rental expense under operating leases for 1993, 1992 and 1991 was $739 million, $678 million and $576 million, respectively. Rental expense for 1993 excludes a charge of $9 million related to certain airport facilities where USAir has, among other things, discontinued or reduced its service. Rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe- 146 fleet. Rental expense for 1991 excludes a credit of $9 million for the BAe-146 fleet. (c) Legal Proceedings USAir and various subsidiaries have been named as defendants in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unset- tled. For these reasons the outcome of these suits and proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations. In 1989 and 1990, a number of U.S. air carriers, including USAir, received two Civil Investigative Demands ("CIDs") from the U.S. Department of Justice ("DOJ") (a CID is a request for information in the course of an antitrust investigation and does not constitute the institution of a civil or criminal action) related to investigations of price fixing in the domestic airline industry. The investigations by the DOJ culminated in the filing of a lawsuit against Airline Tariff Publishing Company ("ATPCo") and eight major air carriers, including USAir, alleging that the defendants had agreed to fix prices in violation of Section 1 of the Sherman Act through the methods used to disseminate fare data to ATPCo, an airline-owned fare publishing service. To avoid the costs associated with protracted litigation and an uncertain outcome, USAir and another carrier decided to settle the lawsuit by entering into a consent decree to modify their fare-filing practices in certain respects and to implement compliance programs that would include education of employees regarding the carriers' responsibilities under the consent decree. Accordingly, the consent decree and the U.S. Government's complaint were filed contemporaneously in the U.S. District Court for the District of Columbia in December 1992. Due to certain legal requirements associated with the settlement of government antitrust suits, the consent decree could not be entered until a notice and comment period had expired. On November 1, 1993, after it had reviewed the comments, the Court entered the consent decree. USAir does not believe that the fare-filing practices reflected in the consent decree will have a material adverse effect on its financial condition or on its ability to compete. In March 1994, the remaining six air carrier defendants agreed to the entry of a separate consent decree to settle the lawsuit. This consent decree cannot be entered until a notice and comment period has expired. When that consent decree is entered, USAir can petition the Court to have its consent decree amended to conform with the other settlement and the Court will enter the amended consent decree. On March 19, 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit. The class action suit, which was filed in July 1990, alleged that the airlines used ATPCo to signal and communicate carrier pricing intentions and otherwise limit price competition for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers will pay $45 million in cash and issue $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. USAir's share of the cash portion of the settlement, $5 million, was recorded in results of operations for the second quarter of 1992. The certificates provide a dollar-for-dollar discount against the cost of a ticket generally of up to a maximum of 10% per ticket, depending on the cost of the ticket. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir has employed the incremental cost method to estimate a range of costs attributable to the exercise of the certificates, based on the assumption that the estimated maximum number of certificates to be redeemed for travel on USAir will be related to USAir's market share relative to the total market share of the six carriers involved in the settlement. USAir's estimated percentage of such market share is less than 9%. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, liability insurance, and denied boarding compensation expenses expected to be incurred on a per passenger basis. USAir has estimated that its incremental cost will not be material based on the equivalent free trips associated with the settlement. The Attorney General of the State of Florida and the Attorneys General of several other states are investigating whether several major airlines, including USAir, have engaged in price fixing and other unlawful restraints of trade. Certain of these Attorneys General have issued document requests to USAir and several other airlines requiring them to provide certain information and documents. At this time, USAir cannot predict the manner in which these investigations will be resolved and if the resolution will have an adverse effect on USAir's results of operations or financial position. (d) Aircraft Commitments At December 31, 1993, USAir's new aircraft on firm order, options for new aircraft and scheduled payments for new aircraft orders (including progress payments, buyer furnished equipment, spares, and capitalized interest) were: USAir may elect, under certain circumstances, to convert Boeing 737 Series and Boeing 767 Series firm order or option deliveries to Boeing 757-200 deliveries. If USAir were to elect such a substitution, the payments presented in the table above would change. USAir is currently in negotiations with Boeing regarding, among other things, the above schedule of new aircraft deliveries. In addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration ("FAA") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $29.1 million - 1994; $12.0 million - 1995; $42.3 million - 1996; $43.4 million - 1997; $44.0 million - 1998; and $30.8 million thereafter. (e) Concentration of Credit Risk USAir does not believe it is subject to any significant concentration of credit risk. At December 31, 1993, most of USAir's receivables related to tickets sold to individual passen- gers through the use of major credit cards (47%) or to tickets sold by other airlines (16%) and used by passengers on USAir or USAir Group's commuter subsidiaries. These receivables are short-term, generally being settled shortly after sale or in the month following usage. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts. (f) Guarantees At December 31, 1993, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $16 million. In addition, at December 31, 1993, USAir guaranteed payments of debt and lease obligations of USAir Group's three wholly-owned subsidiaries amounting to approximately $148 million. (5) SALE OF RECEIVABLES USAir is party to an agreement ("Receivables Agreement") to sell, on a revolving basis, undivided interest of up to $240 million in a pool of designated receivables. Approximately $141 million was available for sale at December 31, 1993 based on receivable balances at that date. The maximum amount available under the Receivable Agreement to be sold gradually reduces from $240 million at December 31, 1993, to $190 million on June 30, 1994. The Receivables Agreement expires on December 21, 1994. USAir had no outstanding amounts due under the Receivable Agreement at December 31, 1993. The net amounts sold reduce receivables in the accompanying balance sheet by $220 million and $188 million at December 31, 1992 and 1991, respectively. Included in the accounts payable balances at December 31, 1992 and 1991, are $74 million and $64 million, respectively, which represent funds held by USAir related to previously sold receivables that had been collected. USAir obtained a waiver from the purchaser of the receivables and its operating agent, exempting USAir from compliance with the coverage ratio financial covenant in the Receivables Agreement for the quarter ended December 31, 1993. USAir is currently unable to sell receivables under the Receivables Agreement because it is in violation of a minimum net worth covenant thereunder. In addition, based on current projections of its results for 1994, USAir expects that it will not be in compliance with the coverage ratio test and possibly other financial covenants at March 31, 1994 and during the remainder of the year. There can be no assurance that USAir will be able to obtain a waiver of compliance with these covenants or arrange a replacement facility. (6) INCOME TAXES Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the year ended December 31, 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating losses. USAir files a consolidated Federal income tax return with its parent USAir Group pursuant to a tax allocation agreement. The components of the provision (credit) for income taxes are as follows: The significant components of deferred income tax ex- pense/(benefit) for the year ended December 31, 1993, are as follows: (in thousands) Deferred tax benefit (exclusive of the other components listed below) $(121,847) Adjustments to deferred tax assets and liabilities for enacted changes in tax laws and rates (9,429) Increase for the year in the valuation allowance for deferred tax assets 131,276 -------- Total $ 0 ======== For the years ended December 31, 1992 and 1991, deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: A reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows: The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1993 are presented below: (in thousands) Deferred tax assets: Leasing transactions $ 129,276 Tax benefits purchased/sold 79,434 Gain on sale and leaseback transactions 162,400 Employee benefits 429,312 Net operating loss carryforwards 508,240 Alternative minimum tax credit carryforwards 20,881 Investment tax credit carryforwards 47,880 Other deferred tax assets 61,210 --------- Total gross deferred tax assets 1,438,633 Less valuation allowance (568,816) --------- Net deferred tax assets 869,817 Deferred tax liabilities: Equipment depreciation and amortization (840,584) Other deferred tax liabilities (29,233) --------- Net deferred tax liabilities (869,817) --------- Net deferred taxes $ 0 ========= The valuation allowance for deferred tax assets as of January 1, 1993, was $438 million. The increase in the valuation allowance for 1993 was $131 million. At December 31, 1993, the Company had unused net operating losses of $1.3 billion for Federal tax purposes, which expire in the years 2005-2008. USAir also has available, to reduce future taxes payable, $429 million alternative minimum tax net operating losses expiring in 2007 and 2008, $47 million of investment tax credits expiring in 2002 and 2003, and $20 million of minimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service. (7) STOCKHOLDER'S EQUITY USAir Group owns all of the outstanding common stock of USAir. USAir Group's Credit Agreement includes a provision that limits USAir's ability to declare dividends to USAir Group. (8) EMPLOYEE STOCK OWNERSHIP PLAN In August 1989, USAir established an Employee Stock Ownership Plan ("ESOP"). USAir Group sold 2,200,000 shares of its Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. The amount of dividends used for debt service by the ESOP was $127,000 in 1991. As the loan is repaid over time, participating employees receive allocations of the Common Stock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if the Company's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in 1993, 1992 and 1991. The interest portion of these contributions was $10.5 million in 1993, $10.6 million in 1992 and $10.7 million in 1991. Approximately 366,000 shares of Common Stock have been allocated to employees. USAir recognized approximately $4 million of compensation expense related to the ESOP in each of 1993, 1992 and 1991 based on shares allocated to employees (the "shares allocated" method). Deferred compensation related to the ESOP amounted to approximately $95 million, $98 million and $102 million at December 31, 1993, 1992 and 1991, respectively. (9) EMPLOYEE BENEFIT PLANS (a) Pension Plans USAir has several pension plans in effect covering substan- tially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensation. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974. The defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993. The funded status of the qualified defined benefit plans at December 31, 1993 and 1992 was as follows: Approximately 97% of the accumulated benefit obligation was vested at December 31, 1993 and 1992. Unrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 7.6% and 8.75% as of December 31, 1993 and 1992, respectively. The expected long-term rate of return on plan assets used in 1993 and 1992 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1993, plan assets consisted of approxi- mately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other invest- ments. At December 31, 1992, plan assets consisted of approximate- ly 4% in cash equivalents and short-term debt investments, 70% in equity investments, and 26% in fixed income and other investments. The following items are the components of the net pension cost for the qualified defined benefit plans: 1993 1992 1991 ---- ---- ---- (in millions) Service cost (benefits earned during the year) $ 90 $ 79 $ 98 Interest cost on projected benefit obligation 188 171 168 Actual return on plan assets (224) (114) (353) Net amortization and deferral 40 (65) 201 ---- ---- ---- Net pension cost $ 94 $ 71 $ 114 ==== ==== ==== Net pension cost for 1993 and 1991 presented above excludes a charge of approximately $33.9 million and $21.6 million, respec- tively, related to "early-out" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1992. Non-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from the Company's funds so that total pension payments equal amounts that would have been payable from the Company's principal pension plans if it were not for limitations imposed by income tax regulations. The following table sets forth the non-qualified plans' status at December 31, 1993 and 1992: Net supplementary pension cost for the two years included the following components: The discount rate used to determine the actuarial present value of the projected benefit obligation was 7.5% and 8.75% as of December 31, 1993 and 1992, respectively. Rates of 3% and 6% were used to estimate future salary levels. In addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. Company contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. USAir's contribution expense was $42 million for 1993. USAir recognized no such expense in 1992 and 1991. (b) Postretirement Benefits Other Than Pensions USAir offers medical and life insurance benefits to employees who retire from the Company and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with the Company. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis. USAir adopted Statement of Financial Accounting Standards No. 106 ("FAS 106") during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation ("APBO") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.5 million ($638.8 million net of tax benefit). The following table sets forth the financial status of the plans as of December 31, 1993 and 1992: The postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to "early- out" programs offered to a limited number of employees during the year. No such charges were incurred in 1992 or 1991. The discount rate used to determine the APBO was 7.75% and 8.75% at December 31, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 10.5% in 1993 and 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by 1 percentage point, the APBO at December 31, 1993 would be increased by 10% and 1993 periodic postretirement benefit cost would increase 13%. Prior to the adoption of FAS 106, USAir recognized expense for retiree health care at an estimated monthly rate (based on payments) and recognized expense for death benefits when paid. The expense using this methodology was approximately $8 million for 1991. (c) Postemployment Benefits USAir adopted Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" ("FAS 112"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million. (10) SUPPLEMENTAL BALANCE SHEET INFORMATION The components of certain accounts in the accompanying balance sheets are as follows: (11) NON-RECURRING AND UNUSUAL ITEMS (a) 1993 USAir's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full-time positions between November 1993 and the first half of 1994; (iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reservation system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft, recorded in the second quarter of 1993. (b) 1992 USAir's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; and (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992. (c) 1991 USAir's results for 1991 include (i) a $107 million a pre-tax gain related to freezing of the fully funded non-contract employee pension plan; (ii) a $21.6 million pre-tax expense related to early retirement incentives offered to certain employees during 1991; (iii) a $21 million pre-tax charge to establish an additional reserve for USAir's grounded BAe-146 fleet; and (iv) a $18.5 million, net, in miscellaneous pre-tax non-recurring charges. (12) SELECTED QUARTERLY FINANCIAL DATA (Unaudited) The following table presents selected quarterly financial data for 1993 and 1992: Item 9.

701345

1993

876858

1993

Item 6. Selected Financial Data The summary of selected financial data appearing under Financial Summary in CBI's 1993 Annual Report to Shareholders is incorporated herein by reference. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Information appearing under Financial Review in CBI's 1993 Annual Report to Shareholders is incorporated herein by reference. Item 8.

310431

1993

Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Encore Computer Corporation ("Encore" or the "Company") was founded in May 1983 and was in the development stage until October 1986. During this period, the Company was primarily involved in the research, development and marketing of its UNIX- based Multimax computers and Annex terminal server. Initial sales of the Multimax and Annex products as well as revenues under certain U.S. government agency research contracts began in 1986. During 1989, Encore acquired substantially all of the assets of the Computer Systems Division of Gould Electronics Inc. (the "Computer Systems Business"). This was a significantly larger business which for over twenty-five years, provided real- time computer systems solutions to the simulation, range and telemetry, and energy marketplaces. Since the acquisition, the Company has fully integrated the businesses blending the strengths of each into next generation product offerings. This has resulted in the development of the Infinity 90 and Encore 90 Families of open systems targeted toward demanding, time critical applications in both the general purpose computing and real-time marketplaces. Based on RISC processors, a standard UNIX operating system and industry standard connectivity and networking protocols, both the Infinity 90 and Encore 90 Families offer massive I/O throughput, a broad I/O bandwidth, complete computational scalability and price/performance advantages over traditional mainframe solutions. The first members of the Encore 90 Family, the Encore 91 Series and the Encore 93 Series began shipments in 1991. The Infinity 90, an open system mainframe alternative, was available in the second half of 1992 and then during the second half of 1993, the Infinity R/T, a real-time version of the Infinity 90, was released for volume shipments. During the late 1980s, product demand in the computer marketplace began a migration away from more traditional proprietary computing technologies and towards an open systems technology. The Company anticipated this market trend and since the acquisition of the Computer Systems Business focused its research and development investments toward the development of a new generation of computer system based on a state of the art open system architecture. Since the beginning of 1991, the Company has spent approximately $76,000,000 in research and development activities with a significant portion of this directed toward programs aimed at bringing new open system technology products, such as the Infinity 90, Infinity SP and Encore 90 Families, to market. The Company must continue to invest heavily in the areas of research and development to remain competitive in the marketplace. As a percentage of net sales, research and development spending will remain high in comparison to industry averages. The Company believes that this will allow it to provide early availability of leading-edge computer technology which could position the Company favorably as the marketplace continues to migrate. During 1993 the Company's products have been favorably reviewed by certain market research firms and the Infinity 90 set a world record in performance of the industry-standard AIM-II TPC benchmarks. While the general opinion of industry analysts is that future computer solutions will be based on open systems and standards, this market is still in its infancy. Many data processing users are only now beginning to define their strategies for implementation of such technology. Accordingly, demand for the Company's open systems products has been weak. Over the three year reporting period, this has placed the Company in an extended period of product transition. Older, established products have reached the end of their competitive life cycle and are now experiencing a significant decline in revenues while the Company's newer technology product offerings have not yet generated the level of customer demand anticipated by the Company. Revenues have decreased from $153,302,000 in 1991 to $93,532,000 in 1993 and as a result the Company has incurred significant net losses. In response to the declining revenue base and resultant lower gross margin dollars, management has taken aggressive actions throughout this period to restructure the organization to levels more consistent with the declining size of the Company. These actions have included reducing the workforce to levels required to support the business, eliminating organizational redundancies and consolidating certain facilities to eliminate unneeded capacity. In connection with the restructuring activities, the Company has also recognized the non- recoverability of certain capitalized software products and the impairment in value of certain other long lived assets, including goodwill. As a result of the actions taken, the Company has recorded restructuring charges of $57,545,000 over the three year period. Because of the net losses incurred since the beginning of 1991, the Company has not generated sufficient levels of cash flow to fund its operations and cumulatively used cash in operating and investing activities of $104,998,000. While a portion of the losses incurred were funded by reductions in the working capital, the principal source of financing has been provided by Japan Energy Corporation ("Japan Energy"; formerly Nikko Kyodo Co., Ltd.) and certain of its wholly owned subsidiaries. Should the Company continue to incur significant losses, it will be difficult to operate as a going concern without the on-going financial support of Japan Energy. Until the Company returns to a sustained state of profitability, it will not be able to secure financing from other sources. Accordingly, should Japan Energy withdraw its financial support prior to the time the Company returns to profitability, the Company will experience a severe liquidity crisis and have difficulties settling its liabilities in the normal course of business. However, management believes the current availability of new technology products, such as the Infinity 90 and Infinity SP, could improve the Company's revenue stream and related profitability. Until such a time, the Company will continue to adjust spending to levels consistent with expected business conditions. Comparison of Calendar 1993, 1992 and 1991. Net sales for 1993 were $93,532,000 compared to net sales for 1992 and 1991 of $130,893,000 and $153,302,000, respectively. The 1993 revenue decline is due to both lower product and service sales. In 1993, equipment sales decreased to $43,622,000 from $67,840,000 and $81,272,000 in 1992 and 1991, respectively. Service revenues for fiscal 1993, 1992, and 1991 were $49,910,000, $63,053,000, and $72,030,000, respectively. In general as discussed below, the principal declines since 1990 are due to lower sales volumes. Despite the availability of new technology products such as the Infinity 90 and Encore 90 Families of products and continued enhancements to the Encore RSX product line, 1993 equipment sales decreased from prior years. This decline is due to a continued general softness in the computer industry as well as the fact that certain of the Company's products have reached the end of their life cycles. The computer industry is strongly influenced by changes in microchip technology. Customers tend to purchase those products offering leading-edge implementations of the most currently available technology. In recent years, product demand has begun a migration from proprietary to open system architectures. Prior to 1992, the Company's principal product offerings were proprietary architectures whose core technology was developed in the early 1980s. While product enhancements have been made, the Company's older products lost some of their technological edge. Accordingly, the Company was increasingly less competitive selling into new, long-term programs in its traditional real-time markets. This has contributed to the continuing decline in net sales. During 1992, both the Infinity 90 and Encore 90 Families based on new state of the art open systems technology, were available for sale. However, the open systems computer market place is still in its infancy and data processing users are now just beginning to adopt this technology. As a result, demand for new products based on an open systems architecture has not generated the levels of sales necessary to offset the declines realized on sales of the older, traditional product lines. It is possible that the Company will continue to experience declining revenues until such time as the overall market conditions improve and customer demand for open system products increases. Service revenues have declined from the prior year by 21% and 13% in 1993 and 1992, respectively reflecting the continued price competitiveness of the marketplace as well as the effect of the Company's declining system sales. However, as a percentage of total net sales, service revenues have increased from 47% in 1991 to 53% in 1993. Because most of the Company's installed equipment base remains in use for several years after installation and customers generally elect to purchase maintenance contracts for their system while it is in service, the rate of decline in service revenues has lagged that of equipment revenues. Accordingly, since 1991 service revenues have become an increasingly larger portion on the Company's sales mix. International sales in 1993, 1992 and 1991 were $41,371,000, $65,209,000, and $71,167,000 and 44%, 50%, and 46%, respectively of total net sales. The principal decreases in all years have occurred in Western Europe. The European markets have been adversely impacted by the same factors as the overall business, i.e. the effect of a prolonged product line transition combined with an overall general weakness in both the economy and the computer marketplace. Additionally, during 1993 a major United Kingdom distributor decided to delay the purchase of new computer systems until an enhanced version of the Infinity 90 product line becomes available for sale. This product offering is not anticipated until the middle of 1994. During 1993 sales to this distributor decreased by approximately 75% compared to 1992. In light of the downturn in international operations, management has taken actions as discussed below to reduce expenses to levels more consistent with expected future business levels. However, the decrease in international margins caused by the decline in international revenue has not been fully offset by lower international operating expenses. As displayed in Note K of the Notes to Consolidated Financial Statements, international operations have incurred operating losses in 1993 and 1992. While no single customer has accounted for as much as 10% of total net sales during the last three years, sales to various U.S. government agencies have represented approximately 37% and 29% of net sales in 1993 and 1992. The Company recognizes that reductions in current levels of U.S. government agency spending on computers and computer related services could adversely affect its traditional sources of revenue. To mitigate any potential risk, plans are in place to strategically expand into non- traditional, high growth markets with the Infinity 90 and Infinity SP Family of products. The high speed processing capabilities of these products combined with its architecture's scalability, make the product well suited for applications traditionally thought to be the sole domain of mainframe computers. Among the markets being targeted by the Company are Input-Output (I/O) intensive transaction processing data base applications and data storage applications where high speed performance is a critical factor. In certain cases, U.S. government agencies, such as the Department of Defense, are precluded from awarding contracts requiring access to classified information to foreign owned or controlled companies. The principal source of both debt and equity financing for the Company has been through Japan Energy (a Japanese corporation) and certain of its wholly owned subsidiaries. Aware of U.S. government limitations on the ability of certain agencies to do classified business with foreign owned or controlled companies, Encore and Japan Energy have proactively worked to comply with all U.S. government requirements. In this connection, Japan Energy has agreed to accept certain terms and conditions relating to its equity securities in the Company, including the limitation of voting rights of its shares, limitations on the number of seats it may have on the board of directors and certain restrictions on the conversion of its preferred shares into common stock. In connection with the recapitalizations discussed in more detail below and in Notes G, J, and L of the Notes to Consolidated Financial Statements, the Company requested the United States Defense Investigative Service ("DIS") to review the relationship between the Company, Japan Energy, and Japan Energy's wholly owned subsidiaries, Gould Electronics Inc. ("Gould") and EFI International Ltd. ("EFI"), under the United States Government requirements relating to foreign ownership, control or influence. DIS has indicated that it has no objection. Encore is committed to complying with all U.S. government requirements regarding foreign ownership and control of U.S. companies. At this time, the Company is unaware of any circumstances that would adversely affect the opinions previously issued by DIS. However, should DIS change its opinion of the nature of Japan Energy's influence or control on the Company, a significant portion of the Company's future revenues realized through U.S. government agencies could be jeopardized. Total cost of sales decreased in 1993 to $65,831,000 from $79,040,000 in 1992 and $98,163,000 in 1991. The decrease in 1993 was due generally to lower sales volumes when compared to 1992 and lower spending resulting from the restructuring of manufacturing and customer service operations during the three year period. Since the beginning of 1991, manufacturing and customer service headcount have been reduced by 54%, certain customer service field operations have been closed or scaled back, and all manufacturing operations have been consolidated in Melbourne, Florida. Gross margins on equipment sales in 1993 were $14,041,000 (32.2%) compared to 1992 gross margins of $33,557,000 (49.5%) and $30,182,000 (37.1%) in 1991. The decrease in 1993 equipment gross margins of $19,516,000 is due principally to: (i) lower margins of $12,500,000 on lower equipment sales, (ii) lower margins of $2,200,000 due to price erosion, (iii) increased obsolescence charges of $3,280,000 in connection with the Company's continued migration to its newer open systems product offerings and (iv) non-recurring engineering charges and other miscellaneous cost increases of $1,536,000. The 1992 gross margin improvement of $3,375,000 from 1991 on lower equipment sales is attributable primarily to lower manufacturing costs of $2,450,000 resulting from lower spending and improved operational efficiencies when compared to the prior year as well as lower inventory obsolescence costs of $6,437,000. These improvements more than offset the gross margin reduction from the year's lower revenue. In response to the reduced production volumes, expenditures have been reduced throughout the three year period to minimize the further deterioration of equipment gross margins. Among the actions taken since 1991 have been a 45% reduction in manufacturing personnel and the consolidation of all manufacturing activities in Melbourne, Florida. 1993 service gross margin was $13,660,000 (27.4%), a decrease of $4,636,000 from 1992. The lower margin is due to lower revenues of $13,143,000 which were only partially offset by lower operating costs achieved through restructuring actions taken during both 1992 and 1993. Among the principal cost reductions during 1993 were lower employee costs of approximately $5,500,000 due to reduced headcount, lower field office rental costs of approximately $1,200,000 as marginally profitable field locations have been consolidated or closed and other miscellaneous cost reductions of $1,807,000. Service gross margins also decreased in 1992 by $6,661,000 to $18,296,000 (29.0%) compared to prior year's gross margin of $24,957,000 (34.6%). The 1992 reduction was due to a decline of $8,977,000 in 1992 annual service revenues which were only partially offset by lower operating costs. Since 1990, the service business has been unfavorably affected by the Company's declining computer equipment sales, competitive pricing pressures, declining defense spending which has resulted in some maintenance program cancellations, and the termination of certain other service contracts as older installed systems are being decommissioned by their users. Since 1990 approximately 25% of each year's existing service contracts have not been renewed with the Company. Management will continue efforts to minimize the effect of declining service sales on the service gross margins by taking actions to maintain spending at levels consistent with expected future business levels. In the past, these actions have included reductions in workforce, the closing and consolidation of unprofitable field operations and the outsourcing of certain business functions. In the fourth quarter of 1993 the Company took further action to minimize the fixed cost associated with its domestic service business when it agreed to subcontract its equipment maintenance business to Halifax Corporation ("Halifax"). Under the terms of the agreement which takes full effect in 1994, Halifax will provide the manpower required to service equipment under maintenance contract with the Company. The agreement allows the Company to reduce the fixed cost base associated with its field maintenance operation while continuing to provide the same level of service to its customers. 1993 research and development expenses were $23,331,000 (24.9% of net sales) or an increase of $998,000 from 1992. The increase in the current year's spending is due to efforts in the fourth quarter to accelerate the availability of new products scheduled for release in the first half of 1994. For the first three quarters of 1993, spending was essentially unchanged from 1992 levels. Research and development expense increased only 4% in 1993, however, as a percentage of net sales it increased by 7.8% from 17.1% to 24.9% of net sales as a direct result of the year's net sales decline. During 1992, research and development expenses were $22,333,000 (17.1% of net sales) compared to expenses of $30,543,000 (19.9% of net sales) in 1991. In total and as a percentage of net sales, 1992 expenses decreased from 1991 levels as efforts to accelerate the introduction of the Encore 90 and Infinity 90 Family of computers concluded during 1992 and the benefit of cost reduction actions taken in 1991 were fully realized. During 1991 priorities were realigned to focus future expenditures toward those strategically aligned product offerings necessary to the future growth of the business. This significantly reduced the level of investment in areas outside the Company's strategic focus and has allowed the development organization to reduce its headcount by 30% since 1991. Activities at the Marlborough, Massachusetts facility were significantly reduced with on-going activities consolidated in Ft. Lauderdale, Florida, thereby eliminating the on-going fixed expenses associated with that facility. The reductions made in research and development spending since 1991 generally reflect operational efficiencies realized through the elimination of efforts not targeted toward the core business and are not expected to impact the Company's future competitiveness in the marketplace. To effectively compete in its market niches, the Company must continue to invest aggressively in research and development activities. Sales, general and administrative (SG&A) expenses in 1993 were $42,499,000 compared to $45,156,000 and $48,732,000 in 1992 and 1991, respectively. SG&A expenses decreased by $2,657,000 in 1993 when compared to 1992 due primarily to (i) the effect of prior restructuring actions taken by the Company, including lower labor on a reduced 1993 workforce and (ii) lower sales commissions due to lower 1993 revenues. These savings were partially offset by a non-recurring charge to compensation expense of $788,000 made in connection with the extension of the expiration date of certain stock options made during the Company's fourth fiscal quarter. A more complete discussion of this transaction is included in Note J of Notes to the Consolidated Financial Statements. The 1992 SG&A expense reduction of $3,576,000 from 1991 was due primarily to reductions in staff made in 1991 and worldwide facility consolidation programs implemented as part of earlier restructuring programs. As a percentage of net sales, sales, general and administrative expenses were 45.4%, 34.5%, and 31.8% in 1993, 1992, and 1991, respectively. The increase as a percentage of sales reflects the fact that reductions in sales, general and administrative spending have been more than offset by declines in net sales. This is partially due to the time delay in reducing certain fixed costs. In the future, sales, general and administrative costs should begin to return toward 1991 levels. The Company employs a multi-level distribution system to market its products, consisting of direct sales, OEMs, systems integrators and value added resellers (VARs). The Company is committed to expanding its distribution channels for its new products by aggressively seeking strategic alliances with other industry leaders in the marketplace. In this connection, during the first quarter of 1994, the Company and Amdahl Corporation entered into a non-exclusive multi-year agreement whereby Amdahl Corporation will remarket the Company's Infinity SP under the Amdahl brand. In each of the three years reported, the Company has taken actions to restructure its operations to levels consistent with the expected levels of future revenues. As discussed in Note F to Consolidated Financial Statements, 1993 operating expenses include restructuring charges of $23,265,000 compared to $5,248,000 and $29,032,000 for 1992 and 1991, respectively. In connection with the 1993 charges, during the second and fourth quarters management evaluated the latest financial projections of the business and based upon its evaluation concluded: (i) the rate of decline in real-time equipment and service revenues had exceeded its previous estimates, (ii) the rate of worldwide sales growth anticipated in newer product lines remained significantly below projected levels and (iii) overall business conditions in Western Europe had continued to deteriorate during the year. In light of these conclusions, management initiated the following actions to restructure its operations to levels required to meet expected future business conditions including: (i) reductions in the workforce to levels consistent with planned future sales (ii) the closure or consolidation of marginally profitable field offices and (iii) the reassessment of carrying values of certain long lived assets including property and equipment and goodwill. In June 1993, the Company reduced its workforce by approximately 10% with significant reductions made in manufacturing, customer services and international sales operations. In December 1993, plans were approved to further reduce the European workforce by 20% and U.S. headcount by approximately 8%. Because of the reduced field sales and service workforce, actions were also taken to eliminate the resulting excess field office space by closing those offices which were considered underutilized. Due to the decline in traditional real-time product line profits, the Company re-evaluated its investment in the property and equipment employed to support future real-time product sales. As a result of the analysis, management wrote down the carrying value of certain of these assets by $5,700,000 during the year. Finally, as discussed below, during June 1993 the Company wrote off the remaining carrying value of the goodwill originally recorded in connection with the 1989 acquisition of the Computer Systems Business. Of the total 1993 restructuring charges, approximately $12,000,000 reflects the write-off of long lived assets, resulting in a non-cash charge to the business. The actions taken during 1993 are intended to reduce the Company's future annual operating costs by approximately $12,000,000. Management will continue to assess its cost structure and the carrying value of its assets in light of expected future business. While there are no existing plans to take any additional actions, should future conditions necessitate it, management could approve additional plans to further reduce its cost base or recognize the additional impairment of certain long lived assets. The 1992 restructure charge includes severance and outplacement costs associated with a 9% reduction in the workforce, the write- off of certain capitalized software assets relating to the on- going transition of the Company's UNIX-based product lines, and certain costs to be incurred related to the closure of certain sales and service offices. $1,250,000 of this charge reflects non-cash charges to operation and as a result of the 1992 restructuring, annual operating expenses were reduced by approximately $6,000,000. The 1991 restructuring charge included: (i) severance and outplacement costs associated with a 24% reduction in the workforce, (ii) the write-down of goodwill related to the acquisition of the Computer Systems Business, (iii) costs incurred during the scale back of operations in Marlborough, Massachusetts, (iv) the write-off of certain capitalized software assets relating to the transition of the Company's UNIX-based product lines, and (v) costs incurred related to a facilities consolidation program including certain Ft. Lauderdale, Florida properties. $14,000,000 of the 1991 restructuring expense involved non-cash charges to operations. As a result of the 1991 restructuring actions, the Company lowered annual operating expenses by approximately $15,000,000. With regard to the write-off of goodwill, in 1989 the Company acquired the Computer Systems Business of Gould. In recording the acquisition, the Company recognized goodwill which represented the excess of acquisition cost over the fair value of assets acquired. During 1991 management determined the future earnings power associated with the certain portions of the acquired Computer Systems Business had diminished. However, the customer service business which represented in excess of 45% of the acquired Computer Systems Business revenues, continued to yield gross margins in excess of those of its direct competitors. The analysis indicated this earnings premium could result in additional future profits over the next seven years. Furthermore, at that time in management's judgment, the infrastructure acquired by the Company was still largely intact and continued to provide the potential for higher earnings in other portions of the business. In conjunction with this review, management assessed the carrying value assigned to goodwill and determined the future earnings potential of the Computer Systems Business was now less than the current carrying value of goodwill. Accordingly, in the fourth quarter of 1991, the Company wrote down the carrying value of goodwill from $12,979,000 to $4,979,000 by charging operations. The carrying value of goodwill after the write-down was equivalent to the estimated remaining earnings premium associated with the Computer Systems Business. During 1992 the Company's customer service operations came under increasing competitive pressure and some customers began to decommission installed systems canceling service contracts with the Company. In light of the declining base of acquired customer service business, management increased the rate of amortization of goodwill so that by the end of 1994 any excess value associated with the Computer Systems Business customer service base would be fully amortized. However, the continued decline in the earnings base during 1993 resulted in the write off of the remaining carrying value of goodwill ($2,628,000) by charging operations. Interest expense decreased to $6,380,000 in 1993 from $7,425,000 in 1992 and $9,175,000 in 1991 due primarily to lower average debt in 1993 when compared to the prior years. During 1992 and 1991, Encore completed a series of refinancing agreements with Japan Energy, Gould and EFI as discussed in more detail below and in Notes G and J of the Notes to Consolidated Financial Statements. As a result of the various refinancings, the Company's annual interest expense was reduced by approximately $12,000,000 through the conversion of debt with a face value of $140,000,000 into the Company's preferred stock. Interest income decreased in 1993 by $129,000 to $134,000 compared to $263,000 and $561,000 in 1992 and 1991, respectively due primarily to lower interest rates. Other expense was $780,000 in 1993, a decrease of $1,297,000 from 1992's $2,077,000, due principally to lower foreign exchange losses. In 1991, other expense was $1,259,000. Income taxes provided in 1992, 1991, and 1990 relate to taxes payable by foreign subsidiaries (see Note H of the Notes to Consolidated Financial Statements). Liquidity and Capital Resources Because of operating losses incurred for the three years ending December 31, 1993, the Company has been unable to generate cash from operating activities. In 1993, 1992, and 1991, the Company used cash in operating activities of $36,415,000, $15,307,000, and $8,817,000, respectively. During these years, losses incurred due to declining net sales were partially funded by reductions in current assets, principally accounts receivable. In 1993, 1992, and 1991 accounts receivable decreased by $11,857,000, $4,787,000, and $14,207,000, respectively. Further benefit of cash generated through the reduction in the Company's investment in accounts receivable is unlikely. During 1993 some of the benefit received from lower accounts receivable was offset as the Company used cash of $2,649,000 to increase its investment in new product inventories. The increase was due principally to acquisition of materials in the second half of 1993 to support forecasted deliveries of new products including the Infinity 90. Expenditures for property and equipment during 1993, 1992, and 1991 are $11,780,000, $10,119,000 and $17,025,000, respectively. Expenditures for capitalized software during 1993, 1992, and 1991 are $2,142,000, $2,365,000, and $2,640,000, respectively. As of December 31, 1993, there were no material commitments for capital expenditures. Total cash used in operating and investing activities during 1993, 1992 and 1991 of $50,277,000, $27,441,000 and $27,280,000, respectively. These cash outflows were principally offset by cash provided through financing activities of $49,007,000, $24,327,000, and $24,392,000 in 1993, 1992, and 1991, respectively. As discussed below, the principal source of financing has been through various agreements provided by Japan Energy and its wholly owned subsidiaries Gould and EFI (the "Japan Energy Group"). Most recently, on February 4, 1994, Gould exchanged $100,000,000 of indebtedness owed to it by the Company for Series E Convertible Preferred Stock ("Series E"). Also on April 11, 1994, the Company and Gould agreed to amend and restate its existing revolving loan agreement with the Company to increase the amount available under the agreement to $50,000,000 and extend the maturity date of the agreement to April 16, 1996. The other terms and conditions of the agreement are essentially unchanged from those of the prior agreement except certain financial covenants which were modified to more closely reflect the Company's financial position. The Company believes this credit agreement should be sufficient to meet the needs of the business through December 31, 1994. Since 1990, the Company and the Japan Energy Group have entered into the following financing transactions: On January 28, 1991, the Company exchanged Series B Convertible Preferred Stock ("Series B") and Series C Redeemable Preferred Stock ("Series C") for $60,000,000 of indebtedness owed to Gould and concurrently entered into a revolving loan agreement with Gould which, as amended, provided for borrowings of up to $50,000,000. Terms of the Series B are discussed in detail in Note J of the Notes to Consolidated Financial Statements. Effective March 31, 1992, the Company, Gould and Japan Energy completed an agreement whereby Gould converted the Company's existing revolving credit facility with a balance of $50,000,000 into a two year term loan and made available to Encore a new $10,000,000 revolving loan facility with a maturity date of March 31, 1993. Concurrently, Japan Energy through EFI agreed to refinance through its existing term an existing $80,000,000 subordinated loan the Company had with the Industrial Bank of Japan. On September 10, 1992, Gould exchanged 100,000 shares of the Series C with a liquidation preference of $10,000,000 which it held for 100,000 shares of Series D Convertible Preferred Stock ("Series D") also with a liquidation preference of $10,000,000. In connection with the transaction, the Company released Gould from any liability associated with certain outstanding claims related to or arising from the sale by Gould of its Computer System Business to the Company in 1989. Concurrently, EFI exchanged $80,000,000 ($65.5 million net of debt discount) of indebtedness owed to EFI by the Company for 800,000 shares of the Series D with an aggregate liquidation preference of $80,000,000. Completion of the exchange of Series D for the EFI subordinated loan lowered the Company's interest expense by approximately $6,000,000 per year. Terms of the Series D are discussed in detail in Note J of the Notes to Consolidated Financial Statements. On October 5, 1992, Gould agreed to increase the borrowing limit of the revolving loan agreement by $5,000,000 to $15,000,000 under essentially the same terms and conditions as the original agreement. However, as a result of fourth quarter operating losses, the Company exceeded the maximum amount available under the credit facility at December 31, 1992. Effective April 1, 1993, the Company and Gould agreed to: (i) increase the amount available under the revolving credit facility to $35,000,000 under essentially the same terms and conditions as the original agreement, (ii) extend the maturity date of the revolving credit facility to April 16, 1994, (iii) extend the maturity date of the Gould term loan to April 2, 1995 and (iv) waive the covenants contained in the revolving credit facility and the term loan through the end of the first quarter of 1994. Because of operating losses incurred during 1993, the Company reported a capital deficiency throughout the year and exceeded the maximum borrowing limit of the revolving loan agreement during its third fiscal quarter. At December 31, 1993 the Company had borrowed $61,924,000 under the agreement. During the fourth quarter, the Company initiated discussions with Gould to significantly recapitalize the Company. As discussed above and in Note G of Notes to the Consolidated Financial Statements, on February 4, 1994, the Company and Gould agreed to exchange the existing $50,000,000 term loan and $50,000,000 of borrowings under the revolving loan agreement for Series E convertible preferred stock. Terms of the Series E are discussed in detail in Note L of the Notes to Consolidated Financial Statements. On April 11, 1994, the terms of the revolving loan agreement were amended and restated to increase the amount available under the agreement to $50,000,000 and to extend the agreement's maturity date to April 16, 1996. All other terms and conditions of the agreement were essentially unchanged. The Company is dependent on the continued long-term financial support of the Japan Energy Group. Should the Japan Energy Group withdraw its financial support at any time prior to the time the Company returns to profitability by either (i) enforcement of its rights under the terms of its revolving credit agreement in the event of possible future defaults by the Company related to covenants contained therein, (ii) failing to renew existing debt agreements as they expire or (iii) failing to provide additional credit as needed, the Company anticipates it will not be able to secure financing from other sources. In such a case, the Company will suffer a severe liquidity crisis and it will have difficulties settling its liabilities in the normal course of business. The majority of the year end cash on hand of $3,751,000 was at various international subsidiaries. With minor exceptions, all cash is freely remittable to the United States. On January 22, 1992, the Company's stock was excluded from further participation in the Nasdaq National Market system because it was unable to meet minimum capitalization requirements for continuation. Effective February 22, 1992, the Company's common stock began trading on the OTC electronic bulletin board. Upon completion of the $100,000,000 exchange of preferred stock for indebtedness on February 4, 1994, the Company met the minimum requirements for participation in the Nasdaq National Market system and was accepted into the system on March 18, 1994. The Company's common stock trades under the symbol ENCC. ITEM 8

764037

1993

ITEM 6. SELECTED FINANCIAL DATA The selected financial data for the five years ended December 31, 1993, appearing under "Selected Financial Information" on page 7 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1993, is incorporated by reference in this Annual Report on Form 10-K. The Corporation's dividend payout ratio for 1990 and 1989 was 47.4% and 31.0%, respectively. Due to the Corporation's loss in 1991, the dividend payout ratio for 1991 is not meaningful. The Corporation did not pay any dividends in 1993 or 1992. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item appearing on pages 8 through 33 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1993, is incorporated by reference in this Annual Report on Form 10-K. ITEM 8.

201461

1993

ITEM 6 - SELECTED FINANCIAL DATA - -------------------------------- "Eleven Year History - Financial Highlights" at page 43 of Dana's 1993 Annual Report is incorporated herein by reference. ITEM 7

ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------------------------------------------------------------------------ RESULTS OF OPERATIONS - --------------------- "Management's Discussion and Analysis of Results" at pages 35-36 of Dana's 1993 Annual Report is incorporated herein by reference. ITEM 8

26780

1993

Item 6. Selected Consolidated Financial Data. This information is incorporated by reference to "Selected Annual Consolidated Financial Data" on page 36 of the Annual Report to Shareholders for the year ended December 31, 1993. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and note 5 to the consolidated financial statements contained in the Annual Report to Shareholders for the year ended December 31, 1993 for discussion of material uncertainties which might cause the information incorporated by reference above not to be indicative of future financial condition or results of operations. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. This information is incorporated by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 6 through 16 of the Annual Report to Shareholders for the year ended December 31, 1993. Item 8.

741612

1993

ITEM 6. SELECTED FINANCIAL DATA. The information set forth under the caption 'Five-Year Summary of Selected Financial Data' on page 34 of the Warner-Lambert 1993 Annual Report is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The information set forth under the caption 'Management's Discussion and Analysis of Financial Condition and Results of Operations' on pages 28 through 33 of the Warner-Lambert 1993 Annual Report is incorporated herein by reference and should be read in conjunction with the consolidated financial statements and the notes thereto contained on pages 34 through 47 of the Warner-Lambert 1993 Annual Report. ITEM 8.

104669

1993

ITEM 6. SELECTED FINANCIAL DATA. The following selected financial data should be read in conjunction with the financial statements of GE Capital Services and consolidated affiliates and the related Notes to Financial Statements. The Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," on December 31, 1993 resulting in the inclusion of $812 million of net unrealized gains on investment securities in equity at the end of the year. SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," was implemented in 1991 using the immediate recognition transition option. The cumulative effect to January 1 of adopting SFAS No. 106 was $19 million, net of $12 million tax credit. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS. OVERVIEW The Corporation's earnings were $1,807 million in 1993, 21% more than 1992's earnings of $1,499 million, which were 18% more than the comparable 1991 earnings of $1,275 million. The 1993 increase reflected strong performance in the Corporation's financing businesses, mainly as a result of a favorable interest rate environment, asset growth and improved asset quality. Earnings of the Corporation's Securities Broker-Dealer and Specialty Insurance segments were substantially higher in 1993. The 1992 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). increase reflected sharp improvement in the earnings of both the Specialty Insurance and Securities Broker-Dealer Segments. OPERATING RESULTS EARNED INCOME from all sources increased 20% to $22.1 billion in 1993, following a 12% increase to $18.4 billion in 1992. Asset growth in each of the Corporation's financing segments, through acquisitions of businesses and portfolios as well as origination volume, was the primary reason for increased income from time sales, loans, financing leases and operating lease rentals in both 1993 and 1992. Yields on related assets were essentially flat in 1993 compared with 1992, following a decline from 1991. Earned income in 1993 from the Corporation's annuity business, formed through two current year acquisitions, was $571 million. Specialty Insurance revenues increased 26% in 1993, compared with a 29% increase in 1992, due to higher premium and investment income as well as the impact of the creditor insurance business, which was consolidated at the end of the second quarter of 1992 when an existing equity position was converted to a controlling interest. Securities Broker-Dealer revenues increased 21% and 20% in 1993 and 1992, respectively, reflecting higher investment income and investment banking activity. INTEREST AND DISCOUNT EXPENSE on borrowings is the Corporation's principal cost. Interest and discount expense in 1993 totaled $6.5 billion, 6% higher than in 1992, which was 6% lower than in 1991. The 1993 increase was a result of funding increased security positions in the Securities Broker-Dealer segment, partially offset by substantially lower rates on higher average borrowings supporting financing operations. The 1992 decrease reflected substantially lower interest rates, which more than offset higher average borrowings and the cost of funding higher levels of security positions in the Securities Broker-Dealer segment. Composite interest rates on the Corporation's borrowings were 4.96% in 1993 compared with 5.78% in 1992 and 7.46% in 1991. OPERATING AND ADMINISTRATIVE EXPENSES increased to $7.1 billion in 1993, a 20% increase over 1992, which was 40% higher than 1991, primarily reflecting operating costs associated with businesses and portfolios acquired during the past two years. Overall, provisions for losses on investments charged to operating and administrative expense decreased in 1993, following an increase in 1992. These provisions principally related to the Commercial Real Estate and highly leveraged transaction (HLT) portfolios, and in 1993, to commercial aircraft as well. INSURANCE LOSSES AND POLICYHOLDER AND ANNUITY BENEFITS increased 62% to $3.2 billion in 1993, compared with a 21% increase to $2.0 billion in 1992. The 1993 increase principally reflected annuity benefits credited to customers following the current year annuity business acquisitions, as well as higher losses on increased volume in the property and casualty reinsurance and life reinsurance businesses. In 1992, higher losses on increased volume in the property and casualty reinsurance and the private mortgage insurance businesses, and the effects of the creditor insurance business for the second half of the year, were partially offset by lower losses in the life reinsurance business. PROVISION FOR LOSSES ON FINANCING RECEIVABLES decreased $69 million to $987 million in 1993 compared with a $46 million decrease to $1,056 million in 1992. These provisions principally related to the Consumer Services, Commercial Real Estate and HLT portfolios discussed below. DEPRECIATION AND AMORTIZATION OF BUILDINGS AND EQUIPMENT AND EQUIPMENT ON OPERATING LEASES increased to $1.6 billion in 1993, a 22% increase over 1992, which was 9% higher than 1991, primarily as a result of additions to equipment on operating leases through business and portfolio acquisitions. INCOME TAX PROVISION was $841 million in 1993 (an effective tax rate of 32%), compared with $536 million in 1992 (26%) and $382 million (23%) in 1991. The increased provision for income taxes in both 1993 and 1992 reflected the effects of additional income before taxes and, in 1993, the 1% increase in the U. S. Federal income tax rate. The higher rate in 1993, compared with 1992, primarily reflected the 1% increase in the U.S. Federal income tax rate and a lower proportion of tax-exempt income. These items were partially offset by the effects of certain unrelated financing transactions that will result in future cash savings and reduced the Corporation's obligation for previously accrued deferred taxes. The higher rate in 1992, compared with 1991, reflected a relatively lower proportion of tax-exempt income and a 1991 adjustment for tax-deductible claims reserves of the property reinsurance affiliates, for which there was no 1992 counterpart. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). OPERATING PROFIT BY INDUSTRY SEGMENT Operating profit (pre-tax income) of the Corporation, by industry segment, is summarized in Note 19 and discussed below: SPECIALTY INSURANCE operating profit of $770 million in 1993 was 20% higher than the $641 million recorded in 1992, which was 28% higher than in 1991. The 1993 increase reflected higher premium volume from bond refunding in the financial guaranty insurance business as well as reduced claims expense in the creditor insurance business. The 1992 gains primarily reflected higher premium volume and investment income at GE Capital's private mortgage and financial guaranty insurance businesses. CONSUMER SERVICES operating profit of $695 million in 1993, was 32% higher than that of 1992. This increase reflected lower provisions for receivable losses in Retailer Financial Services resulting from declines in consumer delinquency as well as strong asset growth and interest rate favorability in both Auto Financial Services and Retailer Financial Services. Operating profit of $525 million in 1992 was 53% higher than that of 1991 (excluding the impact in 1991 of the $134 million gain on the disposition of a significant portion of GE Capital's auto auction affiliate). This increase reflected higher financing spreads in Retailer Financial Services and increased asset levels in Auto Financial Services. EQUIPMENT MANAGEMENT operating profit increased $9 million to $377 million in 1993. This increase reflected higher volume in most businesses, largely the result of portfolio and business acquisitions, and improved trailer and railcar utilization, offset by lower average rental rates in Fleet Services and Computer Services, coupled with the effects of lower utilization and pricing pressures at Genstar Container. Operating profit decreased $13 million to $368 million in 1992 due to lower utilization in the Railcar Services and Genstar Container businesses, partially offset by operating profit generated as a result of Fleet Services' 1992 acquisition of the fleet leasing operations of Avis-Europe. MID-MARKET FINANCING operating profit of $454 million in 1993 was 29% higher than that of 1992 and reflected higher spreads and higher levels of invested assets, primarily as a result of business and portfolio acquisitions. Operating profit increased $104 million to $352 million in 1992 compared with 1991. Operating profit for 1992 reflected higher levels of invested assets, primarily as a result of asset portfolio acquisitions. SECURITIES BROKER-DEALER (Kidder, Peabody) operating profit was $439 million in 1993, up 46% from 1992's record $300 million, which was $181 million higher than in 1991. Strong performances in both years reflected higher investment income from trading and investment banking activities. Favorable market conditions were an important factor in both years. Higher interest expense in both years reflected costs associated with funding increased security positions. Operating and administrative expenses increased in both years, primarily because of the revenue growth and, in 1992, because of costs associated with certain litigation settlements. SPECIALIZED FINANCING operating profit was $201 million in 1993, compared with $121 million in 1992, and $220 million in 1991. The increase in 1993 principally reflected much lower provisions for losses on Corporate Finance Group HLT investments and higher gains from sales of Commercial Real Estate assets partially offset by higher loss provisions for Commercial Real Estate assets and expenses associated with redeployment and refurbishment of owned aircraft. The decline in 1992 principally reflected higher loss provisions, particularly reserves for Corporate Finance Group in-substance and owned investments, partially offset by higher gains on the sale of assets in both Commercial Real Estate and Corporate Finance Group. Further details concerning loss provisions relating to both the Commercial Real Estate portfolio and Corporate Finance Group HLT investments are discussed below. CAPITAL RESOURCES AND LIQUIDITY The Corporation's principal source of cash is financing activities that involve continuing rollover of short-term borrowings and appropriate addition of long-term borrowings, with a reasonable balance of maturities. Over the past three years, the Corporation's borrowings with maturities of 90 days or less have increased by $14.0 billion. New borrowings of $40.2 billion having maturities longer than 90 days were added during those years, while $25.6 billion of such longer-term borrowings were paid off. The Corporation has also generated significant cash from operating activities, $14.8 billion during the last three years. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). The Corporation's principal use of cash has been investing in assets to grow the business. Of $40.9 billion that the Corporation invested over the past three years, $16.1 billion was used for additions to financing receivables, $9.3 billion for new equipment, primarily for lease to others and $6.9 billion to acquire new businesses. GE Company has agreed to make payments to GE Capital, constituting additions to pre-tax income, to the extent necessary to cause GE Capital's consolidated ratio of earnings to fixed charges to be not less than 1.10 for each fiscal year commencing with fiscal year 1991. Three years advance written notice is required to terminate this agreement. No payments have been required under this agreement. GE Capital's ratios of earnings to fixed charges for the years 1993, 1992 and 1991, were 1.62, 1.44 and 1.34, respectively. The Corporation's total borrowings were $85.9 billion at December 31, 1993, of which $60.0 billion was due in 1994 and $25.9 billion was due in subsequent years. Comparable amounts at the end of 1992 were: $75.1 billion in total; $53.2 billion due within one year; and $21.9 billion due thereafter. Composite interest rates are discussed on page 4. Individual borrowings are structured within overall asset/liability interest rate and currency risk management strategies. Interest rate and currency swaps form an integral part of the Corporation's goal of achieving the lowest borrowing costs for particular funding strategies. Counterparty credit risk is closely monitored -- approximately 90% of the notional amount of swaps outstanding at December 31, 1993 was with counterparties having credit ratings of Aa/AA or better. With the financial flexibility that comes with excellent credit ratings, management believes the Corporation is well positioned to meet the global needs of its customers for capital and continue growing its diverse asset base. PORTFOLIO QUALITY THE PORTFOLIO OF FINANCING RECEIVABLES, $63.9 billion and $59.4 billion at year-ends 1993 and 1992, respectively, is the Corporation's largest asset and its primary source of revenues. Related allowances for losses aggregated $1.7 billion at the end of 1993 (2.63% of receivables -- the same level as 1992) and are, in management's judgment, appropriate given the risk profile of the portfolio. A discussion about the quality of certain elements of the portfolio of financing receivables and investments follows. Further details are included in Notes 5 and 10. CONSUMER LOANS RECEIVABLE, primarily retailer and auto receivables, were $17.3 billion and $14.8 billion at the end of 1993 and 1992, respectively. The Corporation's investment in consumer auto finance lease receivables was $5.6 billion and $4.8 billion at the end of 1993 and 1992, respectively. Non-earning receivables, 1.7% of total loans and leases (2.1% at the end of 1992), amounted to $391 million at the end of 1993. The provision for losses on retailer and auto financing receivables was $469 million in 1993, a 19% decrease from $578 million in 1992, reflecting reduced consumer delinquencies and intensified collection efforts, particularly in Europe. Most non-earning receivables were private label credit card receivables, the majority of which were subject to various loss sharing arrangements that provide full or partial recourse to the originating retailer. COMMERCIAL REAL ESTATE LOANS classified as finance receivables by the Commercial Real Estate business, a part of the Specialized Financing segment, were $10.9 billion at December 31, 1993, up $0.4 billion from the end of 1992. In addition, the investment portfolio of the Corporation's annuity business, acquired during 1993, included $1.1 billion of commercial property loans. Commercial real estate loans are generally secured by first mortgages. In addition to loans, Commercial Real Estate's portfolio also included in other assets $2.2 billion of assets that were purchased for resale from the Resolution Trust Corporation (RTC) and other institutions and $1.4 billion of investments in real estate joint ventures. In recent years, the Corporation has been one of the largest purchasers of assets from RTC and other institutions, growing its portfolio of properties acquired for resale by $1.1 billion in 1993. To date, values realized on these assets have met or exceeded expectations at the time of purchase. Investments in real estate joint ventures have been made as part of original financings and in conjunction with loan restructurings where management believes that such investments will enhance economic returns. Commercial Real Estate's foreclosed properties at the end of 1993 declined to $110 million from $187 million at the end of 1992. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). At December 31, 1993, Commercial Real Estate's portfolio included loans secured by and investments in a variety of property types that were well dispersed geographically. Property types included apartments (36%), office buildings (32%), shopping centers (14%), mixed use (8%), industrial and other (10%). These properties were located, principally across the United States, as follows: Mid-Atlantic (21%), Northeast (20%), Southwest (19%), West (15%), Southeast (12%), Central (8%), with the remainder (5%) across Canada and Europe. Reduced and non-earning receivables declined to $272 million in 1993 from $361 million in 1992, reflecting proactive management of delinquent receivables as well as write-offs. Loss provisions for Commercial Real Estate's investments were $387 million in 1993 ($248 million related to receivables and $139 million to other assets), compared with $299 million and $213 million in 1992 and 1991, respectively, as the portfolio continued to be adversely affected by the weakened commercial real estate market. HLT PORTFOLIO is included in the Specialized Financing segment and represents financing provided for highly leveraged management buyouts and corporate recapitalizations. The portion of those investments classified as financing receivables was $3.3 billion at the end of 1993 compared with $5.3 billion at the end of 1992, as substantial repayments reduced this liquidating portfolio. The year-end balance of amounts that had been written down to estimated fair value and carried in other assets as a result of restructuring or in-substance repossession aggregated $544 million at the end of 1993 and $513 million at the end of 1992 (net of allowances of $244 million and $224 million, respectively). Non-earning and reduced earning receivables declined to $139 million at the end of 1993 from $429 million the prior year. Loss provisions for HLT investments were $181 million in 1993 ($80 million related to receivables and $101 million to other assets), compared with $573 million in 1992 and $328 million in 1991. Non-earning and reduced earning receivables as well as loss provisions were favorably affected by the stronger economic climate during 1993 as well as by the successful restructurings implemented during the past few years. OTHER FINANCING RECEIVABLES, approximately $26 billion, consisted primarily of a diverse commercial, industrial and equipment loan and lease portfolio. This portfolio grew approximately $2 billion during 1993, while non-earning and reduced earning receivables decreased $46 million to $98 million at year end. The Corporation has loans and leases to commercial airlines that aggregated about $6.8 billion at the end of 1993, up from $6 billion at the end of 1992. At year-end 1993, commercial aircraft positions included conditional commitments to purchase aircraft at a cost of $865 million and financial guarantees and funding commitments amounting to $450 million. These purchase commitments are subject to the aircraft having been placed on lease under agreements, and with carriers, acceptable to the Corporation prior to delivery. Expenses associated with redeployment and refurbishment of owned aircraft totaled $112 million in 1993, compared with nominal amounts in prior years. The Corporation's increasing investment demonstrates its continued long-term commitment to the airline industry. ENTERING 1994, management believes that the diversity and strength of the Corporation's assets, along with vigilant attention to risk management, position it to deal effectively with a global and changing competitive and economic landscape. NEW ACCOUNTING STANDARDS SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," modifies the accounting that applies when it is probable that all amounts due under contractual terms of a loan will not be collected. Management does not believe that this Statement, required to be adopted no later than the first quarter of 1995, will have a material effect on the Corporation's financial position or results of operations, although such effect will depend on the facts at the time of adoption. ITEM 8.

797463

1993

ITEM 6. SELECTED FINANCIAL DATA On March 11, 1993, the company filed a shelf registration with the Securities and Exchange Commission for $125 million of first mortgage bonds and 745,000 shares of $50 par value preferred stock. On May 26, 1993 the company issued $94 million of 7 5/8% first mortgage bonds due in 2023. The proceeds from the sale of the bonds were used to retire higher cost bonds due in 1999, 2001, 2002 and 2008. Also, on May 26, 1993 the company issued 545,000 shares of 6.40% preferred stock. The proceeds from the issuance of the stock were used to redeem higher cost series preferred and preference stock. Below is set forth the ratio of earnings to fixed charges for each of the years in the period 1989 through 1993. December 31, 1989................. 3.69 December 31, 1990................. 3.84 December 31, 1991................. 3.77 December 31, 1992................. 2.69 December 31, 1993................. 2.68 Below is set forth the ratio of earnings to fixed charges and pre- ferred stock dividends for each of the years in the period 1989 through 1993. December 31, 1989................. 3.03 December 31, 1990................. 3.11 December 31, 1991................. 3.13 December 31, 1992................. 2.28 December 31, 1993................. 2.21 See Exhibit EX-12 for the computation of the above ratios. For information pertaining to selected financial data required by Item 301 of Regulation S-K please refer to page 32 of Exhibit EX-13 (the Annual Report to Stockholders). ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For information pertaining to management's discussion and analysis required by Item 303 of Regulation S-K please refer to pages 1 through 11 of Exhibit EX-13 (the Annual Report to Stockholders). ITEM 8.

51720

1993

ITEM 6. SELECTED FINANCIAL DATA. Information for the 1989-1993 period required to be reported by this item is included on pages 34 and 35 of the 1993 Annual Report and is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Information required to be reported by this item is included on pages 16, 17 and 18 of the 1993 Annual Report and is incorporated herein by reference. ITEM 8.

100826

1993

ITEM 6. SELECTED FINANCIAL DATA The information on pages 12 through 17 and 34 of the 1993 Shareholder Report, included in this Form 10-K -- Annual Report as Exhibit 13, is incorporated herein by reference in response to this item. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The information on pages 12 through 17 of the 1993 Shareholder Report, included in this Form 10-K -- Annual Report as Exhibit 13, is incorporated herein by reference in response to this item. ITEM 8.

40533

1993

Item 6. Selected Financial Data For information required by Item 6, refer to the "Selected Financial Data" section of the Financial Statements, Financial Statement Schedules and Supplementary Data filed as part of this report. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations For information required by Item 7, refer to the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of the Financial Statements, Financial Statement Schedules and Supplementary Data filed as part of this report. Item 8.

101830

1993

ITEM 6. SELECTED FINANCIAL DATA The Company hereby incorporates by reference the Selected Financial Data of the Company which appears on page 15 of the Company's Annual Report to Shareholders for fiscal 1993. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company hereby incorporates by reference Management's Discussion and Analysis of Results of Operations and Financial Condition which is set forth on pages 12, 13 and 14 of the Company's Annual Report to Shareholders for fiscal 1993. ITEM 8.

33619

1993

Item 6. SELECTED ANNUAL FINANCIAL DATA 1993 1992 1991 1990 1989 ======== ======== ======== ======== ======== (Thousands, except per share data) FOR YEARS ENDED: Net revenues $ 93,034 $ 72,166 $ 52,943 $ 56,742 $ 50,750 Earnings before income taxes $ 2,071 $ 4,891 $ 635 $ 6,707 $ 6,897 Income taxes (benefit) $ 456 $ 463 $ 127 $ (225) $ 1,294 Net earnings $ 1,615 $ 4,428 $ 508 $ 6,932 $ 5,603 Earnings per common share $ .16 $ .45 $ .05 $ .72 $ .61 AT YEAR-END: Working capital $ 27,984 $ 25,792 $ 14,245 $ 17,915 $ 18,742 Long-term debt $ 24,302 $ 9,322 783 $ - $ 1,200 Shareholders' equity $ 53,779 $ 51,061 $ 42,087 $ 41,321 $ 32,610 Total assets $104,999 $ 74,333 $ 57,675 $ 53,129 $ 44,371 SELECTED QUARTERLY FINANCIAL DATA QUARTERS (unaudited) -------------------------------------------- First Second Third Fourth Year ----- ------ ----- ------ ---- (Thousands, except per share data) ---- Net revenues $20,016 $18,026 $26,604 $28,388 $93,034 Gross profit $ 8,700 $ 6,880 $11,385 $11,648 $38,613 Net earnings $ 507 $ 884 $ 112 $ 112 $ 1,615 Earnings per common share $ .05 $ .09 $ .01 $ .01 $ .16 ---- Net revenues $14,222 $16,567 $19,159 $22,218 $72,166 Gross profit $ 6,427 $ 7,570 $ 9,057 $10,462 $33,516 Net earnings $ 150 $ 943 $ 1,272 $ 2,063 $ 4,428 Earnings per common share $ .02 $ .10 $ .13 $ .20 $ .45 CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Item 7.

Item 7. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- Cash and cash equivalents decreased $2,320,000 during the year to a zero balance. The Company's primary sources of cash were funds provided from funding arrangements, ($14,774,000). The primary uses of cash were the acquisition of property, plant and equipment ($4,600,000), net cash used by operating activities ($6,317,000), acquisitions ($3,184,000) and other investing activities of ($3,660,000). For a detailed analysis of the Company's sources and uses of cash from operating, investing and financing activities, refer to the Consolidated Statements of Cash Flows in the financial section of this report. Below is a discussion that further enhances the Statements of Cash Flows. Depreciation and amortization increased $2,483,000 during the year compared to last year ($6,476,000 versus $3,993,000), as a result of investments principally in manufacturing equipment and management information systems. Increases in amortization resulted from software development costs and the purchase of various intangibles, including patents, licenses, trademarks and customers lists. In addition, goodwill generated from recent acquisitions have also increased amortization expense. Accounts receivable increased $2,716,000 as a result of record revenues posted in the fourth quarter. Property, plant and equipment expenditures decreased $1,543,000 during 1993 ($4,600,000 versus $6,143,000). The principal expenditures for the current year have been made in the areas of production, management information systems and lab equipment for research and development activities. Inventories increased $6,816,000 from the start of the year as a result of an expanded product offering and the Company's anticipated needs for the first half of 1994. Accounts payable increased $2,062,000 as a result of the increased inventory purchases required to meet the increased demand for the Company's products. The Company made acquisitions, net of cash acquired, of $3,184,000 relating to the capital stock purchases of the Company's Argentinean distributor and the ID Systems Group, a European manufacturer and distributor of EAM products. The $3,660,000 in other investing activities is mainly comprised of: capitalized legal expenses related to the defense of certain patents in which the Company holds exclusive rights; the purchase of a customers list from the Company's former Mexican distributor; the capitalization of software development costs; the purchase of patents and license related to two of the Company's new products, magnetics and QS1500/1600; and, deposits related to the Company's lease agreement for a new corporate facility. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) For the year, the Company borrowed a total amount of $15,000,000 under a long-term revolving credit facility. Subsequent to year end $8,000,000 outstanding under this credit facility was converted to a six year term loan at a fixed interest rate of 6.5%. Management is currently working towards finalizing a $12,000,000 private placement debt funding. Once completed, this will be used to pay down existing debt under the Company's long-term revolving credit facility. As of December 26, 1993, the current ratio was 2.0 to 1. The quick ratio was .9 to 1. The equity-debt ratio was 1.0 to 1. Management is currently contemplating other financing in order to fund its aggressive acquisition and selling strategies. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF OPERATIONS --------------------- For the Year Ended December 26, 1993 ------------------------------------ Net revenues increased 29% or $20,868,000 when compared to the prior year ($93,034,000 versus $72,166,000). As a percent of net revenues, domestic and foreign net revenues were 64% and 36%, respectively compared to 69% and 31% for 1992. Domestic Electronic Article Merchandising ("EAM") net revenues increased $9,363,000 or 20% while foreign EAM net revenues increased $10,754,000 or 48% when compared to 1992. The domestic expansion is due principally to large revenue and unit increases in the Company's hardware products (sensors and deactivation) and disposable targets. These substantial gains are the result of expansion of business to large domestic retailers, particularly in the mass merchandise, drug stores, supermarkets, apparel and music segments, a broader product offering, and a record number of new customers in 1993. Foreign revenues increased by 48% as a result of the Company's recent acquisitions in Western Europe, Canada and Argentina along with setting up operations in Mexico. Revenues from the Company's subsidiaries in Canada, Mexico and Argentina represented $9.6 million of the $10.8 million increase. During the second quarter of 1993, the Company and Sensormatic Electronics Corporation ("Sensormatic") terminated their exclusive distribution agreement in Europe. During the third quarter of 1993, the Company purchased all of the outstanding capital stock of ID Systems International B.V. and ID Systems Europe B.V. ("ID Systems Group") related Dutch companies engaged in the manufacture, distribution, and sale of security products and services. Revenues from Western Europe in 1993, which combines first half sales through its former distributor and second half sales by the Company's European subsidiary, remained flat as compared to 1992 in which sales were made solely through the Company's former distributor. Management expects revenues from Western Europe in 1994 to increase over 1993 levels as result of the acquisition of the ID Systems Group. The Company is in the process of closing down the acquired manufacturing facilities in Europe and relocating this production to the Company's facilities in Puerto Rico and the Dominican Republic. Once this relocation is fully completed, sometime during the first half of 1994, the Company anticipates a reduction in the cost of manufacturing of those products previously produced overseas. (Refer to Note 14 of the Consolidated Financial Statements.) As a result of having various foreign operations, the Company is exposed to foreign exchange fluctuations. Management is evaluating various strategies in order to minimize the effect of fluctuating foreign currencies on the Company's financial statements associated with having international subsidiaries. The Company has purchased certain foreign currency forward contracts on intercompany commitments in order to hedge anticipated rate fluctuations in Europe. Electronic Access Control ("EAC") net revenues increased $751,000 or 17% over 1992. The EAC business unit first became profitable in 1991, and has remained profitable, as a result of increased revenues and integrating its operations into the New Jersey, Puerto Rico and Dominican Republic facilities in 1990. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Net earnings were $1,615,000 or $.16 per share versus net earnings of $4,428,000 or $.45 per share for 1992. Earnings decreased due to the reduction in gross profit margins and increased selling, general, and administrative expenses resulting primarily from the recently acquired subsidiaries. The gross profit margin declined 4.9% (41.5% versus 46.4%) as a result of the significant expansion business with new and existing major domestic customers that enjoy competitive pricing and the success of several new products introduced during the year which currently carry lower margins. Although the Company obtained overall higher selling prices during the year, the gains were offset by increased service costs, a result of selling directly to nine countries in which the Company previously maintained distributors. Service costs in 1993 increased 4.3% as a percent of sales as compared to 1992. In addition, due to the termination of the Company's European distribution agreement in the second quarter, the Company reduced production volumes which resulted in slightly higher unit costs in the Company's manufacturing facility in Puerto Rico. Selling, general and administrative expenses increased $10,896,000 ($39,238,000 versus $28,342,000) when compared to last year. The higher expenses are due to increases in variable selling and marketing expenses resulting from greater domestic sales, in addition to increases in general and administrative expenses resulting from the operating expenses of the companies acquired in 1993. As a percent of net revenues, this represents an increase of 2.9% (42.2% versus 39.3%) compared to 1992. The Company's manufacturing operations in Puerto Rico are exempt from U.S. Federal income taxes under Section 936 of the Internal Revenue Code. Approximately 50% of the Company's earnings were attributed to Puerto Rico operations. The Company also enjoys local tax exemptions on Puerto Rico based earnings and benefits from the utilization of a Delaware Investment Holding company. (Refer to note 9 of the Notes to Consolidated Financial Statements.) The Company's 1993 effective tax rate was 22%. Due to the Company's foreign subsidiaries operating in countries with different statutory income tax rates, the Company anticipates a 25% tax rate for 1994. In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." The adoption of this standard did not have a material effect on the Company's financial statements. The Company intends to continue its expansion of both product lines and distribution channels. The increased product offerings are due to internally developed products and the acquisition of products or rights to distribute those products. The Company has expanded its channels of distribution by acquisition of international distributors, acquisition of competitors, and by start-up operations. The Company intends to continue worldwide expansion based on these strategies. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Subsequent to year end and as discussed in Item 3. Legal Proceedings, on March 10, 1993, the United States International Trade Commission instituted an investigation of a complaint filed by the Company under Section 337 of the Tariff Act of 1930. On March 10, 1994 the United States International Trade Commission issued a Notice of Commission Determination Not to Review An Initial Determination Finding No Violation of Section 337 of the Tariff Act of 1930. The Company has capitalized $2,027,000 in patent defense costs, included in "Intangibles" (see Consolidated Balance Sheet) as of December 26, 1993. The ultimate resolution is undetermined at this time due to the various courses of action available to management including the right of appeal which the Company currently intends to exercise. Although the Company's management ultimately expects a favorable outcome, should resolution of this matter result in less than a successful defense of the patents in question the deferred patent costs noted above will be written off as a charge to earnings at the time of such resolution. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF OPERATIONS --------------------- For the Year Ended December 27, 1992 ------------------------------------ Net revenues increased 36% or $19,223,000 when compared to the prior year ($72,166,000 versus $52,943,000). As a percent of net revenues, domestic and export net revenues were 69% and 31%, respectively compared to 71% and 29% for the similar period last year. Domestic Electronic Article Merchandising ("EAM") net revenues increased $11,282,000 or 33% and export EAM net revenues increased $7,282,000 or 48% when compared to 1991. The increase in domestic net revenues was primarily due to aggressive sales and marketing programs initiated by the Company during the year. The primary reason for the increase in export sales was the increase in sensor and deactivation products sold to Sensormatic Electronics Corporation ("Sensormatic"), the Company's distributor for Western Europe. In addition, many of the Company's other distributors throughout the world had significant sales increases over the prior year. During 1992, the loss prevention group of the Company's former distributor, Automated Security (Holdings) PLC, ("ASH") was acquired by the Company's largest competitor, Sensormatic. An exclusive distributor agreement was reached with Sensormatic to provide distribution into 15 European countries. Electronic Access Control ("EAC") net revenues increased $659,000 or 18% over 1991's performance. As a result of having integrated this business unit into the Company's New Jersey, Puerto Rico and Dominican Republic facilities in mid 1990, this operation has become profitable in 1991 for the first time since the Company acquired it in 1986, and was again profitable in 1992. Net earnings were $4,428,000 or $.45 per share versus net earnings of $508,000 or $.05 per share for 1991. Earnings increased primarily due to a significant increase in revenues while maintaining comparable gross profit margins to 1991. The gross profit margin remained at 46% compared to 1991. Increases in volumes and manufacturing improvements were offset by price reductions to the Company's largest international distributor (Sensormatic) and aggressive sales programs within the domestic market. CHECKPOINT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Selling, general and administrative expenses increased $4,696,000 ($28,342,000 versus $23,646,000) when compared to last year. This increase was caused primarily by an increase in variable sales and marketing expenses ($3,137,000) in addition to recognition of a new Board of Directors Bonus Award Plan ($318,000), based on the value of the Company's stock as of the end of the fiscal year. The Company's manufacturing operations in Puerto Rico are exempt from U.S Federal income taxes under Section 936 of the Internal Revenue Code. Approximately 50% of the Company's earnings were attributed to Puerto Rico operations. Additionally, the Company enjoys local tax exemptions on Puerto Rico based earnings and also benefits from the utilization of a Delaware Investment Holding company (See note 9 of the Notes to Consolidated Financial Statements). The Company's effective tax rate of 1992 would have been 18% but was reduced by a $417,000 tax benefit resulting from a further refinement of a tax estimate regarding prepaid local Puerto Rico taxes. Item 8.

215419

1993

ITEM 6. SELECTED FINANCIAL DATA Page 17 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1993, is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Pages 17 through 39 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1993, are incorporated herein by reference. ITEM 8.

40454

1993

ITEM 6. SELECTED FINANCIAL DATA. See page for reference to the Selected Financial Data required by this item. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. See page for reference to Management's Discussion and Analysis of Financial Condition and Results of Operations required by this item. ITEM 8.

77227

1993

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data presented below should be read in conjunction with, and is qualified in its entirety by reference to, the Consolidated Financial Statements and the Notes thereto. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS 1993 AND 1992 GENERAL The following discussion of the Registrant's financial condition and results of operations should be read in conjunction with the description of the Registrant's business and properties contained in Items 1 and 2 of Part I and the Consolidated Financial Statements and Notes thereto, included elsewhere in this report. Total revenues generated by the Registrant during 1993 were $69,556,000, a decrease of $1,319,000 from total 1992 revenues of $70,875,000. Net income for the current year increased to $5,069,000 or $.81 per share versus $2,866,000 or $.44 per share for 1992. REAL ESTATE OPERATIONS Rental revenues from real estate operations increased $1,272,000 or 7% during 1993 primarily as a result of additional revenues generated from two hotel properties that the Registrant began operating in February and May 1992, respectively. Of the total increase in revenues, $950,000 is from additional hotel related revenues while the remaining increase of $322,000 results from the renewal of existing leases at higher rents, increased percentage rents and additional revenues associated with mid-1992 property acquisitions. 1992 rental revenues include approximately $520,000 in percentage rents collected by the Registrant in 1992 as a result of a favorable arbitration award. These amounts were earned over a four-year period but not previously accrued. Mortgage interest expense associated with the Registrant's real estate portfolio decreased by $543,000 during 1993 versus that incurred during 1992. This decrease of 9% results from current year mortgage amortization of approximately $5,000,000 as well as the maturity of certain mortgages and is offset by a full year of interest associated with mortgages secured by properties acquired by the Registrant in mid-1992. Depreciation expense for 1993 decreased by approximately $165,000 or 3% from such expense in the preceding year. This decrease results from the reclassification of depreciation on the Registrant's hotel properties to operating expenses and from the sale of several properties in the current and prior year. Other operating expenses associated with those properties managed by the Registrant increased by approximately $1,068,000 during 1993 versus such expenses incurred in 1992. This increase primarily results from a full year of operating costs incurred in connection with the leasing of two hotel properties which accounts for $880,000 of this increase, while the timing of certain maintenance costs and additional lease renewal costs incurred in the current year account for the remaining increase of approximately $188,000. ANTENNA SYSTEMS The Registrant's antenna systems segment includes Dorne & Margolin, Inc. and D&M/Chu Technology, Inc. The operating results of D&M/Chu have been included here and in the accompanying consolidated statements of income since its acquisition by the Registrant in April 1992. See Note 2 of Notes to Consolidated Financial Statements, contained elsewhere in this report, for pro forma results of operations. The operating results of the antenna systems segment for the years ended December 31, 1993 and 1992 are as follows: Net sales of the antenna systems segment decreased by $3,415,000 or 14% during 1993 as compared to such sales of the preceding year. This decrease is the result of continued weakness in the U. S. Military and commercial aviation markets. Sales by Dorne & Margolin during 1993 were 23% lower than those of 1992. As a result of the mid-1992 acquisition of D&M/Chu by the Registrant and therefore a full year of sales in 1993, sales of D&M/Chu increased by 9% during this period. The reductions in military and commercial sales continue to seriously effect the Registrant's antenna systems segment and management is concentrating on reversing this trend. Cost of sales as a percentage of net sales of the antenna systems segment increased in 1993 by approximately 2% from 1992 levels. This increase is primarily the result of changes in the mix of product sales and differences in the gross margins of Dorne & Margolin and D&M/Chu product lines. Selling, general and administrative expenses ("SG&A") of the antenna systems segment have increased by $982,000 in the current year. This is a result of a full year of SG&A costs associated with D&M/Chu in 1993 versus only nine months of such costs in 1992 and from approximately $365,000 in costs incurred in 1993 as a result of the decision to consolidate the operations of D&M/Chu into that of Dorne & Margolin. ENGINEERED PRODUCTS The Registrant's engineered products segment includes Metex Corporation and AFP Transformers, Inc. The operating results of AFP Transformers have been included here and in the accompanying consolidated statements of income since October 1992. Pro forma results of operations have not been separately disclosed as amounts are not material. The operating results of the engineered products segment for the years ended December 31, 1993 and 1992 are as follows: Net sales generated by the engineered products segment increased by $824,000 during 1993 versus that of the previous year. Sales of Metex decreased by $1,540,000 during this period, while sales of AFP Transformers increased $2,364,000. This increase in the sales of AFP Transformers is primarily the result of the Registrant's acquisition of the operating assets of Isoreg Corporation, a manufacturer of Epoxycast transformers, in October 1992. Cost of sales as a percentage of net sales increased approximately 3% during the current year. This increase is primarily the result of lower profit margins on knitted wire sales resulting from lower automotive and European sales. Selling, general and administrative expenses of the engineered products segment increased $380,000 during 1993, as compared to such costs in the preceding year. This increase of approximately 1% as a percentage of net sales results from additional SG&A costs of AFP Transformers including the costs associated with the relocation of operations of Isoreg, which was acquired in October 1992, from Massachusetts to New Jersey. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses not associated with the manufacturing operations decreased $270,000 in 1993 from a year earlier. This decrease is primarily the result of lower professional fees incurred in the current year and represents a change of less than 1% of consolidated revenues. OTHER INCOME AND EXPENSE, NET Other income and expense, net for 1993 of approximately $4.1 million is comprised of $1.1 million in gains from the sale of real estate, the recovery of $744,000 in previously recorded unrealized losses on marketable securities, $578,000 in income from equity investments which represent nonrecurring cash distributions and $1.7 million in other income. The Registrant received a $2 million settlement in 1993 from Metex' insurance carrier in connection with the class action civil suit brought by the former shareholders of Metex. This settlement is included in other income in 1993, net of approximately $450,000 of current year costs incurred in the defense of this action. All defense costs incurred prior to 1993 were included in general and administrative expenses. The components of other income and expense, net in 1992 include approximately $449,000 in gains from the sale of real estate, $723,000 in unrealized losses on marketable securities, $142,000 in income from equity investments and $249,000 in other income. RESULTS OF OPERATIONS 1992 AND 1991 REAL ESTATE OPERATIONS Rental revenues from real estate operations in 1992 increased by $3,420,000 or 21% from such revenues in 1991. This increase is primarily derived from two hotel properties which the Registrant began operating in 1992 and the collection of percentage rents awarded in an arbitration settlement. Upon the termination of existing leases, the Registrant began operating its hotel properties in California and Georgia through the use of a local on-site management company. Revenues generated by these hotels since the inception of operation by the Registrant in February and May 1992, respectively, totaled $1,890,000 for 1992. Approximately $520,000 in percentage rents were collected by the Registrant in 1992 as a result of a favorable arbitration award. These amounts were earned over a four-year period and not previously accrued. The remaining increase in rental revenues over the previous year results from rents derived from property acquisitions in 1992 and 1991 and the renewal of existing leases at higher rents. Mortgage interest expense for 1992 decreased by approximately $80,000 from such expenses in 1991. This decrease results primarily from continuing mortgage amortization which accounted for approximately $8,159,000 and $6,992,000 in mortgage principal repayments during 1992 and 1991, respectively, and is offset by interest expense incurred in connection with mortgages secured by properties acquired in 1992 and 1991. Depreciation expense for 1992 decreased by approximately $319,000 or 5% from such expense in the preceding year. This decrease results from the acquisition and disposal of properties in 1992 and 1991 and from the reclassification to operating expenses of depreciation associated with the Registrant's two hotel properties which it began operating in 1992. Operating expenses associated with the management of real estate properties increased approximately $1,935,000 in 1992 when compared to such expenses incurred in the prior year. This is primarily a result of the change from the leasing of two hotel properties to the management of these facilities, as noted above. Increases in insurance costs and the need for greater repairs and maintenance on real estate properties also contributed to the increase in real estate operating costs from a year earlier. ANTENNA SYSTEMS The Registrant's antenna systems segment includes Dorne & Margolin, Inc. and D&M/Chu Technology, Inc. The operating results of D&M/Chu have been included here and in the accompanying consolidated statements of income since its acquisition by the Registrant in April 1992. See Note 2 of Notes to Consolidated Financial Statements, contained elsewhere in this report, for pro forma results of operations. The operating results of the antenna systems segment for the years ended December 31, 1992 and 1991 are as follows: Net sales generated by the antenna systems segment increased by $2,480,000 during 1992 from such sales generated in 1991. This increase is the result of revenues derived from the acquisition of the operating assets of Chu Associates, a leader in the development and manufacture of navigation and communication antenna systems for land and naval based applications, into a new wholly-owned subsidiary known as D&M/Chu Technology, Inc. Since this acquisition in April 1992, D&M/Chu has generated approximately $6,841,000 in net sales during 1992 which offset a decline in revenues of the Dorne & Margolin subsidiary caused by a continuing decline in the levels of U. S. military defense spending. Cost of sales as a percentage of net sales is virtually unchanged from that of 1991. Higher cost of sales percentages on products sold by D&M/Chu have offset cost containment measures implemented by Dorne & Margolin which reduced their cost of sales percentage by approximately 2%. Increases in the cost of sales level are the result of overall increases in the sales volume of the antenna systems segment. Selling, general and administrative expenses ("SG&A") of the antenna systems segment have increased by $1,203,000 from those of 1991. This increase is the result of additional SG&A costs due to the acquisition of D&M/Chu, offset by a decline in such expenses for Dorne & Margolin as a result of lower sales volumes, noted above. Intensified marketing efforts implemented to generate orders with the highest potential for placement have also caused the increase in SG&A spending as a percentage of net sales over that of the previous year. ENGINEERED PRODUCTS The Registrant's engineered products segment includes Metex Corporation and AFP Transformers, Inc. The operating results of AFP Transformers have been included here and in the accompanying consolidated statements of income since October 23, 1992. Pro forma results of operations have not been separately disclosed as amounts are not material. The operating results of the engineered products segment for the years ended December 31, 1992 and 1991 are as follows: Net sales of the engineered products segment increased by $2,118,000 in 1992 over such sales generated during 1991. This increase is primarily the result of $1,447,000 in additional sales generated by Metex' knitted wire business and $490,000 in sales generated from the acquisition of the operating assets of Isoreg, a manufacturer of EPOXYCAST coil transformers, power conditioners and uninterruptible power supplies. The Registrant, through a new wholly-owned subsidiary known as AFP Transformers, Inc., acquired the operating assets of Isoreg in October 1992. The Field Transformer division of Metex has been combined into AFP Transformers to provide a full line of specialty transformers. Cost of sales as a percentage of net sales for the engineered products segment decreased by 2% from that of 1991. This improvement has been brought about through cost containment programs, material cost reductions and a more favorable mix of product sales. Selling, general and administrative expenses have increased by $822,000 or 1.8% of net sales. This increase is the result of increased marketing efforts and selling costs associated with the mix of products sold and additional SG&A costs from the expanded transformer business. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses not associated with the manufacturing operations were $2,831,000 in 1992, a decrease of $93,000 from such expenses in 1991. This change represents a decrease of less than 1% of consolidated revenues. NET REALIZED AND UNREALIZED GAINS (LOSSES) ON MARKETABLE SECURITIES Marketable securities are stated at the lower of aggregate cost or quoted market value at the balance sheet date. At December 31, 1992 the aggregate cost of marketable securities exceeded their aggregate market value by $743,636. Accordingly, an allowance for unrealized losses has been established and is included in the results of operations for the year. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1993, the Registrant's cash resources were in excess of business requirements and current assets exceeded current liabilities by approximately $3,810,000. The Registrant has an unsecured line of credit with a bank which provides for borrowings up to $7,000,000 at the bank's prime lending rate. At December 31, 1993 there were no amounts outstanding under this facility. The maximum amount outstanding under this facility during 1993 was $2,300,000. All borrowings during the year were repaid together with accrued interest. During the first quarter of 1994, the Registrant borrowed $4 million under this facility, the proceeds of which were used in the acquisition of the operating assets of Kentile Floors, Inc. ("Kentile") and also to fund the working capital requirements of the Registrant and its subsidiaries. This demand facility is reviewed by the bank annually on May 31. On March 14, 1994, the Registrant, through a new wholly-owned subsidiary known as Kentile, Inc., purchased substantially all of the operating assets of Kentile for approximately $14 million. Kentile is a major manufacturer and supplier of resilient vinyl flooring and is expected to generate approximately $40 million in revenues during 1994. The purchase price was comprised of approximately $6.1 million in new bank financing, approximately $5.4 million in cash and the assumption of approximately $2.5 million in operating liabilities. The $5.4 million cash payment includes $775,000 that was advanced to Kentile by the Registrant during 1993 and was also partially derived from a total of $4 million in short-term borrowings by the Registrant during the first quarter of 1994. The proceeds from this sale were used by Kentile to repay amounts outstanding under its asset-based lending agreement, thereby relieving the Registrant of its obligation under the letter of credit, discussed below. In November 1992, Kentile filed for protection under Chapter 11 of the United States Bankruptcy Code. Subsequent thereto, the Registrant acquired a one-third equity interest in Kentile together with an option to purchase an additional interest in the future. In consideration for this interest and option in Kentile, the Registrant provided a $2 million letter of credit to partially guarantee borrowings under Kentile's asset-based lending agreement. This letter of credit arrangement was made pursuant to Bankruptcy Court approval on a priority basis. In light of the uncertain outcome of Kentile's bankruptcy proceedings, no value was assigned to the stock acquired by the Registrant. The acquisition of the operating assets of Kentile will be accounted for by the purchase method and, accordingly, the results of operations of Kentile, Inc. will be included with that of the Registrant for periods subsequent to the date of the acquisition. The Registrant has undertaken the completion of environmental studies and remedial action at Metex' two New Jersey facilities and has filed an action against certain insurance carriers seeking recovery of costs incurred and to be incurred in these matters. Based upon the advice of counsel, management believes such recovery is probable and therefore should not have a material effect on the liquidity or capital resources of the Registrant. See Item 1, "Business-Environmental Regulations," Item 3, "Legal Proceedings" and Note 16 to Consolidated Financial Statements, "Contingencies." The cash needs of the Registrant have been satisfied from funds generated by current operations and additional borrowings. It is expected that future operational cash needs will also be satisfied from ongoing operations and additional borrowings. The primary source of capital to fund additional real estate acquisitions will come from the sale, financing and refinancing of the Registrant's properties and from third party mortgages and purchase money notes obtained in connection with specific acquisitions. In addition to the acquisition of properties for consideration consisting of cash and mortgage financing proceeds, the Registrant may acquire real properties in exchange for the issuance of the Registrant's equity securities. The Registrant may also finance acquisitions of other companies in the future with borrowings from institutional lenders and/or the public or private offerings of debt or equity securities. Funds of the Registrant in excess of that needed for working capital, purchasing real estate and arranging financing for real estate acquisitions are invested by the Registrant in corporate equity securities, corporate notes, certificates of deposit and government securities. BUSINESS TRENDS The 1993 decline in the Registrant's antenna systems revenues continues to reflect the overall weakened economy and reduced government defense spending. These factors have prompted a consolidation in the operations of the Registrant's two antenna system businesses and a reexamination of the current products produced and markets served by these companies. Management is exploring opportunities in two rapidly expanding markets that require antennas; cellular telephones and wireless cable television. Although it remains to be determined whether the Registrant can successfully develop products to compete profitably in these markets, management is committed to reversing the declining revenue trend by identifying new markets and applications, such as these, for its products rather than waiting for an improved overall economy or increased military spending. The Registrant's engineered products business has also implemented a strategy to identify new markets and new applications for its products and technologies. This is evidenced by the increasing sales of knitted wire mesh components used in automobile airbags. Sales in this area have increased to over $3 million in 1993 from virtually zero only three years ago. Metex is also developing a flex coupling device that will be used in place of existing coupling devices which require an exhaust seal manufactured by the company. This change will occur as a result of changing environmental laws and the need for tighter controls on the release of pollutants from automobile engines. The Registrant's real estate portfolio continues to perform well with an increase of $1,272,000 in revenues during the current year. Future growth is expected in the Registrant's real estate operations through opportunities to re-lease properties at higher rents or through the acquisition of similar properties that have long-term leases in place and generate positive cash flow. Since many of the properties in the Registrant's real estate portfolio are generating rents under leases that were implemented ten to twenty years earlier, they provide an excellent opportunity to increase revenues in the future. With primarily self-liquidating mortgages covering the portfolio, most of which fully amortize over the next ten years, increases in cash flow from the existing portfolio can be expected to provide opportunities to expand the current portfolio of properties or operating companies. Although there can be no assurance as to how the events discussed above, or other changes in the economy, will impact the future financial condition or results of operations of the Registrant, management continues to monitor such developments and has implemented measures to minimize any possible negative effects they may have upon these businesses. ITEM 8.

65358

1993

ITEM 6: SELECTED FINANCIAL DATA ________________________________ FIVE-YEAR REVIEW Selected Financial Data (Dollars in Thousands Except Per Share Amounts) (1) Restated to reflect a three-for-two common stock split in 1993. ITEM 7:

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ________________________________________________________________________ RESULTS OF OPERATIONS _____________________ CONSOLIDATED FINANCIAL RESULTS Continuing Operations Income from continuing operations and the applicable earnings per share and return on beginning of year common equity for the three years ended December 31, 1993, were as follows: Earnings per share for 1993 exceeded 1992 results by 23 percent, despite the negative effects of record low gas sales to irrigation customers. The impact of lower irrigation sales was more than offset by positive contributions from acquisitions of natural gas facilities, expense controls, favorable resolution of rate cases, and insurance settlements. In addition, 1993 first quarter gas sales, transportation and natural gas liquids revenues were significantly greater than those in the first quarter of 1992 due to colder weather. The decline in 1992 earnings, in comparison with 1991, reflected the impact of unfavorable weather on natural gas sales and natural gas liquids revenues, and higher interest expense which resulted, in part, from reduced operating cash flows. These negative earnings factors were partially offset by increased transportation revenues, rate increases, lower operating costs as a result of expense controls and reduced litigation expense provisions. Discontinued Operations In 1991, the Company recorded an after-tax loss of $17.3 million resulting from the sale of its coal subsidiaries and the discontinuance of this business segment. RESULTS OF CONTINUING OPERATIONS Discussion of operating results by business segment and consolidated other income and (deductions) and income taxes follows. Segment operating revenues, gas purchases, operations and maintenance expenses, and volumetric data cited here are before intersegment eliminations (dollars in millions). Revenues and expenses of the Federal Energy Regulatory Commission ("FERC")-regulated Wattenberg transmission system, acquired on April 1, 1993, are included in this segment's 1993 operating results. The decline in gas sales and transportation revenues (and related gas purchases) primarily reflects FERC Order No. 636 ("Order 636") implementation and the resultant elimination of the gas cost component from FERC-regulated service revenues. An additional cause for the decline in 1993 gas sales and transportation revenues was the record low sales to irrigation customers due to the abnormally wet summer. Irrigation sales were 3.1 Bcf below 1992 volumes. However, revenues from the Wattenberg transmission system, rate increases in essentially all K N retail jurisdictions (including resolution of the 1990 rate case in Nebraska), and increases in 1993 residential and commercial sales volumes (4.3 Bcf above 1992 due to colder weather) substantially offset the decline in irrigation sales. Greater systems throughput, costs and expenses of the Wattenberg transmission system and higher costs related to increased natural gas liquids recoveries impacted 1993 operations and maintenance expenses. These increases were partially mitigated by insurance settlements related to the Brookhurst Subdivision Superfund site near Casper, Wyoming. Gas service's 1992 operating revenues were ten percent below 1991 as a result of unfavorable weather. Most notably impacted by the adverse 1992 weather were gas sales to irrigation customers, which were 7.2 Bcf below 1991. Gas sales revenues were positively affected in 1992 by rate increases, including $3.8 million collected in prior years but reserved from earnings for the 1990 eastern and central Nebraska rate case. Transportation revenues in 1992 were $3.4 million higher than 1991 as off-system transport volumes increased by 13.3 Bcf. Natural gas liquids revenues in 1992 were $2.9 million below 1991 as the unfavorable weather affected both prices and volumes. Operating costs and expenses for 1992 were 11 percent below 1991 due principally to reduced on-system throughput and expense controls. Gas purchases declined significantly as a result of lower 1992 gas sales and processing of volumes for natural gas liquids recoveries. In addition, 1992 operations and maintenance expenses were affected by lower provisions for litigation issues. The increase in 1992 taxes, other than income taxes, primarily results from state property tax legislation in Nebraska. In addition to continued growth in nonregulated gas marketing activities, this segment's 1993 and 1992 operating results reflect the Douglas gathering and processing acquisition beginning in October 1992 and the Wattenberg gathering facilities acquisition beginning in April 1993. Additionally, with Order 636 restructuring effective October 1, 1993, this segment assumed the gas sales function previously provided by K N for its wholesale customers as part of its bundled services. The increases in 1993 and 1992 oil and gas revenues and production result from the July 1992 acquisition of producing properties in western Colorado and successful drilling in the Denver-Julesburg Basin in northeastern Colorado. The increase in interest expense primarily reflects the Company's issuance of $195 million of long-term debt during the last three years. The majority of the net proceeds from these debt issues were used to fund capital expenditures and acquisitions; however, $65 million was used to refund higher coupon debt in 1993 and 1992. As a result, the Company's year end 1993 weighted-average embedded cost of long-term debt was 8.3 percent compared with a cost of 9.6 percent at December 31, 1990. The effect of the one percent increase in the Federal tax rate, resulting from enactment of the Revenue Reconciliation Act of 1993, was more than offset by increased 1993 tax credits on gas production from wells qualifying for non-conventional fuel credit under Section 29 of the Internal Revenue Code. The 1991 effective tax rate reflects higher state income tax provisions. LIQUIDITY AND CAPITAL RESOURCES The primary sources of cash during 1993 included cash generated from operations, short-term borrowings and the issuance of long-term debt. Principal cash outflows were capital expenditures and acquisitions, redemptions of long-term debt and preferred stock, and payment of interest and dividends. Cash Flows from Operating Activities Net cash flows from continuing operations were $43.3 million, $33.2 million and $72.1 million for 1993, 1992 and 1991, respectively. In addition to the factors discussed previously, which affect cash generation as well as operating results, net cash flows have been impacted by litigation settlements (including recoupable take-or-pay payments) and environmental costs. In both 1993 and 1992, actual cash disbursements exceeded expense provisions for litigation and environmental issues. Net operating cash flows for 1993 were also reduced by repayments to gas service customers for previous years' over-recovery of gas costs. Capital Expenditures and Commitments Excluding acquisitions, 1993 capital expenditures were $63.1 million compared with expenditures of $60.1 million in 1992 and $59.4 million in 1991. (Refer to Note 13 of Notes to Consolidated Financial Statements for business segment expenditures.) The increased 1993 spending includes approximately $9.0 million of Order 636 transition costs (measurement facilities and systems) and $11.0 million for construction of a new corporate office building. The regulated portion of the Wattenberg system and the Company's portion of the Wind River gathering system primarily account for the $26.8 million of capital expenditures for acquisitions in 1993. Consolidated 1994 capital expenditures are budgeted at $54.5 million, excluding acquisitions. This includes $7.6 million for the first phase of the Rifle to Avon pipeline being jointly constructed by the Company's subsidiary, Rocky Mountain Natural Gas Company, and Public Service Company of Colorado. The second phase of this pipeline will be constructed in 1995; the Company's portion of estimated costs is approximately $5.0 million. In February 1994, K N's oil and gas subsidiaries completed the acquisition of gas reserves and production in western Colorado and southwestern Wyoming. During the first half of 1994, the Company plans to bring in one or more partners to participate in this acquisition and to assist in further development of the properties. The Company has no substantial disagreements related to take-or-pay matters. The Company monitors contractual obligations, including obligations to pay above-market prices under certain contracts, and at the end of each contract year pays those producers to whom take-or-pay amounts are payable. All amounts paid by the Company for take-or-pay are fully recoupable from future gas production. Statement of Financial Accounting Standards No. 112 ("SFAS 112"), "Employers' Accounting for Postemployment Benefits," establishes standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. SFAS 112 is effective for fiscal years beginning after December 15, 1993. Implementation of SFAS 112 is not expected to have a material effect on the Company's financial position or results of operations. Capital Resources Short-term debt was $47.0 million at December 31, 1993, compared with $2.0 million of borrowings at December 31, 1992. The Company has credit agreements with eight banks to either borrow or use as commercial paper support up to $90 million. In November 1993, K N filed a shelf registration statement with the Securities and Exchange Commission for the sale of $200 million of debt securities in anticipation of long-term financing needs over the next three years. In January 1994, the Company received $41.0 million from the sale of contract demand receivables to a financial institution. The demand receivables resulted from gas sales contracts between some of K N's former wholesale customers and a K N subsidiary. Proceeds were used to reduce short-term debt. The Company expects that 1994 cash requirements for debt service, preferred stock redemptions, dividends and capital expenditures will be provided by internal cash flows, short-term borrowings, and the issuance of common stock for dividend reinvestment and employee benefit plans. OUTLOOK Restructuring and Reorganization The Company's implementation of Order 636 and the related corporate reorganization are discussed in other sections of this annual report. This discussion will focus on the expected 1994 financial implications of these events. As a result of recent acquisitions and the transfer of substantially all of K N interstate's gathering and processing facilities to a nonregulated subsidiary, the composition of 1994's operating income will differ significantly from the past. Historically, the Company's gas service segment has accounted for more than 90 percent of consolidated operating income. The expectation for 1994 is that this segment will account for approximately 65 to 70 percent of operating income. Secondly, Order 636 mandated the use of SFV rate design for FERC- regulated services. Accordingly, fluctuations in operating revenues resulting from significant variations in weather temperatures should be reduced. Revenues from the Company's important summer irrigation load will remain vulnerable to abnormal weather patterns, such as those experienced in 1993 and 1992. Finally, the effect of both of the above items is expected to change the Company's historical quarterly earnings distribution. The 1994 first and fourth quarters will account for a smaller percentage of annual earnings, while the second and third quarters will be higher. Gas Service The Company's Order 636 implementation and reorganization will significantly impact this business segment's future operating results. The transfer of substantially all of K N interstate's gathering facilities and the principal processing plant to a subsidiary within the gas marketing and gathering segment will result in a significant shift in operating revenues, expenses and operating income. Additionally, with the elimination of the merchant function from FERC-regulated services, this segment's operating revenues and gas purchases will be substantially lower than prior periods; however, this elimination should not impact operating income. Operating results for 1994 should benefit from a full year's operation of the Wattenberg transmission system and from rate increases placed into effect during 1993. As a result of the unbundling and the diverse services offered under the post-Order 636 environment, competition will increase. The Company believes that its interstate and intrastate systems are well-positioned to capitalize on opportunities resulting from future development of natural gas reserves in the Rocky Mountain region. The Company expects continued moderate growth in its retail distribution operations due, principally, to the continued customer additions being realized by its Colorado intrastate system. Gas Marketing and Gathering On January 1, 1994, substantially all of the gathering facilities and the principal processing plant, which were previously a part of the K N interstate system, were transferred to a subsidiary within the gas marketing and gathering business segment. This segment's 1993 operating results included only partial year activity of the Wattenberg nonregulated gathering system and the Wind River gas gathering joint venture. Accordingly, this segment's 1994 operating revenues, expenses and operating income are expected to be significantly higher than in 1993. Oil and Gas Production The February 1994 acquisition of producing properties and undeveloped gas reserves in western Colorado and southwestern Wyoming is expected to have a positive impact on 1994 operating results of this business segment. The Company also believes that its involvement in oil and gas development and production provides opportunities to enhance the value of its associated gas service, gathering and processing businesses. Litigation During the last three years, the Company has resolved or settled four major cases or environmental matters -- three cases related to the Brookhurst Subdivision Superfund site near Casper, Wyoming, and long-standing litigation with FM Properties Inc. and other parties. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on the Company's pending litigation. Management believes it has established adequate reserves such that resolution of pending litigation or environmental matters will not have a material adverse effect on the Company's financial position or results of operations. INFLATION Current ratemaking practices allow the Company to recover through revenues the historical cost, rather than the current replacement cost, of utility plant and equipment. In the past three years, the rate of inflation has not had a material impact on the Company's costs. ITEM 8:

54502

1993

Item 6. Selected Financial Data Annual Report to Stockholders, Exhibit 13) pages 34-35, 48-51, 59 Item 7.

Item 7. Management's Discussion Annual Report to Stockholders, and Analysis of Financial (Exhibit 13) pages 1-25, 28-29, 31-52, Condition and Results of 54-55 Operations Item 8.

37785

1993

ITEM 6. SELECTED FINANCIAL DATA. 1993 1992 (THOUSANDS OF DOLLARS, EXCEPT AS NOTED) Period Ended December 31: Distributable Cash----------------- 10,781 -- Distributable Cash per Trust Unit (in dollars)--------------------- 1.71116 -- At December 31: Investment in Royalty Interests, net------------------------------ 77,356 87,276 Trust Corpus----------------------- 77,301 87,277 ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL; LIQUIDITY AND CAPITAL RESOURCES The Trust is a passive entity with the Trustee's primary responsibility being the collection and distribution of proceeds from the Wasson Royalties and the Net Profits Royalties and the payment of Trust liabilities and expenses (see Note 1 to the financial statements of the Trust). The Trust's results of operations are dependent upon the difference between the prices received for oil and gas and the costs of producing such resources. Since, on an equivalent basis, approximately eighty percent of the Trust's proved reserves are crude oil, even relatively modest changes in crude oil prices may significantly affect the Trust's revenues and results of operations. Crude oil prices are subject to significant changes in response to fluctuations in the world supply, economic conditions in the United States and elsewhere, the world political situation as it affects OPEC, the Middle East (including the current embargo of Iraqi crude oil from worldwide markets) and other producing countries, the actions of OPEC and governmental regulation. In addition, a substantial portion of the Trust's revenues come from properties which produce sour (i.e. high sulfur content) crude oil which sells at prices lower than sweeter (i.e. low sulfur) crude oils. The sales price of crude oil dropped significantly in the fourth quarter of 1993, as reflected in the average prices with respect to the royalty payment received in the first quarter of 1994 (see Results of Operations). For factors affecting the sale of natural gas see Item 1. Business--Gas Production. Cash proceeds from the Royalty Properties in the first quarter of 1994 included a Support Payment of $362,000, primarily due to lower realized oil prices and capital expenditures incurred with respect to certain Royalty Properties, a substantial portion of which relates to the drilling of new wells. Based on current prices, it is expected that cash proceeds from the Royalty Properties in the second quarter of 1994, which relates to operations of the Royalty Properties in the first quarter of 1994, will include a Support Payment, the amount of which has not been determined. In addition to costs and expenses related to the Royalty Properties, Trust administrative expenses are estimated to be approximately $450,000 annually, including approximately $250,000 for legal, accounting, engineering, trustee and other administrative fees and a $200,000 annual fee to Santa Fe, which will increase by 3.5 percent per year. In addition, Santa Fe paid approximately $379,000 in Trust formation costs of which $271,000 was recovered in 1993 and $108,000 was recovered in the first quarter of 1994. RESULTS OF OPERATIONS The following table reflects pertinent information with respect to the cash proceeds from the Royalty Properties and the net distributable cash of the Trust for the year 1993 and the first quarter of 1994 (in thousands of dollars, except as noted): Volumes with respect to the Wasson ODC Royalty and the Wasson Willard Royalty increased in periods subsequent to the first quarter of 1993 because (i) the first quarter of 1993 represented the initial quarter of operations of the Trust and included only two months of operations with respect to such royalties and (ii) there was an increase in the maximum net quarterly production in accordance with the royalty conveyance beginning in the second quarter of 1993. Volumes increased from the first quarter of 1993 with respect to the Net Profits Royalties generally reflecting that the first quarter of 1993 included only two months of operations with respect to such properties. ITEM 8.

893486

1993

ITEM 6. SELECTED FINANCIAL DATA The Selected Financial Data included on page 11 is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides a narrative discussion and analysis of the consolidated financial condition and results of operations of Society Corporation and its subsidiaries (the "Corporation"). The financial data included throughout the remainder of this discussion should be read in conjunction with the consolidated financial statements and notes presented on pages 39 through 61 of this report. On March 1, 1994, KeyCorp ("old KeyCorp"), a financial services holding company headquartered in Albany, New York, with approximately $33 billion in assets as of December 31, 1993, merged into and with Society Corporation ("Society"), an Ohio corporation, which was the surviving corporation of the merger under the name "KeyCorp". Because the merger, which was accounted for as a pooling of interests, occurred subsequent to December 31, 1993, the financial information and narrative discussion presented herein covers Society's financial performance prior to the merger and does not give effect to the restatement to include old KeyCorp's financial results. However, the supplemental financial statements included on pages 65 through 94 of this report present the combined financial condition and results of operations of Society and old KeyCorp as if the merger had been in effect for all periods presented. In addition to the merger of Society and old KeyCorp, the following transactions, which were completed over the past two years and have had a significant impact on the Corporation's overall growth and geographic diversification, are described in greater detail in Note 2, Mergers, Acquisitions and Divestitures, on page 45 of this report: (i) the March 16, 1992, merger of Ameritrust Corporation ("Ameritrust") with and into Society, (ii) the September 30, 1992, acquisition by Society of all the outstanding shares of First of America Bank - Monroe ("FAB-Monroe"), (iii) the December 4, 1992, formation by Society and three other bank holding companies of a joint venture in a new corporation named Electronic Payment Services, Inc., (iv) the January 22, 1993, acquisition by Society of all the outstanding shares of First Federal Savings and Loan Association of Fort Myers ("Society First Federal"), (v) the September 15, 1993, sale by Society of Ameritrust Texas Corporation ("ATC"), and (vi) the October 5, 1993, acquisition by Society of Schaenen Wood & Associates, Inc. ("SWA"). PERFORMANCE OVERVIEW Net income for 1993 reached a record level of $347.2 million, or $2.93 per Common Share, up from the previous record of $301.2 million, or $2.51 per Common Share, achieved in 1992 and $76.5 million, or $.61 per Common Share, in 1991. The return on average common equity for the current year rose to 17.87%, up from 17.52% and 4.24% in 1992 and 1991, respectively. The return on average total assets was 1.36% in 1993, 1.26% in 1992 and .30% in 1991. Record-level earnings were attained in 1993 despite fourth-quarter merger and integration charges of $53.9 million ($39.6 million after tax, $.33 per Common Share) recorded in connection with the merger with old KeyCorp. In 1992, earnings were also adversely impacted by similar charges of $50.0 million ($34.2 million after tax, $.29 per Common Share) recorded in the first quarter in connection with the merger with Ameritrust. In addition, 1992 earnings reflected a $20.1 million ($13.2 million after tax, $.11 per Common Share) gain on the sale of certain branch offices and loans. Excluding the impact of the above items, 1993 net income grew by $64.6 million, or 20%, relative to the previous year. On a pre-tax basis, this improvement reflected a $62.1 million, or 5%, increase in taxable-equivalent net interest income, a $28.3 million, or 6%, increase in noninterest income and a $75.1 million, or 51%, decrease in the provision for loan losses. These positive factors were offset in part by a $52.1 million, or 5%, increase in noninterest expense. Adjusting for the merger and integration charges in both years and the 1992 gain, the returns on average common equity and the returns on average total assets were 19.92% and 1.51%, respectively, in 1993, and 18.77% and 1.35%, respectively, in 1992. In 1991, net income was also impacted by merger and integration charges totaling $93.8 million ($68.2 million after tax, $.59 per Common Share) recorded during the fourth quarter in connection with the Ameritrust merger. Excluding the merger and integration charges in both 1992 and 1991 and the gain referred to above, net income in 1992 grew by $177.5 million, or 123%, relative to the previous year. On a pre-tax basis, this improvement reflected a $72.3 million, or 7%, increase in taxable-equivalent net interest income, a $26.4 million, or 6%, increase in noninterest income and a $132.7 million, or 47%, decrease in the provision for loan losses. Noninterest expense also decreased $22.7 million, after adjusting for the merger and integration charges in both years. On an adjusted basis, the 1991 return on average common equity and the return on average total assets were 8.36% and .57%, respectively. RESULTS OF OPERATIONS NET INTEREST INCOME Net interest income, which is comprised of interest and loan-related fee income less interest expense, is the principal source of earnings for Society's banking affiliates. Net interest income is affected by a number of factors including the level, pricing and maturity of earning assets and interest-bearing liabilities, interest rate fluctuations and asset quality. To facilitate comparisons in the following discussion, net interest income is presented on a taxable-equivalent basis, which increases reported interest income on tax-exempt loans and securities by an amount equivalent to the taxes which would be paid if the income were taxable at the statutory Federal income tax rate. The trends in various components of the balance sheet and their respective yields and rates which affect interest income and expense are illustrated in Figure 3. The table presented in Figure 4 provides an analysis of the effect of changes in yields/rates and average balances on net interest income in 1993 and 1992. A more in-depth discussion of changes in earning assets and funding sources is presented in the Financial Condition section beginning on page 23. Net interest income was $1.2 billion in 1993, up $62.1 million, or 5%, from the prior year. This followed an increase of $72.3 million, or 7%, in 1992 relative to the comparable 1991 period. In 1993, the growth in net interest income resulted from a higher level of average earning assets, which more than offset a slight decline in the net interest margin. The net interest margin is computed by dividing taxable equivalent net interest income by average earning assets. Average earning assets in 1993 totaled $23.2 billion which represented an increase of $1.5 billion, or 7%, from the prior year. This followed a decrease of $1.6 billion, or 7%, in 1992 relative to the previous year. Excluding the impact of the January 1993, acquisition of Society First Federal, average earning assets increased by $325.2 million in 1993 due to increases of $461.8 million in total securities and $69.2 million in loans and mortgage loans held for sale. These increases were partially offset by a $205.7 million decline in aggregate short-term investments. The increase in loans can be primarily attributed to growth in student loans held for sale, residential mortgage loans and lease financing, offset in part by lower levels of outstanding loans in the consumer and commercial portfolios. The $1.6 billion decrease in average earning assets in 1992 resulted primarily from a $1.3 billion decline in average loans, principally in the commercial and real estate construction portfolios. The decline also reflected a decrease of $375.4 million in Federal funds sold and security resale agreements. This latter decrease resulted from reduced short-term funding requirements for loans and the planned reduction of excess liquidity. The decrease in loans in 1992 can be attributed to a decline in demand due to weak economic conditions, strategic efforts to reduce certain types of lending, the anticipated run-off of certain Ameritrust credits and the second quarter sale of branch offices, including $331.8 million in loans, required in connection with the merger with Ameritrust. As shown in Figure 3, the net interest margin for the current year was 5.26% compared with 5.33% in 1992 and 4.65% in 1991. The slight decline in the 1993 net interest margin reflected the narrower interest rate spread contributed by Society First Federal and the lower proportion of interest free funds supporting earning assets in comparison with the prior year. The interest rate spread is computed as the difference between the taxable-equivalent yield on earning assets and the rate paid on interest-bearing liabilities. Excluding the impact of Society First Federal, the net interest margin increased to 5.35%. On an adjusted basis, the improvement in the margin over the past two years was principally the result of a wider spread. In 1993 and 1992 the spread increased by 16 basis points and 85 basis points, respectively, as the decrease in the rate paid on interest-bearing liabilities exceeded the decrease in the yield on earning assets. Several factors were responsible for the widened spreads, including an interest rate sensitivity position which has enabled the Corporation to benefit from the lower interest rate environment. This position was enhanced through the increased use of "portfolio" interest rate swaps and securities. The notional amount of such swaps increased to $5.2 billion at December 31, 1993, up from $4.8 billion at December 31, 1992, and $2.9 billion at December 31, 1991. Interest rate swaps contributed $131.1 million to net interest income and 56 basis points to the net interest margin in 1993. In 1992 interest rate swaps increased net interest income by $93.8 million and added 44 basis points to the net interest margin. The manner in which interest rate swaps are used in the Corporation's overall program of asset and liability management is described in the Asset and Liability Management section on page 16 of this report. Also contributing to the widened spread was a shift in deposits from time to lower rate savings deposits with higher liquidity and to noninterest-bearing deposits. The improved margin also reflected the effects of a lower level of nonperforming assets and the 1992 reduction in short-term investments (made by Ameritrust prior to the merger) which had narrower spreads. [PAGE INTENTIONALLY LEFT BLANK] ASSET AND LIABILITY MANAGEMENT The Corporation manages its exposure to economic loss from fluctuations in interest rates through an active program of asset and liability management within guidelines established by the Corporation's Asset/Liability Management Committee ("ALCO"). The ALCO has the responsibility for approving the asset/liability management policies of the Corporation, approving changes in the balance sheet that would result in deviations from guidelines in the policy, approving strategies to improve balance sheet positioning and/or earnings, and reviewing the interest rate sensitivity positions of the Corporation and each of the affiliate banks. The ALCO meets twice monthly to conduct this review and to approve strategies consistent with its policies. The primary tool utilized by management to measure and manage interest rate exposure is a simulation model. Use of the model to perform simulations of changes in interest rates over one-and two-year time horizons has enabled management to develop strategies for managing exposure to interest rate risk. In performing its simulations, management projects the impact on net interest income from pro forma 100 and 200 basis point changes in the overall level of interest rates. ALCO policy guidelines provide that a 200 basis point increase or decrease over a 12-month period should not result in more than a 2% negative impact on net interest income. Simulations as of December 31, 1993, indicated that a 200 basis point increase in interest rates over the next twelve months would have reduced net interest income by 2.2%. Conversely, a 200 basis point decrease in interest rates over the same time period would have increased net interest income by 1.4%. Accordingly, as of December 31, 1993, the simulation model indicated that the Corporation's liability-sensitivity position was outside of policy guidelines. ALCO determined that this interest rate sensitivity position was appropriate considering the pending merger with old KeyCorp. Simulations on a pro forma combined basis with old KeyCorp as of December 31, 1993, indicated that the combined corporation was positioned within the guidelines and was slightly liability sensitive. The simulation model is supplemented with a more traditional tool used in the banking industry for measuring interest rate risk known as interest rate sensitivity gap analysis. This tool measures the difference between assets and liabilities repricing or maturing within specified time periods. An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing within specified time horizons, which would generally imply a favorable impact on net interest income in periods of rising interest rates. Conversely, a liability sensitive position, where rate-sensitive liabilities exceed the amount of rate-sensitive assets repricing or maturing within applicable time frames, would generally imply a favorable impact on net interest income in periods of declining interest rates. The interest rate gap analysis table shown in Figure 5 presents the gap position (including the impact of off-balance sheet items) of the Corporation at December 31, 1993. Gap analysis has several limitations. For example, it does not take into consideration the varying degrees of interest rate sensitivity pertaining to the assets and liabilities that reprice within one year. Thus at December 31, 1993, the cumulative adjusted interest rate sensitivity gap of 4.78% within the one-year time frame indicated that the Corporation was asset-sensitive, whereas the more precise simulation model, previously described, indicated the Corporation was slightly liability-sensitive. The Corporation's core lending and deposit-gathering businesses tend to generate significantly more fixed-rate deposits than fixed-rate interest-earning assets. Left unaddressed, this tendency would place the Corporation's earnings at risk to declining interest rates as interest-earning assets would reprice faster than would interest-bearing liabilities. To reduce this risk, management has utilized its securities portfolio and, for the past several years, interest rate swaps in the management of interest rate risk. The decision to use "portfolio" interest rate swaps to manage interest rate risk versus on-balance sheet securities has depended on various factors, including funding costs, liquidity, and capital requirements. The Corporation's "portfolio" swaps totaled $5.2 billion at December 31, 1993, and consisted principally of contracts wherein the Corporation receives a fixed rate of interest, while paying at a variable rate, as summarized in Figure 6. In addition to "portfolio" swaps, the Corporation has entered into interest rate swap agreements to accommodate the needs of its customers, typically commercial loan customers. The Corporation offsets the interest rate risk of customer swaps by entering into offsetting swaps, primarily with third parties. These offsetting swaps are also included in the customer swap portfolio. Where the Corporation does not have an existing loan with the customer, the swap position of the customer and any offsetting swap with a third party are carried at their respective fair values. The $1.2 billion notional value of customer swaps in Figure 6 includes $645 million of interest rate swaps that receive a fixed rate and pay a variable rate and $569 million of interest rate swaps that receive a variable rate and pay a fixed rate. The total notional value of all interest rate swap contracts outstanding was $6.5 billion and $5.5 billion as of December 31, 1993 and 1992, respectively. Figure 7 shows the current year activity for such swaps. At December 31, 1993, the aggregate notional values of interest rate swap contracts, excluding customer swaps, maturing in each of the years 1994 through 1998 were $2.5 billion, $1.0 billion, $500 million, $200 million and $650 million, respectively. The credit risk exposure to the counterparties for each interest rate swap contract is monitored by the appropriate credit committees at both the Corporate and affiliate bank levels. Based upon detailed credit reviews of the counterparties, these credit committees establish limitations on the total credit exposure the Corporation may have with each counterparty and indicate whether collateral is required. At December 31, 1993, excluding customer swaps, the Corporation had 16 counterparties to interest rate swap contracts, of which the largest credit exposure to an individual counterparty was $16.4 million on a notional amount of $900 million. The average total notional amount of swap contracts with these 16 counterparties was $328 million with an average credit exposure of $4.1 million. NONINTEREST INCOME As shown in Figure 9, noninterest income totaled $509.8 million in 1993, up $8.3 million, or 2%, from the prior year. After excluding the $29.4 million gain on the sale of ATC, the $26.1 million in net securities gains and certain other nonrecurring items, noninterest income in 1993 was $457.6 million. This represented an increase of $14.1 million, or 3%, from the amount reported in 1992, after excluding last year's $20.1 million gain on the sale of branch offices and loans, and net securities gains totaling $9.8 million. Adjusting for the 1992 gains and the securities transactions recorded in 1991, noninterest income in 1992 rose $23.9 million, or 5%, relative to the prior year. Trust fees continued to be a major source of revenue. After excluding the gains referred to above, these fees accounted for 45% of noninterest income in both 1993 and 1992, compared to 44% in 1991. The growth during the 1992 period reflected the development of new business, expanded geographic coverage and enhanced service capability. At December 31, 1993, the Corporation, through Society Asset Management, Inc. ("SAMI") and the trust departments of its affiliate banks and trust subsidiaries, managed assets (excluding corporate trust assets) of approximately $29.4 billion. SAMI, which is a wholly-owned subsidiary of Society National Bank, is registered with the Securities and Exchange Commission ("SEC") as an investment advisor and is one of the largest money managers in the Great Lakes region. The sale of ATC in September 1993 reduced managed trust assets and trust fees by approximately $4 billion and $8.0 million, respectively. Service charges on deposit accounts decreased $1.6 million, or 2%, in 1993 following an increase of $3.7 million, or 4%, in 1992. The decrease in 1993 was due, in part, to the change in the mix of the deposit base and related pricing structure resulting from acquisitions and divestitures. Factors contributing to the improvement in 1992 were pricing strategies and other corporate-wide initiatives designed to offset higher costs associated with servicing deposit accounts. In 1993, credit card fees decreased $6.8 million, or 12%, primarily due to a decline in annual membership fees relative to the prior year. This compared to an increase of $2.5 million, or 5%, in 1992. Growth in the insurance and brokerage component of other income over the past three years was due to increased broker dealer commissions at Society Investments, Inc. (SII). SII, which is a wholly-owned subsidiary of Society National Bank, is a registered broker dealer with the SEC and the National Association of Securities Dealers. The increase in commissions at SII resulted from aggressive and strategic sales initiatives, including an expanded sales force and product line. "Miscellaneous" other income in 1993 decreased $8.0 million, or 12%, from the comparable 1992 amount. Primary factors contributing to this decrease were an $8.2 million decline in ATM fees resulting from Society's contribution of the Green Machine subsidiary to the newly formed Electronic Payment Systems joint venture which Society entered into in the fourth quarter of 1992, and $10.2 million in gains resulting from the curtailment and settlement of retirement obligations recorded in 1992 in connection with merger-related staff reductions. The impact of these factors was partially offset by a $4.5 million interest rate swap trading gain recorded in 1993. NONINTEREST EXPENSE Noninterest expense, as shown in Figure 10, totaled $1.1 billion in 1993, up $55.9 million, or 5%, from the 1992 level. In both 1993 and the prior year, noninterest expense was adversely impacted by merger and integration charges of $53.9 million and $50.0 million, respectively. In addition, the current year included several nonrecurring charges totaling $34.4 million. Significant items included in these charges were $21.6 million related to various systems conversion costs, $7.0 million of facilities-related charges and $4.0 million associated with the adoption of SFAS No. 112, "Employers' Accounting for Postemployment Benefits." Excluding the merger and integration charges and the nonrecurring items, 1993 expenses rose $17.6 million, or 2%, principally due to increases in personnel expense, marketing expense and the "Miscellaneous" category, offset in part by lower fees for professional services. The overall increase in recurring noninterest expense was due, in large part, to the acquisition of Society First Federal in January 1993. The 1991 period also included merger and integration charges of $93.8 million, as well as $6.9 million of costs associated with a branch optimization program. After adjusting for these items, 1992 noninterest expense decreased $15.8 million, or 2%, relative to the prior year, reflecting the effectiveness of cost management initiatives. Personnel expense for 1993 increased $15.0 million, or 3%, over 1992. In addition to the $9.3 million impact of the Society First Federal acquisition, this increase reflected the Corporation's January 1, 1993, adoption of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," which added $4.7 million to 1993 employee benefits expense, as well as additional costs associated with a new employee incentive program. Excluding the impact of the adoption of SFAS No. 106 and SFAS No. 112, personnel expense for 1993 increased $6.3 million or 1%. SFAS No. 106 and SFAS No. 112 are more fully described below. Personnel expense for 1992 increased $4.5 million, or less than 1%, from the prior year. The 1992 increase in the salaries component was mainly due to higher costs related to temporary contracted personnel, but was substantially offset by the decrease in benefits resulting from reduced staff levels. At December 31, 1993, the number of full-time equivalent employees was 12,038, down 3% and 11% from 1992 and 1991 levels, respectively. Merger and integration charges of $53.9 million, $50.0 million and $93.8 million were recorded in 1993, 1992, and 1991, respectively. The 1993 charges were incurred in connection with the merger with old KeyCorp, while the 1992 and 1991 amounts related to the merger with Ameritrust. The merger and integration charges directly attributable to the old KeyCorp merger included accruals for merger expenses, consisting primarily of investment banking and other professional fees directly related to the merger ($12.6 million); severance payments and other employee costs ($17.6 million); systems and facilities costs ($16.7 million); and other costs incident to the merger ($7.0 million). These charges were recorded by the parent company in the fourth quarter of 1993 at which time management determined that it was probable that a liability for such charges had been incurred and could be reasonably estimated. The merger and integration charges recorded in connection with the Ameritrust merger in 1992 and 1991 were similar in nature. Although no assurance can be given, it is also expected that as a result of the old KeyCorp merger, cost savings will be achieved by the combined institution at an annual rate of approximately $100 million by the end of the first quarter of 1995. These cost savings are anticipated to result from the integration of operations and from efficiencies in certain combined lines of business. Management presently expects that approximately 50% of the annual cost savings will be achieved in 1994. One measure used in the banking industry to assess the level of noninterest expense is the efficiency ratio, which is defined in Figure 10. The efficiency ratios for 1993, 1992, and 1991 were 60.41%, 61.11%, and 66.44%, respectively. The improvement in the Corporation's efficiency ratios reflects, in large part, the success achieved in reducing overhead costs through the successful integration of banking companies, coupled with the strong growth in taxable-equivalent net interest income. SFAS No. 106, previously referred to on page 20, requires that employers recognize the cost of providing postretirement benefits over the employees' active service periods to the date they attain full eligibility for such benefits. A transition obligation, defined as the unfunded accumulated postretirement benefit obligation at the date the standard is adopted, may be recognized immediately (through a charge to earnings in the year of adoption), or on a delayed basis, generally over a transition period not to exceed 20 years. The Corporation elected to recognize the transition obligation of approximately $77 million over a 20-year transition period. As previously stated, adoption of the new standard added $4.7 million to noninterest expense in the current year. As of December 31, 1993, the discount rate used in determining the actuarial present value of both pension and other postretirement benefits was reduced from 8.5% to 7.5%. In addition, the assumed rate of increase in future compensation levels (applicable only to the determination of pension benefits) was reduced from 4.5% to 4.0%. The net effect of these assumption changes on 1994 expense levels is not expected to be material. Another assumption used in the determination of the costs of other postretirement benefits is the health care cost trend rate. Because of certain cost-sharing provisions and benefit limitations in effect, increasing the rates assumed in each future year by one percentage point would not be expected to have a material impact on the costs for other postretirement benefits. The Corporation adopted the provisions of SFAS No. 112, "Employers' Accounting for Postemployment Benefits" during 1993. This standard requires that employers who provide benefits to former and inactive employees after employment but before retirement recognize a liability for such benefits if specified conditions are met. Adoption of the standard increased third quarter and full year 1993 noninterest expense by $4.0 million. Postemployment benefits for 1992 and 1991, which were recorded on a cash basis, were not restated. INCOME TAXES The provision for income taxes for 1993 was $187.5 million, compared with $137.4 million in 1992 and $33.2 million in 1991. The increases in both 1993 and the prior year resulted from an overall increase in the level of taxable earnings. The Omnibus Budget Reconciliation Act of 1993, which was signed into law on August 10, 1993, includes a number of significant items which impacted the Corporation's Federal income tax provision. Primary among these items is a retroactive increase in the Federal statutory tax rate from 34% to 35% as of January 31, 1993. In addition, the Act places certain limitations on deductible expenses which take effect after 1993. The effective tax rate (provision for income taxes as a percentage of income before income taxes) was 35.1% in 1993, 31.3% in 1992 and 30.3% in 1991. The effective tax rate in 1993 exceeded the current Federal statutory tax rate of 35% as a higher tax-basis gain on the sale of ATC and non tax-deductible expenses, including the amortization of certain intangible assets and certain merger expenses, exceeded tax-exempt income in the current year. The non tax-deductible merger expenses incurred in 1993 were primarily due to additional costs associated with the merger with old KeyCorp. The effective tax rate in 1992 and 1991 was less than the Federal statutory tax rate of 34.0%, in effect at the time, due primarily to tax-exempt income from certain investment securities and loans. During the first quarter of 1992, the Corporation adopted the provisions of SFAS No. 109, "Accounting for Income Taxes." The adoption of this standard did not have a material effect on the Corporation's financial condition or results of operations. FINANCIAL CONDITION The financial condition of Society and its subsidiaries as of December 31 is presented in the comparative balance sheet on page 39. The following discussions address significant elements of financial condition including loans, securities, credit quality and experience, sources of funds, liquidity and capital adequacy. Unless otherwise indicated, amounts presented in the discussions are as of the appropriate period-end. LOANS At December 31, 1993, total loans outstanding were $17.9 billion, as compared with $16.0 billion at December 31, 1992, and $16.8 billion at December 31, 1991, as shown in Figure 11. The increase from the year-end 1992 level was due, in part, to the acquisition of Society First Federal in January 1993. Excluding the $836.6 million impact of this acquisition and adjusting for $200.0 million of student loans securitized or sold in 1993, loans increased by $1.3 billion since the prior year end. This reflected increases of $603.0 million in residential real estate loans, $578.5 million in student loans held for sale and $289.3 million in lease financing receivables. These increases were partially offset by decreases of $360.0 million in commercial mortgage and construction loans, $43.6 million in commercial loans, $41.5 million in credit card outstandings and $38.1 million in foreign loans. Commercial loans outstanding at December 31, 1993, were $4.4 billion, down slightly from the December 31, 1992 level, following a decrease of $747.6 million, or 14%, in the prior year. The declines in both years can be attributed to weaker loan demand as a consequence of the economic environment and to strategic efforts to reduce the level of exposure related to highly-leveraged transactions ("HLT"s), principally acquired in the Ameritrust Merger, where there has not been a long-standing relationship with the borrower. These transactions are defined and monitored based upon the criteria previously used by the banking regulators. In addition, the decline in 1992 reflected the run-off of certain other Ameritrust credits which management believed were incompatible with the Corporation's credit risk profile. At December 31, 1993, the Corporation had $247.5 million in HLT loans outstanding, down $157.7 million, or 39%, from the December 31, 1992, level. This followed a decline of $145.3 million, or 26%, in 1992. Loans secured by real estate totaled $7.3 billion at December 31, 1993, compared with $6.3 billion at December 31, 1992, and $6.4 billion at December 31, 1991. Loans secured by real estate consist of construction loans, one-to-four family residential loans (including home equity loans) and commercial mortgage loans. The increase from 1992 was mainly attributable to the acquisition of Society First Federal. The acquisition accounted for $811.9 million of the increase in total real estate loans and $767.2 million of the increase in the residential mortgage portfolio. Construction loans decreased to $623.2 million at December 31, 1993, from $737.6 million at December 31, 1992, and $839.4 million at December 31, 1991. After adjusting for the impact of the acquisition of Society First Federal, the decrease from year-end 1992 was $132.6 million. As portrayed in Figure 12, loans in the construction portfolio are concentrated in the Midwest, which has not experienced, to the same degree, the level of overbuilding and declines in real estate values as have certain other regions of the country. At December 31, 1993, 70% of the portfolio was secured by properties in Ohio, and 17% were in Indiana and Michigan, Society's principal banking markets. The commercial mortgage loan portfolio totaled $2.1 billion at December 31, 1993, compared with $2.3 billion at December 31, 1992, and $2.6 billion at December 31, 1991. In addition to efforts to downsize the portfolio, the slower economy also contributed to this decrease. As depicted in Figure 12, commercial mortgages are also geographically concentrated in the Midwest, with 64% of outstandings secured by properties in Ohio, and 21% in Indiana and Michigan. At December 31, 1993, 49% of the commercial mortgage loan portfolio was comprised of loans secured by owner-occupied properties. Those borrowers are engaged in business activities other than real estate, and the primary source of repayment is not solely dependent on the real estate market. The Corporation manages risk exposure in the construction and commercial mortgage portfolios through prudent underwriting criteria and by monitoring loan concentrations by geographic region and property type. One-to-four family residential mortgages (including home equity loans) were $4.6 billion at December 31, 1993, compared with $3.2 billion at December 31, 1992, and $2.9 billion at December 31, 1991. Excluding the SECURITIES In December 1992, the Corporation transferred its U.S. Treasury securities from the investment portfolio to the "available for sale" portfolio. At December 31, 1993, the book value of the securities portfolio, including securities available for sale, totaled $6.4 billion, up $784.7 million, or 14%, from December 31, 1992. The year-end 1992 amount was $816.1 million, or 17%, higher than the comparable amount for 1991. The growth from the 1992 year-end primarily resulted from an increase of $1.2 billion, or 35%, in mortgage-backed securities and an increase of $145.5 million, or 25%, in other securities. These increases were partially offset by decreases in securities issued by states and political subdivisions of $150.2 million, or 29%, and $384.1 million, or 34%, in securities available for sale. The increase during 1992 primarily resulted from purchases of U.S. Treasury securities, collateralized mortgage obligations ("CMOs") and other mortgage-backed securities. The securities portfolio comprised 26% of total earning assets at December 31, 1993, up from 25% at December 31, 1992, and up from 21% at December 31, 1991. The yield on the securities portfolio declined to 6.49% at December 31, 1993, from 7.61% at December 31, 1992. This reduction is attributable to prepayments on higher-yielding mortgage-backed securities and lower reinvestment yields resulting from the declining rate environment. The yield on the securities portfolio has not declined as rapidly as market yields due primarily to prior investment programs in which the portfolio was structured to benefit from the declining interest rate environment. The portfolio's market value exceeded its book value by $125.6 million at December 31, 1993, compared with an excess of $111.7 million at December 31, 1992, and $192.9 million at December 31, 1991. At December 31, 1993, the Corporation had $4.5 billion invested in mortgage-backed pass-through securities and collateralized mortgage obligations ("CMO") within the investment securities portfolio, compared with $3.4 billion at December 31, 1992. A mortgage-backed pass-through security depends on the underlying pool of mortgage loans to provide a cash flow "pass-through" of principal and interest. The Corporation had $2.9 billion invested in mortgage-backed pass-through securities at December 31, 1993. A CMO is a mortgage- backed security that is comprised of classes of bonds created by prioritizing the cash flows from the underlying mortgage pool in order to meet different objectives of investors. The Corporation had $1.6 billion invested in CMO securities at December 31, 1993. The CMO securities held by the Corporation are primarily shorter-maturity class bonds that were structured to have more predictable cash flows by being less sensitive to prepayments during periods of changing interest rates. At December 31, 1993, substantially all of the CMOs and mortgage-backed pass-through securities held by the Corporation were issued by Federal agencies or backed by Federal agency pass-through securities. ASSET QUALITY The measurement and management of asset quality is the responsibility of the Corporation's Credit Policy/Risk Management Group. This Group is responsible for both commercial and consumer lending credit policy, credit systems development and procedures, loan examination, providing additional controls in the early identification of problem loans, and the monitoring of major loan workouts in the subsidiary banks. The Group is also responsible for the determination of the adequacy of the allowance for loan losses for each of Society's bank subsidiaries. Each allowance is reviewed on the basis of three methodologies which, when combined, determine the allocated and unallocated portions of the allowance and provide management with a benchmark by which its adequacy is measured. The methodologies are: (1) a review of internal loan classifications; (2) an historical analysis of prior periods' charge-off experience; and (3) an evaluation of estimated worst-case losses on internally-classified credits. Management targets the maintenance of a minimum allowance equal to the indicated allocated requirement plus an unallocated portion, as appropriate, in light of current and expected economic conditions and trends, geographic and industry concentrations, and similar risk-related matters. The 1993 provision for loan losses was $72.2 million compared to $147.4 million for 1992 and $280.0 million for 1991. The 1991 amount included an additional provision of $93.9 million recorded by Ameritrust during the fourth quarter to conform its approach with that of the Corporation to determine the adequacy of the allowance. The significantly lower provisions in 1993 and 1992 reflect the continued corporate-wide improvement in asset quality trends, including significant declines in nonperforming loans. Net loans charged-off in 1993 decreased $76.4 million, or 45%, from the 1992 level, following a decrease of $43.4 million, or 20%, from 1991. The significant decrease in 1993 was due to lower net charge-offs in all loan categories with the largest improvement occurring in the consumer and real estate-mortgage portfolios. The 1992 decrease was largely due to a lower level of net charge-offs in the commercial loan portfolio and the consumer loan portfolio, partially offset by higher net charge-offs in the real estate portfolios. The majority of the charge-offs in both 1993 and 1992 reflected losses on problem credits for which reserves were established in previous periods. The allowance at December 31, 1993, was $480.6 million, or 2.69% of loans, as compared with $502.7 million, or 3.10% of loans, at December 31, 1992. The allowance as a percent of nonperforming loans was 295.20% at December 31, 1993, compared with 144.17% at December 31, 1992. Although used as a general indicator, the allowance to nonperforming loans ratio is not a primary factor in the determination of the adequacy of the allowance by management. As indicated in Figure 14, the unallocated portion of the allowance increased in 1993, reflecting the continued improvement in the overall quality of the loan portfolios. As shown in Figure 16, nonperforming assets totaled $224.4 million at December 31, 1993, down $272.5 million, or 55%, from the December 31, 1992, level. This followed a decrease of $130.1 million, or 21%, in the previous year. The significant improvement in 1993 resulted largely from a $185.9 million, or 53%, decrease in nonperforming loans and an $85.2 million, or 63.9%, decrease in other real estate owned. Other nonperforming assets, which are comprised primarily of nonperforming venture capital investments, decreased $1.4 million, or 9.4%, in 1993. The reduction in nonperforming loans was principally attributable to decreases in nonaccrual commercial (including HLTs), construction and commercial real estate loans. At the end of 1993, nonaccrual loans in these categories comprised 40%, 17% and 24%, respectively, of total nonperforming loans and totaled $131.9 million, down $173.8 million, or 57%, from the previous year-end. This reduction reflected progress made in working through the credit problems associated with the Ameritrust acquisition, principally through the efforts of the Special Assets Group ("SAG"). As indicated in Figure 17, the reduction in other real estate owned was primarily due to the selective sale of assets. At December 31, 1993, HLT loans classified as nonperforming amounted to $25.3 million, or 16% of total nonperforming loans. At December 31, 1992, nonperforming HLT loans aggregated $4.6 million, or 1% of total nonperforming loans. One individual nonperforming HLT loan represented $18.1 million or 72% of the total at December 31, 1993. The SAG was formed in conjunction with the acquisition of Ameritrust, and charged with the responsibility to manage and resolve primarily problem assets acquired in the merger. These assets totaled $865.3 million at March 31, 1992, and were comprised of commercial loans, commercial real estate loans and other real estate owned. At that date, the nonperforming portion of these assets was $432.6 million, and represented 69% of the Corporation's total nonperforming assets. As a result of the efforts of the SAG, total SAG assets declined $275.9 million, or 32%, to $589.4 million at December 31, 1992, and during 1993 declined $337.3 million, or 57%, to $252.1 million at December 31, 1993. The nonperforming portion of SAG assets at year-end totaled $68.4 million and represented 30% of the Corporation's total nonperforming assets, while comparable amounts at December 31, 1992, were $254.8 million and 51%, respectively. In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." This standard affects the definition and basis for measuring impaired loans and is more fully discussed in Note 5, Nonperforming Assets, on page 48. (FIG. 15) - SUMMARY OF LOAN LOSS EXPERIENCE (FIG. 17) - SUMMARY OF CHANGES IN NONACCRUAL LOANS AND OREO DEPOSITS AND OTHER SOURCES OF FUNDS Core deposits, defined as domestic deposits other than certificates of deposit of $100,000 or more, are the Corporation's primary source of funding. These deposits averaged $16.4 billion in both 1993 and 1992 and $17.5 billion in 1991. In 1993 average core deposits were significantly impacted by the January 1993 acquisition of Society First Federal. Excluding the impact of Society First Federal, core deposits declined $1.1 billion during the current year reflecting declining interest rates and other alternatives pursued by consumers. Over the past year, balances have also shifted significantly from the "Other time deposits" category, consisting primarily of fixed rate certificates of deposit, to demand and savings deposits (including NOW accounts) with higher liquidity, also principally as a result of declining interest rates. Based on the amounts shown in Figure 3, and after excluding the impact of Society First Federal, the $1.3 billion decline in the "Other time deposits" category and the $407.0 million decline in money market deposit accounts were partially offset by increases of $258.4 million in NOW accounts, $244.6 million in savings deposits and $72.9 million in demand deposits. The decline in core deposits in 1992 was primarily due to the sale of approximately $1.0 billion in deposits late in the second quarter (as part of the agreement reached with the United States Department of Justice and in accordance with the Federal Reserve Board order to divest certain branches in connection with the Ameritrust merger) and the pursuit of other alternatives by consumers in response to declining interest rates. Purchased funds, which are comprised of large certificates of deposit, foreign office deposits, and short-term borrowings, averaged $5.6 billion for 1993, up $1.1 billion, or 25%, from the prior year, following a decrease of $680.8 million, or 13%, in 1992. Average purchased funds were not materially impacted by the acquisition of Society First Federal. Based on the amounts shown in Figure 3, and after excluding the impact of Society First Federal, the 1993 increase was largely attributable to a $650.9 million increase in foreign office deposits, a $416.9 million increase in Federal funds purchased and securities sold under agreements to repurchase, and a $457.4 million increase in other short-term borrowings due to the issuance of Medium-Term Notes in the current year. These increases were partially offset by a $425.9 million decline in large certificates of deposits. LIQUIDITY Liquidity represents the availability of funding to meet the needs of depositors, borrowers, and creditors at a reasonable cost and without adverse consequences. The Corporation's ALCO actively analyzes and manages the Corporation's liquidity in coordination with similar committees at each bank subsidiary. The bank subsidiaries individually maintain sufficient liquidity in the form of short-term money market investments, anticipated prepayments on securities and through the maturity structure of their loan portfolios. Another source of liquidity are those securities classified as available for sale. In addition, the bank subsidiaries have access to various sources of non-core market funding for short-term liquidity requirements should the need arise. The effective management of balance sheet volumes, mix, and maturities enables the bank subsidiaries to maintain adequate levels of liquidity while enhancing profitability. During 1993, Society's lead bank, Society National Bank, issued $685 million in debt securities under a Medium-Term Bank Note program. These securities have maturities of less than one year and are included in other short-term borrowings. At December 31, 1993, the lead bank was authorized to issue up to an additional $2.3 billion of securities with maturities ranging from 9 months to 15 years under this program and an additional $1.0 billion under a separate, Medium-Term Deposit Note program. The proceeds from these programs are to be used for general corporate purposes in the ordinary course of business. During both the second quarter of 1993 and the fourth quarter of 1992, the lead bank issued $200 million in subordinated long-term debt to be used to supplement its capital base and to provide funds for loans and investments. During 1993, Society issued $111 million in debt securities under a separate Medium-Term Note program. These securities have maturities in excess of one year and are included in long-term debt. During 1993, Society redeemed $100 million in long-term debt securities due in 1996 at par plus accrued interest. In addition, Society redeemed 1,200,000 outstanding shares of Fixed/Adjustable Rate Cumulative Preferred Stock at 103% of its stated value of $60 million plus accumulated but unpaid dividends. The liquidity requirements of Society, primarily for dividends to shareholders, retirement of debt and other corporate purposes, are met principally through regular dividends from bank subsidiaries. As of December 31, 1993, $76.0 million was available in the bank subsidiaries for the payment of dividends to Society without prior regulatory approval. Excess funds are maintained in short-term investments. Society has no lines of credit with other financial institutions, but has ready access to the capital markets as a result of its favorable debt ratings. CAPITAL AND DIVIDENDS Total shareholders' equity at December 31, 1993, was $2.0 billion, up 9%, or $170.5 million, from the balance at the end of 1992. This followed an increase of $212.9 million, or 13%, in the prior year. In both years the increase was principally due to the retention of net income after dividends on Common Shares. Further information with respect to dividends is presented in the "Common Shares and Shareholder Information" section which follows and in the dividend restriction discussion included on page 56. In 1993, shareholders' equity was also impacted by the redemption of preferred stock referred to above. Capital adequacy is an important indicator of financial stability and performance. Overall, Society's capital position remains strong with a ratio of total shareholders' equity to total assets of 7.55% at December 31, 1993, up from 7.48% and 6.47% at December 31, 1992 and 1991, respectively. Banking industry regulators define minimum capital ratios for bank holding companies and their bank and savings association subsidiaries. Based on the risk-based capital rules and definitions prescribed by the banking regulators, the Corporation's Tier I and total capital to risk-adjusted assets ratios at December 31, 1993, were 8.65% and 12.88%, respectively. These compare favorably with the minimum requirements of 4.0% for Tier I and 8.0% for total capital. The Tier I leverage ratio standard prescribes a minimum ratio of 3.0%, although most banking organizations are expected to maintain ratios of at least 100 to 200 basis points above the minimum. At December 31, 1993, the Corporation's leverage ratio was 7.18%, substantially higher than the minimum requirement of 3%. Figure 19 presents the details of Society's capital position at December 31, 1993 and 1992. Effective in December 1992, Federal bank regulators adopted new regulations to implement the prompt corrective action provisions of the FDIA which group FDIC-insured institutions into five broad categories based on certain capital ratios. The five categories are "well-capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." Although these provisions are not directly applicable to Society under existing law and regulations, based upon its ratios Society would qualify, and the banks do qualify, as "well capitalized" at December 31, 1993. The Corporation's capital category, as determined by applying the prompt corrective action provisions of law, may not constitute an accurate representation of the overall financial condition or prospects of Society or its banking subsidiaries. The OCC, the Federal Reserve, and the FDIC are proposing amendments to their respective regulatory capital rules to include in Tier I capital the net unrealized changes in the value of securities available for sale for purposes of calculating the risk-based and leverage ratios. The proposed amendments are in response to the provisions outlined in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which takes effect for fiscal years beginning after December 15, 1993. See Note 3, Securities, on page 46 for a more complete description of SFAS No. 115. This new accounting standard establishes, among other things, net unrealized holding gains and losses on securities available for sale as a new component of stockholders' equity. If adopted as proposed, the rules could cause the Tier I capital to be subject to greater volatility. However, neither SFAS No. 115 nor the capital proposals would have any direct impact on reported earnings. Based upon the Corporation's securities portfolio classified as available for sale as of December 31, 1993, the estimated impact of the new standard would be an increase to shareholders' equity of approximately $28 million. The regulatory agencies are also proposing to add an additional component to the risk-based capital requirements based upon the level of an institution's exposure to interest rate risk. COMMON SHARES AND SHAREHOLDER INFORMATION On September 1, 1992, Society's Common Shares commenced trading on the New York Stock Exchange under the symbol SCY. The sales price ranges of the Common Shares and per Common Share net income and dividends by quarter for each of the last two years are presented in Figure 20. Common Shares outstanding and per Common Share data have been adjusted for a two-for-one stock split declared on January 21, 1993, which was effected by means of a 100% stock dividend paid on March 22, 1993, to Common Shareholders of record on March 2, 1993. At December 31, 1993, book value per Common Share was $17.37 based on 117,377,404 shares outstanding, compared with $15.49 based on 116,725,976 shares outstanding at December 31, 1992. At year-end 1993, the closing sales price on the New York Stock Exchange was $29.75 per share. This price was 171% of year-end book value per share and had a dividend yield of 3.76%. On January 20, 1994, the quarterly dividend on Common Shares was increased by 14% to $.32 per Common Share, up from $.28 per Common Share in 1993. The new quarterly dividend rate of $.32 per Common Share will be payable on March 15, 1994, to shareholders of record on February 28, 1994. There were 36,331 holders of record of Society Common Shares at December 31, 1993. FOURTH QUARTER RESULTS As shown in Figure 20, net income for the fourth quarter of 1993 was $57.0 million, or $.49 per Common Share, compared with $86.5 million, or $.72 per Common Share, for the same period last year. The 1993 period was impacted by merger and integration charges of $53.9 million ($39.6 million after-tax, $.33 per Common Share) recorded in connection with the merger with old KeyCorp. Excluding the impact of the merger and integration charges, net income was $96.6 million, up $10.1 million or 12%, from the prior year. This reflected a $4.8 million, or 2%, increase in taxable-equivalent net interest income and an $18.0 million, or 58%, decrease in the provision for loan losses, which were partially offset by an increase of $10.3 million, or 4%, in noninterest expense. On an annualized basis, the return on average total assets for the fourth quarter of 1993 was .87% compared with 1.40% for the fourth quarter of 1992. The annualized returns on average common equity for the fourth quarters of 1993 and 1992 were 11.09% and 19.08%, respectively. Excluding the merger and integration charges, the fourth quarter 1993 annualized return on average total assets was 1.47%, while the return on average common equity was 18.80%. The improvement in taxable-equivalent net interest income in the fourth quarter of 1993, as compared to the fourth quarter of 1992, reflected a $1.4 billion or 6% increase in the level of average earning assets, offset in part by a 23 basis point decline in the net interest margin to 5.10%. The higher level of average earning assets was primarily due to the acquisition of Society First Federal in January 1993. Excluding the impact of this acquisition, average earning assets increased by $177.1 million, mainly due to an increase of $579.3 million in average loans, principally those in the residential real estate portfolio, an increase of $732.8 million in securities available for sale and an increase of $146.2 million in mortgage loans held for sale. These increases were substantially offset by decreases of $670.9 million in interest-bearing deposits with banks and $573.0 million in investment securities. The decline in the net interest margin reflected the narrowing of spreads available on the replacement of matured and prepaid securities and interest rate swaps and the narrower spread contributed by Society First Federal. The lower provision for loan losses resulted from the overall improvement in asset quality, including a $185.9 million or 53% decline in nonperforming loans from December 31, 1992, to December 31, 1993. The increase in noninterest expense, excluding merger and integration charges, was primarily due to higher personnel expense, offset in part by lower costs associated with professional services. ITEM 8.

91576

1993

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES On August 20, 1986, the Partnership commenced an offering to the public of $100,000,000, subject to increase by up to $250,000,000, of Interests pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. On April 14, 1987, the offering was consummated and a total of 126,409 Interests were issued to the public by the Partnership from which the Partnership received gross proceeds of $126,409,000. After deducting selling expenses and other offering costs, the Partnership had approximately $113,741,000 with which to make investments primarily in existing commercial real property, to pay legal fees and other costs (including acquisition fees) related to such investments and to satisfy working capital requirements. A portion of such proceeds was utilized to acquire the properties described in Item 1 above. At December 31, 1993, the Partnership and its consolidated venture had cash and cash equivalents of approximately $1,300,000. Such funds and short- term investments of approximately $11,520,000 are available for future distri- butions to partners, working capital requirements, anticipated releasing costs at the Rivertree Court Shopping Center and to make additional investments in the venture which owns the First Financial Plaza Office Building as described in Note 3. As more fully described in Note 5, distributions to the General Partners have been deferred in accordance with the subordination requirements of the Partnership Agreement. The Partnership and its consolidated venture have currently budgeted in 1994 approximately $689,000 for tenant improvements and other capital expenditures. The Partnership's share of such items and its share of similar items for its unconsolidated ventures in 1994 is currently budgeted to be approximately $950,000. Actual amounts expended in 1994 may vary depending on a number of factors including actual leasing activity, results of property operations, liquidity considerations and other market conditions over the course of the year. The source of capital for such items and for both short-term and long-term future liquidity and distributions is expected to be through cash generated by the Partnership's investment properties and through the sale of such investments. The Partnership's and its ventures' mortgage obligations are all non-recourse. Therefore, the Partnership and its ventures are not obligated to pay mortgage indebtedness unless the related property produces sufficient net cash flow from operations or sale. In 1992, the Partnership paid approximately $345,000 relating to significant seismic-related improvements made to certain buildings at the Fountain Valley and Cerritos Industrial Parks in 1991. In 1993, the Partnership paid approximately $305,000 to complete significant land and building improvements at the Cerritos Industrial Park originally budgeted in 1992 as a result of a mandate from the City of Cerritos. In 1995 and 1996, leases at the Cerritos Industrial Park representing 33% and 22%, respectively, of the leasable square footage are scheduled to expire, not all of which are expected to be renewed. The Fountain Valley Industrial Park currently operates in a market with industrial vacancy rates ranging from 15% to 16%. Fountain Valley is currently 85% leased and occupied. The Partnership and the Newport Corporation, which vacated in March 1992 prior to its 1995 lease expiration and continues to pay rent pursuant to its one remaining lease obligation, entered into an agreement to terminate one of Newport's leases for approximately 77,000 square feet (representing approximately 20% of the leasable square footage at the property) in July 1993 for a $487,000 fee paid to the Partnership. The space has been leased to Fry's Electronics, an electronics retailer, for a twelve-year term effective July 1993. International Tile vacated its approximate 36,000 square feet in August 1993 prior to its lease expiration in 1997. In January 1994, International Tile filed for protection under Chapter XI of the United States Bankruptcy Code. It is unlikely that the Partnership will collect the approximate $90,000 owed by International Tile at December 31, 1993. In 1995 and 1996, leases representing 21% and 13%, respectively, of the leasable square footage at Fountain Valley are scheduled to expire, not all of which are expected to be renewed. Currently, as leases at the Fountain Valley and Cerritos Industrial Parks expire, lease renewals and new leases will likely be at rental rates less than the rates on existing leases. The supply of industrial space has caused increased competition for tenants, a corresponding decline in rental rates and a corresponding increase in time required to re-lease tenant space in these markets. This anticipated decline in rental rates and anticipated increase in re-leasing time will result in a decrease in cash flow from operations over the near term. Fountain Valley incurred minimal damage and Cerritos incurred no damage as a result of the earthquake in southern California on January 17, 1994. In February 1994, the Partnership extended and increased the first mortgage loan in the principal amount to $11,200,000, which is secured by the Fountain Valley and Cerritos Industrial Parks. The extended loan bears interest at a rate of 7.32% per annum, provides for monthly payments of principal and interest based on a twenty-year amortization period and matures March 1, 2001. After payment of costs and fees related to the re-financing, there were no distributable proceeds from the loan extension. Prior to the extension, the Partnership had entered into a forbearance agreement with the lender providing, among other things, that the lender agreed not to exercise its rights and remedies under the original loan documents from November 2, 1993, the original maturity date, until January 31, 1994. The Partnership continued to pay interest only at an annual rate of 8.83% on the original $11,000,000 principal balance through the effective date of the refinancing. As of December 31, 1993, the Partnership has made an aggregate investment of approximately $24,994,000 relating to a maximum total commitment of $25,750,000 to an existing partnership (Adams/Wabash) that constructed a parking garage and retail space structure known as the Adams/Wabash Self Park as described in Note 3(e). The Partnership is not required to increase this original aggregate investment. Pursuant to the Adams/Wabash Partnership Agreement, the Partnership's interest in the venture increased from 49.9% to 74.9% effective October 1, 1993. The Rivertree Court Shopping Center operates in a market which is experiencing significant growth in the commercial and residential sectors. The growth in the area is expected to continue in the next several years. However, in January 1994, Filene's Basement vacated their space of approximately 26,000 square feet (representing approximately 9% of the leasable square footage at the property) but continues to pay rent pursuant to its lease. The Partnership is finalizing its approval of a sub-tenant for the Filene's store. During the third quarter of 1992, Highland Superstores, Inc. and Phar-Mor, both of which then had stores at the Rivertree Court Shopping Center, filed for protection under Chapter XI of the United States Bankruptcy Code. Highland vacated its space at the end of August 1992. The Partnership has leased the Highland space to Best Buy, an appliance and home electronics retailer, which opened during February 1993. The Phar-Mor store at the center continues to operate and pay rent under its lease obligation since its bankruptcy filing. The Partnership has received no notification of Phar-Mor's intentions regarding the continued operations of this store. However, the Partnership has finalized negotiations with a replacement tenant should Phar- Mor vacate its space in the near future. On January 30, 1992, the Partnership, through JMB/Mid Rivers Mall Associates, sold its interest in the Mid Rivers Mall located in St. Peters, Missouri to the unaffiliated joint venture partner. The Partnership received in connection with the sale, after all fees, expenses and joint venture partner's participation, a net amount of cash of $13,250,000. See Note 7 for a further description of this transaction. The West Dade joint venture which owns the Miami International Mall entered into an agreement with J.C. Penney which opened a department store at the mall in October 1992 (see Note 3(d)). The addition of J.C. Penney has had a positive impact on the operations of the mall. During the third quarter of 1992, the property experienced storm damage caused by Hurricane Andrew. It has been determined that structural damage to the building was minimal; however, the landscaping surrounding the building, including the irrigation system and street curbs, was impacted more severely. All repairs necessary to continue operations have been made. The Partnership believes West Dade has adequate insurance coverage for this damage. A claim has been submitted to the property's insurance company for approximately $750,000. In January 1994, a partial settlement of approximately $710,000 of the expected insurance proceeds had been received. West Dade sold a 3.9 acre outparcel of land at the Miami International Mall in June 1993 for a net sale price of approximately $1,560,000, after certain selling costs, of which the Partnership's share was approximately $390,000. For financial reporting purposes, West Dade has recognized a gain in 1993 of approximately $1,385,000, of which the Partnership's share is approximately $346,000. West Dade is currently negotiating the sale of an additional 4 acre outparcel of land. In December 1993, West Dade obtained a new mortgage loan in the principal amount of $47,500,000 replacing the existing first mortgage loan at the property. The new mortgage loan bears interest at 6.91% per annum and matures December 21, 2003. The loan provides for monthly interest-only payments for years one through three and monthly principal and interest payments based on a twenty-year amortization period for years four through ten. The non-recourse loan is secured by a first mortgage on the Miami International Mall. After payment of costs and fees related to the refinancing, there were no distributable proceeds from the new loan. At December 31, 1993, the First Financial Plaza office building is approximately 85% occupied. In July 1993, Mitsubishi vacated its approximate 8,100 square feet prior to its lease expiration of January 1997 and continues to pay rent pursuant to its lease obligation. Including the Misubishi lease and recently executed leases, the building is 91% leased. In 1994, leases representing approximately 20% of the leasable square footage are scheduled to expire. Although renewal discussions with the majority of these tenants have been favorable, there can be no assurance that all of these tenants will renew their leases upon expiration. The Los Angeles office market in general and the Encino submarket in particular have become extremely competitive resulting in higher rental concession granted to tenants and flat or decreasing market rental rates. Furthermore, due to the recession in southern California and to concerns regarding tenants' ability to perform under current lease terms, the venture has granted rent deferrals and other forms of rent relief to several tenants including First Financial Housing, an affiliate of the unaffiliated venture partner. The property incurred minimal damage as a result of the earthquake in southern California on January 17, 1994. There 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 interest or goals that are inconsistent with those of the Partnership. In response to the weakness of the economy and the limited amount of available real estate financing in particular, the Partnership is taking steps to preserve its working capital. Therefore, the Partnership is carefully scrutinizing the appropriateness of any discretionary expenditures, particularly in relation to the amount of working capital it has available. By conserving working capital, the Partnership will be in a better position to meet future needs of its properties without having to rely on external financing sources. RESULTS OF OPERATIONS The increase in interest, rents, and other receivables as of December 31, 1993 as compared to December 31, 1992 is primarily due to the timing of the collection of tenant escalations at the Rivertree Court Shopping Center. The increase in deferred expenses as of December 31, 1993 as compared to December 31, 1992 and the related amortization expense for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to the capitalization and amortization of the lease commissions related to the 1993 commencement of the Fry's Electronics lease at the Fountain Valley Industrial Park. The decrease in amortization expense for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily due to the write off of deferred lease costs relating to a tenant vacating its space at the Fountain Valley Industrial Park in 1991. The decrease in current portion of long-term debt and the corresponding increase in long-term debt at December 31, 1993 as compared to December 31, 1992 is due to the extension of the $11,000,000 first mortgage loan secured by the Fountain Valley and Cerritos Industrial Parks subsequent to December 31, 1993 (see Note 4(b)). The increase in rental income for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to higher average occupancy levels at the Adams/Wabash Self Park, the Rivertree Court Shopping Center, and the Fountain Valley and Cerritos Industrial Parks. The increase in rental income is also due to the $487,000 termination fee received for the termination of one of the Newport Corporation lease obligations at the Fountain Valley Industrial Park in July 1993. In addition, parking revenue at the Adams/Wabash Self Park increased due to two monthly parking contracts which were executed during October 1992 and to increased activity from the Palmer House Hotel parking contract. The increase in leasing at the above- mentioned properties has also resulted in an increase in accrued rents receivable at December 31, 1993 as compared to December 31, 1992. The increase in rental income for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily due to an increase in parking revenue at the Adams/Wabash investment property due to two monthly parking contracts which were executed during October 1992 and to increased activity from the Palmer House Hotel parking contract. In addition, rental income from the retail space at the Adams/Wabash investment property increased due to higher average occupancy levels during 1992 as compared to 1991. Fountain Valley Industrial Park also received a partial bankruptcy settlement of $80,000 in 1992. The decrease in interest income for the year ended December 31, 1993 as compared to the year ended December 31, 1992 and the increase in interest income for the year ended December 31, 1992 as compared to the year ended December 31, 1991 are primarily due to the Partnership maintaining a higher average invested balance in U.S. Government obligations during 1992. The higher average invested balance resulted primarily from the receipt of cash proceeds (a portion of which were subsequently distributed to the Limited Partners in 1992) from the sale of the Partnership's interest in the Mid Rivers Mall in January 1992. The decrease in the amount of loss from Partnership's share of operations of unconsolidated ventures for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is due primarily to increased operations at the Miami International Mall. The decrease in the amount of loss from Partnership's share of operations of unconsolidated ventures for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily due to the sale of the Partnership's interest in the Mid Rivers Mall. The decrease in Partnership's share of gain on sale of investment property and gain on sale of land from unconsolidated venture for the year ended December 31, 1993 as compared to the year ended December 31, 1992 and the increase for the year ended December 31, 1992 as compared to the year ended December 31, 1991 are primarily due to the gain recognized in connection with the sale of the Partnership's interest in the Mid Rivers Mall in January 1992, partially offset by the sale of a 3.9 acre outparcel of land at the Miami International Mall in June 1993 (see Note 3(d)). The decrease in extraordinary item from unconsolidated venture for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to a prepayment penalty to the first mortgage lender as a result of the loan refinancing at the Miami International Mall in December 1993 (see Note 3(d)). INFLATION Due 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. To the extent that inflation in future periods does have an adverse impact on property operating expenses, the effect will generally be offset by amounts recovered from tenants as many of the long-term leases at the Partnership's commercial properties have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, there should be little effect on operating earnings if the properties remain substantially occupied. In addition, substantially all of the leases at the Partnership's shopping center investment property contain provisions which entitle the Partnership to participate in gross receipts of tenants above fixed minimum amounts. Future inflation may also cause capital appreciation of the Partnership's investment properties over a period of time to the extent that rental rates and replacement costs of properties increase. ITEM 8.

790603

1993

Item 6. Selected Financial Data. The information required by Item 6 is filed herewith under "Selected Financial Data" of the Financial Information section included in Appendix A to this report. Form 10-K 1993 Stone & Webster, Incorporated Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required by Item 7 is filed herewith under "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Financial Information section included in Appendix A to this report. Item 8.

94601

1993

ITEM 6. SELECTED FINANCIAL AND OPERATING DATA ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (Dollars in Millions) RESULTS OF OPERATIONS -- 1993 RESULTS COMPARED TO 1992 BellSouth Telecommunications, Inc. ("BellSouth Telecommunications") reported net income of $835.0 for the year ended December 31, 1993, a decrease of $739.3 (47.0%) compared to 1992. The decrease was primarily attributable to a charge of $696.6 for the restructuring of telephone operations (see Note J). Other charges in 1993 that contributed to the decrease were $86.6 for debt refinancings (see Note E), $64.8 for the adoption of Statement of Financial Accounting Standards ("SFAS") No. 112 (see Note H), $47 for the initial impact of a regulatory settlement in Florida, approximately $24 related to the increase in the Federal statutory income tax rate for corporations, exclusive of the tax benefit associated with the restructuring charge, and approximately $25 associated with severe weather conditions during first quarter 1993. The decreases were also attributable in part to the inclusion in 1992's results of gains of $39.5 and $32.9, respectively, from the settlement of a Federal income tax matter and the settlement of prior year regulatory issues. The 1993 decreases were partially offset by overall growth of operating revenues, driven by an improvement in key business volumes, and the inclusion in 1992 of charges for debt refinancing and Hurricane Andrew. OPERATING REVENUES Operating Revenues increased $397.5 (3.0%) in 1993 compared to 1992 primarily due to a $341.3 (5.5%) increase in Local Service revenue and smaller increases in Interstate Access, Intrastate Access and Other revenues. These increases were partially offset by a $29.3 (2.3%) decrease in Toll revenues. See "Volumes of Business." Local service revenues reflect amounts billed to customers for local exchange services, which include connection to the network and secondary central office feature services, such as custom calling features and custom dialing packages. (Paging and other mobile service revenues and revenues from cellular interconnection are included in Other operating revenues for both periods presented.) The increase in 1993 revenues of $341.3 (5.5%) was primarily attributable to an increase of 683,000 access lines since December 31, 1992 and a $42.0 increase from secondary central office services. In addition, the effects of a $27.9 refund in Florida during 1992 and revenue shifts from toll to local due to expanded local area calling plans, including a plan implemented in Louisiana in 1992, contributed to the increase in 1993 (see "Toll"). The increase in revenues from local area calling plans is primarily attributable to access line growth. Interstate access revenues result from the provision of access services to interexchange carriers to provide telecommunications services between states. Interstate access revenues increased $45.6 (1.5%) in 1993. The increase for 1993 reflects increased rates effective July 1, 1993 in conjunction with the selection of a 3.3% productivity offset factor under the Federal Communications Commission's ("FCC") price cap plan, growth in minutes of use and increases in end user charges attributable to growth in the number of access lines in service. The effect of these increases was substantially offset by decreased net settlements with the National Exchange Carriers Association and revenue deferrals under the FCC's price cap plan. Since BellSouth Telecommunications' earnings are currently in the sharing range of the FCC's price cap plan and because of other factors, significant revenue growth in this category is not likely. See "Operating Environment and Trends of the Business." Intrastate access revenues result from the provision of access services to interexchange carriers which provide telecommunications services between LATAs within a state. Revenues increased $10.1 (1.2%) in 1993. The increase, due primarily to growth in minutes of use, was substantially offset by rate reductions since December 31, 1992. Toll revenues are received from the provision of long-distance services within (but not between) LATAs. These services include intraLATA service beyond the local calling area; Wide Area Telecommunications Service ("WATS" or "800" services) for customers with highly concentrated demand; and special services, such as transport of voice, data and video. Toll revenues decreased $29.3 (2.3%) in 1993. The decrease reflects rate reductions since December 31, 1992 and a decline in toll message volumes largely attributable to the expansion of local area calling plans which have the effect of shifting revenues from Toll to Local Service. The decrease was partially offset by revenue increases due to optional calling plans and independent company settlements. The overall decline in toll revenues is expected to continue over the long term. Other revenues include revenues from publishing rights fees, customer premises equipment sales and maintenance services, billing and collection services, cellular interconnect services and other nonregulated services (primarily inside wire services). Other revenues increased $29.8 (1.6%) in 1993 primarily due to an increase in publishing rights fees and revenues from nonregulated services, due in part to higher demand. Billing and collection revenues also increased due to the effect of nonrecurring adjustments; however, such revenues are expected to decline over the long term due to interexchange carriers' assuming more direct billing for their own services. The overall increase was offset by the effect of reclassifying in 1992 a $27.9 Florida refund to ratepayers from Other revenues to Local Service and the inclusion in 1992 of $52.7 for the settlement of prior year regulatory issues. OPERATING EXPENSES Operating expenses increased $1,332.0 (13.0%) during 1993 primarily due to a pre-tax charge of $1,136.4 for restructuring of the telephone operations. Adjusted for the effect of the restructuring charge, Operating expenses increased $195.6 (1.9%) due to expenses associated with improved business volumes, higher levels of salaries and wages, a regulatory settlement in Florida, and expenses attributable to severe weather conditions in the first quarter of 1993. The increase was partially offset by decreased overtime compensation and the inclusion in 1992 of expenses related to Hurricane Andrew. Cost of Services and Products includes operating expenses associated with network support and maintenance of telecommunications property, plant and equipment, material and supplies expense, cost of tangible goods sold and other expenses associated with the cost of providing services. Cost of services and products increased $118.8 (2.4%) during 1993. This increase was due to increased expenses associated with volume growth, approximately $40 of expenses related to severe weather conditions during first quarter 1993, network service improvement activities, higher levels of base salary and wage expenses resulting from annual increases for management and craft employees and an increase in employee benefits expense, including amounts reclassified from Selling, General and Administrative. The increase in employee benefits expense was driven by the higher overall cost of medical services and an increase of $26 due to the adoption of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," partially offset by a decrease in pension expense. Pension expense is expected to decrease further in 1994 due primarily to the effect of modifying the benefit level under the recently adopted cash balance pension plan for management employees and reevaluating certain actuarial assumptions (see Note H). Other postretirement benefit expenses for 1994 are expected to increase due to the effect of changes in certain actuarial assumptions. The overall expense increase for 1993 was partially offset by reduced expenses for overtime compensation, rents, software license fees and expenses related to Hurricane Andrew reflected in 1992. Depreciation expense increased $40.1 (1.4%) during 1993. The increase was partially attributable to higher levels of property, plant and equipment since December 31, 1992 resulting from continued growth in the customer base and approximately $20 of additional depreciation expense related to extraordinary property retirements in conjunction with a regulatory settlement in Florida. Higher intrastate depreciation rates for Mississippi and higher interstate depreciation rates for Alabama, Kentucky, Louisiana, Mississippi and Tennessee, all retroactive to January 1, 1993, also contributed to the increase. The 1993 increase was partially offset by the continued expiration of inside wire and reserve deficiency amortizations and reduced depreciation expense in Florida and Alabama resulting from represcription. Selling, General and Administrative expenses include operating expenses related to sales activities such as salaries, commissions, benefits, travel, marketing and advertising expenses. Also included are the provision for uncollectibles and research and development costs. Selling, General and Administrative expenses increased $36.7 (1.6%) in 1993. The increase was primarily attributable to approximately $55 for the initial impact of a regulatory settlement in Florida, higher levels of salaries, wages and taxes other than income taxes and an increase of $11 due to the adoption of SFAS No. 112, "Employers' Accounting for Postemployment Benefits." The 1993 increase was partially offset by the effect of a reclassification of certain benefit expenses to Cost of Services and Products and a decrease in advertising expense. During 1993, BellSouth Telecommunications recognized a business restructuring charge of $1,136.4. The restructuring is being undertaken to redesign and streamline the fundamental processes and work activities of the telephone operations to better respond to an increasingly competitive business environment. The restructuring is expected to improve overall responsiveness to customer needs, permit more rapid introduction of new products and services and reduce costs. As a part of the restructuring, BellSouth Telecommunications plans to consolidate and centralize its existing operations. BellSouth Telecommunications plans to establish a single point of contact and accountability for the receipt, analysis and resolution of customer installation, repair activities and service activation. As a result, 288 existing operations centers will be consolidated into 80 locations. Data management centers used to support company operations will be reduced from 11 to 6. In addition, customer service processes and systems will be designed to provide one-number access, specific appointment times, on-line and real-time access to customer records and immediate service activation where facilities are already in place. The material components of the $1,136.4 charge relate to the downsizing of the existing workforce by 10,200 employees through 1996. These components include $368.2 for separation payments and relocations of remaining employees, $342.8 for the consolidation and elimination of certain operations facilities and $425.4 for enabling changes to information systems, primarily those used to provide services to existing customers. Substantially all of the restructuring charge is expected to require cash payments in future periods. Exclusive of capital requirements, cash payments related to restructuring for 1994, 1995 and 1996 are expected to be approximately $500, $350 and $220, respectively. In addition, future capital expenditures associated with the overall restructuring are estimated to be approximately $650. The cash requirements associated with the restructuring activities, including related capital expenditures, will be provided primarily from BellSouth Telecommunications' operations and, if necessary, from external sources. BellSouth Telecommunications reduced its overall workforce by approximately 1,300 employees in 1993 following implementation of the restructuring plan. Workforce reductions for 1994, 1995 and 1996 are expected to be approximately 3,700, 2,900 and 2,300, respectively. BellSouth Telecommunications expects that the restructuring will result in cost savings beginning in 1994 due to the workforce reductions. Once the restructuring is completed, annual cost savings are expected to be approximately $600 due primarily to reduced employee-related expenses. Interest expense includes interest on debt, certain other accrued liabilities and capital leases, offset by allowance for funds used during construction, which is capitalized as a cost of installing equipment and constructing plant. Interest expense decreased $20.7 (3.5%) in 1993. The decrease was due primarily to a decline in interest rates on borrowings, both short and long term, including the impact of refinancings of long-term debt at lower interest rates. The decrease was offset by a higher average level of short-term borrowings. (See Notes E and K.) Other income, which primarily includes interest and dividend income, decreased $54.1 (71.7%) during 1993 due to the inclusion in 1992 of $56.6 of interest income that resulted from a tax settlement with the Internal Revenue Service. Income tax expense decreased $339.3 (42.4%) in 1993 due to the impact of the restructuring charge, which reduced tax expense by $439.8. The decrease was partially offset by the impact of the Omnibus Budget Reconciliation Act of 1993, including the increase in the Federal statutory income tax rate for corporations, which, exclusive of the tax benefit associated with the restructuring charge, increased tax expense by approximately $24. BellSouth Telecommunications' effective tax rates were 31.9% and 33.1% in 1993 and 1992, respectively. A reconciliation of the statutory Federal income tax rates to these effective tax rates is provided in Note L. A discussion of the adoption of SFAS No. 109, "Accounting for Income Taxes," also is included therein. OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS REGULATORY ENVIRONMENT. In providing telecommunications services, BellSouth Telecommunications is subject to regulation by both state and federal regulators with respect to rates, services and other issues. While the states in BellSouth Telecommunications' service area currently provide for some form of regulation of earnings, as discussed below, BellSouth Telecommunications believes that the existing regulatory framework is not appropriate for the increasingly competitive telecommunications environment. Accordingly, BellSouth Telecommunications' primary regulatory focus continues to be directed toward modifying the regulatory process to one that is more closely aligned with changing market conditions and overall public policy objectives. As an alternative to the current regulatory process, BellSouth Telecommunications believes that price regulation, whereby prices of basic local exchange service are directly regulated and prices for other products and services are based on market factors, is a logical progression in regulatory flexibility and is fair to consumers. As such, BellSouth Telecommunications intends to pursue implementation of price regulation plans through filings with state regulatory commissions or through legislative initiatives. STATE REGULATION Seven of the nine states in which BellSouth Telecommunications operates are now under some alternative form of regulation other than traditional rate of return regulation. The seven states are Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi and Tennessee. These state plans are designed to provide BellSouth Telecommunications with economic incentives to improve cost controls and general efficiency in the form of shared earnings over benchmark rates of return. The plans in Georgia and Kentucky are scheduled to expire in 1994. BellSouth Telecommunications attained the earnings sharing range in Alabama, Kentucky, Louisiana and Mississippi at certain times during 1993. For a part of 1993, South Carolina also operated under a form of alternative regulation. However, in August 1993, the South Carolina Supreme Court ruled that the South Carolina Public Service Commission (the "SCPSC") lacked the statutory authority to approve incentive regulation plans of the type under which BellSouth Telecommunications had been operating since 1992. Legislation has been proposed in South Carolina which would permit the SCPSC to adopt alternative forms of regulation including price regulation. In the interim, traditional rate of return regulation is in effect in South Carolina. In January 1994, the Florida Public Service Commission approved a settlement reached by BellSouth Telecommunications and Florida's Office of Public Counsel related to pending rate proceedings initially filed by BellSouth Telecommunications in July 1992 and other consolidated matters. This settlement ended outstanding rate case and consolidated issues in Florida and extended the incentive regulation plan through at least 1996. Under the terms of the settlement, BellSouth Telecommunications was required to recognize in 1993 business all remaining deferred expenses related to Hurricane Andrew and to record expenses associated with extraordinary asset retirements, also related to Hurricane Andrew. The aggregate impact of these items was approximately $75, which reduced BellSouth Telecommunications' net income for 1993 by approximately $47. The terms of the settlement also required BellSouth Telecommunications to reduce rates by $55 in February 1994 and will require reductions of an additional $60 in July 1994, $80 in October 1995 and $84 in October 1996. The settlement provides for other changes in service offerings and tariffs including approximately $21 in revenue reductions or increased expenses. Certain other service rates have been capped at their current levels through 1997, and BellSouth Telecommunications has agreed not to propose any local measured service on a statewide basis through the same time period. FEDERAL REGULATION At the national level, BellSouth Telecommunications has been operating under price cap regulation since January 1, 1991. In contrast to regulation which limits the rate of return that can be achieved, price cap regulation limits the prices telephone companies can charge for use of their services. The current FCC plan allows for the sharing of earnings over a benchmark range of earnings. This benchmark is dependent upon the productivity offset factor chosen annually by the carrier. During the price cap plan's annual election period in 1993, BellSouth Telecommunications selected a productivity offset factor of 3.3% which increased access rates more than they would otherwise have been had the 4.3% factor been selected; however, selection of this lower productivity factor provides for a lower allowed return before sharing is required. As of December 31, 1993, BellSouth Telecommunications' recorded liability for estimated sharing was $45.6. In February 1994, the FCC initiated its review of the current price cap plan. Under a notice of proposed rulemaking, the FCC identified for examination three broad sets of issues including those related to the basic goals of price cap regulation, the operation of price caps, and the transition of local exchange services to a fully competitive market. BellSouth Telecommunications believes and will advocate that a revised price cap plan should be structured to provide increased pricing flexibility for services as competition evolves in the telecommunications markets. Any changes to the current plan are expected to be effective January 1, 1995 or soon thereafter. ECONOMY. The nine-state region served by BellSouth Telecommunications' wireline telephone business, as a whole, posted solid economic gains in 1993, while continuing economic slumps on the West Coast and in the Northeast kept the national economy sluggish for much of the year. Employment growth averaged 2.1% in the region in 1993, slower than the 4% annual rate experienced in the 1980's, but still above the national average of 1.6%. Manufacturing employment in the region grew slightly during 1993 while the nation lost approximately 180,000 manufacturing jobs. Services employment increased about 4% to lead the region's growth. Employment growth is expected to improve further in 1994. Residential construction growth moved back above pre-recession levels with housing starts in the region up 12% over the year. Housing demand is expected to remain strong in 1994. The region's relatively strong economy along with its attractive climate have kept net in-migration near 400,000 per year, boosting the demand for telecommunications services. However, increasing competition makes BellSouth Telecommunications' financial performance more susceptible to changes in the economy than previously, as its operations reflect the more competitive environment and greater elasticity in demands for its products and services. VOLUMES OF BUSINESS. Network Access Lines in Service at December 31 (Thousands): The total number of access lines in service increased by 683,000 over 1992, representing a 3.7% increase, an improvement over the 3.4% rate of increase for 1992 over 1991. The overall increase, led by growth in Florida, Georgia, North Carolina and Tennessee, was primarily attributable to continued economic improvement, including expanding employment in BellSouth Telecommunications' nine-state region and an increase in the number of second lines in residences. While the overall growth rate for residence lines remained constant at 3.0%, the growth rate for business lines continued to increase, reaching 5.9% in 1993, compared to 5.1% in 1992. Access Minutes of Use (Millions): Access minutes of use represent the volume of traffic carried by interexchange carriers between LATAs, both interstate and intrastate, using BellSouth Telecommunications' local facilities. Total access minutes of use increased by 4,065.3 million (6.3%) in 1993 compared to a 6.7% increase in 1992. The 1993 increase in access minutes of use was partially attributable to access line growth and also to intraLATA toll competition, which has the effect of increasing access minutes of use while reducing toll messages carried over BellSouth Telecommunications' facilities. The growth rate in total minutes of use continues to be negatively impacted by the effects of bypass and the migration of interexchange carriers to categories of service (e.g., special access) that have a fixed charge as opposed to a volume-driven charge and to high capacity services, which causes a decrease in minutes of use. Toll messages, comprised of Message Telecommunications Service and Wide Area Telecommunications Service, decreased 29.3 million (2.3%) compared to a 7.7% decrease in 1992. The lower rate of decrease for 1993 was attributable to the inclusion of the impact of the Louisiana area calling plan in both 1992 (beginning in March) and 1993. Competition in the intraLATA toll market and the effects of expanded local area calling plans continue to have an adverse impact on toll message volumes. These plans and the effects of competition have the effect of shifting calls from toll to local service and access, respectively, but the corresponding revenues are not generally shifted at commensurate rates. The decline in toll message volumes is expected to continue for the foreseeable future. COMPETITION. Recent developments in the telecommunications marketplace indicate that a technological convergence is occurring in the telephone, cable and broadcast television, computer, entertainment and information services industries. The technologies utilized and being developed in these industries will enable multiple communications offerings. Several large companies have recently announced proposed acquisitions or business alliances that, if consummated, could intensify and expand competition for local communications and other services currently provided over BellSouth Telecommunications' networks. Other competitors have announced plans to build local phone connections that would permit business and residential customers to bypass the facilities of local telephone companies, including those of BellSouth Telecommunications in certain cities in its service territory. In addition, legislative activities in Congress could affect BellSouth Telecommunications' business and competitive position. BellSouth Telecommunications has undertaken a plan to streamline its telephone operations and to improve its overall cost structure as a part of its competitive strategy (see "Results of Operations"). Notwithstanding the risks associated with increased competition, BellSouth and BellSouth Telecommunications will have the opportunity to benefit from entry into new business markets. BellSouth believes that in order to remain competitive in the future, it must aggressively pursue a corporate strategy of expanding its offerings beyond its traditional businesses which may include information services, interactive communications and cable television and other entertainment services. BellSouth plans to enter such businesses through acquisitions, investments and strategic alliances with established companies in such industries and through the development of such capabilities internally. Such transactions, if accomplished, could initially reduce earnings and require substantial capital. Financing for such business opportunities will be provided from funds generated through internal operations and from external sources. ACCOUNTING UNDER SFAS NO. 71. BellSouth Telecommunications continues to account for the economic effects of regulation under SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation." BellSouth Telecommunications, for strategic and business planning purposes, continuously monitors and evaluates the impacts of both existing and potential competitive factors. If, in BellSouth Telecommunications' judgment, changes in the competitive structure of the telecommunications industry dictate that it could not charge prices to customers which provide for the recovery of costs, SFAS No. 71 would no longer apply. BellSouth Telecommunications currently believes that the existing and anticipated levels of competition still permit prices based on costs to be charged to and collected from customers. However, the rapid pace of change in the industry is making it increasingly likely that BellSouth Telecommunications will be required to discontinue its accounting under SFAS No. 71 in the future. BellSouth Telecommunications believes that the existing regulatory framework is not appropriate for the increasingly competitive telecommunications environment. Accordingly, BellSouth Telecommunications intends to pursue implementation of price regulation plans in all of its jurisdictions through filings with state regulatory commissions or through legislative initiatives. Since price regulation plans do not provide for the recovery of specific costs, SFAS No. 71 would no longer apply. If BellSouth Telecommunications is successful in altering the existing regulatory framework and achieving price regulation, BellSouth Telecommunications would be required to discontinue its accounting under SFAS No. 71. If BellSouth Telecommunications were to discontinue its accounting under SFAS No. 71 due to the overall level of competition or to changes in regulatory frameworks, the effect on its financial condition and results of operations would be material. Specific financial impacts would depend on the timing and magnitude of changes, both in the marketplace and in the overall regulatory framework. OTHER MATTERS ACCOUNTING PRONOUNCEMENTS. Effective January 1, 1993, BellSouth Telecommunications adopted three new accounting standards issued by the Financial Accounting Standards Board. SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," requires employers to accrue the cost of providing postretirement benefits other than pensions during the period employees are expected to earn the benefit. BellSouth Telecommunications is recognizing the related transition benefit obligation over 15 years. As a result of the adoption of SFAS No. 106, operating expenses in 1993 were $26 higher than they would have been using the former accounting method. Accordingly, net income was reduced by approximately $16 (see Note H). SFAS No. 109, "Accounting for Income Taxes," requires companies to compute deferred income taxes using a liability approach rather than the deferred method previously required under Accounting Principles Board Opinion No. 11. The adoption of SFAS No. 109 did not materially affect tax expense or net income for 1993 (see Note L). SFAS No. 112, "Employers' Accounting for Postemployment Benefits," requires employers to accrue the cost of postemployment benefits provided to former or inactive employees after employment but before retirement. A one-time charge of $64.8, net of a deferred tax benefit of $40.8, related to the adoption of SFAS No. 112 was recognized as an accounting change (see Note H). Other pronouncements have been issued by authoritative accounting bodies but not yet adopted by BellSouth Telecommunications. The adoption of such standards in future periods, where required, is not expected to have a material impact on BellSouth Telecommunications' operating results and financial condition. DEBT REFINANCINGS. During 1993, BellSouth Telecommunications refinanced $2,760 of long-term debt at more favorable interest rates. An extraordinary loss of $86.6, net of taxes of $58.8, was recognized in connection with the early extinguishment of certain of these issues. ENVIRONMENTAL ISSUES. BellSouth Telecommunications is subject to a number of environmental matters as a result of its operations and shared liability provisions in the Plan of Reorganization, related to the Modification of Final Judgment. As a result, BellSouth Telecommunications expects that it will be required to expend funds to remedy certain facilities, including those Superfund sites for which BellSouth Telecommunications has been named as a potentially responsible party and also for the remediation of sites with underground fuel storage tanks and other expenses associated with environmental compliance. At December 31, 1993, BellSouth Telecommunications' recorded liability related primarily to remediation of these sites was $35.5. BellSouth Telecommunications continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. BellSouth Telecommunications' recorded liability reflects those specific issues where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. BellSouth continues to believe that expenditures in connection with additional remedial actions under the current environmental protection laws or related matters will not have a material impact on BellSouth Telecommunications' operating results or financial condition. SUBSEQUENT EVENT. During the first quarter of 1994, BellSouth Communication Systems, Inc., a wholly-owned subsidiary, entered into an agreement to sell its customer premise equipment sales and service operations outside the nine-state region. The transaction is expected to close by the end of April 1994. ITEM 8.

92088

1993

Item 6. SELECTED FINANCIAL DATA The selected financial data presented hereinafter as of and for each of the years in the five year period ended December 31, 1993, are derived from consolidated financial statements of the Company, which financial statements have been audited by KPMG Peat Marwick, independent certified public accountants. This data should be read in conjunction with the accompanying notes, the Company's financial statements and the related notes thereto, and "Management's Discussion and Analysis of Financial Condition and Results of Operations", all included elsewhere herein. Item 7.

Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company derives approximately 41% of its net sales from tests performed for beneficiaries of Medicare and Medicaid programs. Several changes have been made which impact the reimbursement the Company receives from such programs. On January 1, 1993, numerous changes in the Physicians' Current Procedural Terminology were published which became effective on August 1, 1993. These changes impact the reimbursement the Company receives on some of its services that are billed to the Medicare and Medicaid programs. For example, certain codes for calculations, such as LDL cholesterol were deleted and are no longer a payable service under Medicare and Medicaid. Had such changes been implemented as of January 1, 1993, the Company estimates that 1993 net sales would have been reduced by approximately $7 million. During 1993, provisions were included in OBRA '93 which reduced Medicare reimbursement schedules by lowering payments under the fee schedule methodology from 88% to 84% of the national limitation amounts, effective January 1, 1994. The Company estimates that this change would have decreased 1993 net sales by approximately $10 million had it been implemented as of January 1, 1993. A further reduction in payments to 80% of the national limitation amounts will become effective on January 1, 1995, followed by an additional reduction to 76% on January 1, 1996. OBRA '93 also eliminated, for 1994 and 1995, the provision for annual fee schedule increases based upon the consumer price index. In the latter part of 1993, the Company held discussions with HCFA concerning the reimbursement policy for serum ferritin and HDL cholesterol tests. HCFA expressed concerns that the incidence of orders of these tests by physicians remained too high despite changes in the Company's requisition forms, pricing and compendia of tests instituted after the Company's 1992 settlement. As a result of a HCFA directive to Medicare carriers, the Company began to receive denials of claims submitted in September 1993 for serum ferritin and HDL cholesterol tests ordered by physicians and performed in conjunction with automated chemistry panels. Such denials and related suspended billings reduced the Company's 1993 net sales by approximately $18.6 million. The Company continues to discuss the status of these claims with HCFA. The Company has undertaken actions with regard to HCFA's concerns. The Company has removed the HDL cholesterol and serum ferritin tests from all standard chemistry profiles offered on its test requisition form. These tests may be ordered separately or as part of a custom designed profile where specific authorization is provided by the requesting physician. The Company estimates that the annualized effect of these changes would have been a reduction in net sales of approximately $60 million. A portion of such impact aggregating approximately $18.6 million, as discussed above, was reflected in the Company's 1993 net sales. In March 1992, HCFA published proposed regulations to implement the Medicare statute's prohibition (with certain exceptions) against compensation arrangements between physicians and laboratories. The proposed regulations would define remuneration that gives rise to a compensation arrangement as including discounts. If that definition of remuneration were to become effective, it could have an impact on the way the Company prices its services to physicians. However, in August 1993, the referenced Medicare statute was amended by OBRA '93. One of these amendments makes it clear that day-to-day transactions between laboratories and their customers, including, but not limited to discounts granted by laboratories to their customers, are not affected by the compensation arrangement provisions of the Medicare statute. Thus, the Company expects the definition of remuneration in HCFA's proposed regulations will be changed to reflect this amendment to the Medicare statute. Currently, these proposed regulations have not been finalized. The Clinton Administration has announced its intention and desire to reform health care in the United States. Some of the proposals that have been discussed include managed competition, global budgeting, price controls and freezes on health care costs. Health care reform as well as additional future changes in federal, state or local regulations (or in the interpretation of current regulations) affecting governmental reimbursement for clinical laboratory testing could have a material adverse effect on the Company. The Company is unable to predict, however, whether and what type of legislation will be enacted into law. Due to the effect of numerous changes which are reshaping the clinical laboratory market, including aggressive pricing by many competitors, reduced rates of government reimbursement, pricing pressures generated by managed care providers and the demand for increased service levels, coupled with the decline in utilization of ferritin and HDL tests, the Company expects that its margins will be significantly lower in 1994 than in 1993. Year Ended December 31, 1993 compared with Year Ended December ---------------------------------------------------------------- 31, 1992 -------- Net sales increased by $39.1 million to $760.5 million in 1993, an increase of 5.4% over 1992. Revenues generated by new accounts increased net sales by approximately 12.0%. The acquisition of thirty-four small clinical laboratory companies increased the growth in net sales by approximately 3.5%. In addition, net sales for 1993 increased approximately 2.7% because of the Company's annual price increases (effective in January of 1993). Changes in Medicare's reimbursement policy for LDL tests, coupled with changes in various state Medicaid fee schedules and reimbursement methodologies partially offset the increase in net sales by approximately 1.0%. Medicare's denial of claims for ferritin and HDL tests, which began in September 1993 and continued through December 20, 1993 when the Company introduced new test forms and procedures, and related suspended billings also offset the increase in net sales by approximately 2.6%. Additionally, a decline in the utilization of laboratory services, and, to a lesser extent, severe weather in the first three months of the year further offset the increase in net sales by approximately 7.3%. The Company believes that the decline in utilization was due to fewer patient visits to physicians' offices since the number of tests ordered per patient remained relatively constant. Improved accuracy in estimating the difference between amounts billed and amounts received for services provided under third party payor programs, primarily due to the wider use of specific fee schedules for individual third party carriers, resulted in an increase in the growth in net sales of 1.6%. The aggregate of various other impacts, including discounts granted to meet competitive pressure and movement between payor mix categories, reduced the growth in net sales by approximately 3.5%. Revenues derived from tests performed for beneficiaries of Medicare and Medicaid programs were approximately 41% and 42% of net sales in 1993 and 1992, respectively. The Company actively pursued acquisitions of small clinical laboratory companies during 1993. The laboratory industry is consolidating rapidly as smaller, less efficient organizations are experiencing decreasing profitability in the current health care environment. The purchase of thirty-four small laboratories, primarily in the second half of 1993, increased net sales for the year by approximately $25 million. Had all such acquisitions occurred as of the beginning of 1993, the aggregate contribution to net sales would have been approximately $80.6 million. The Company intends to continue its acquisition program. Cost of sales primarily includes laboratory and distribution costs, a substantial portion of which varies directly with sales. Cost of sales increased to $444.5 million in 1993 from $395.1 million in 1992. As a percentage of net sales, cost of sales increased to 58.4% in 1993 from 54.8% in 1992. Labor costs increased approximately 2.7% of net sales, primarily as a result of an increase in phlebotomy staffing to improve client service and meet competitive demands. Rental of premises also grew approximately 0.3% of net sales due to expanding the number of patient service centers by 50% during 1993. Higher capital spending led to increased depreciation expenses of approximately 0.3% of net sales. Also, several expense categories increased slightly, aggregating approximately 0.3% of net sales. The Company continues to focus on cost savings as part of an ongoing program to improve its cost structure. Internal operating reviews were completed in 15 of the Company's 16 laboratories which were in operation during 1993. In 1994, operating reviews will once again be conducted in all laboratories. The Company believes that the relationship of its expense base to net sales is affected by volume growth, cost control efforts and changing emphasis in various functional areas; therefore, a decrease or increase in any cost as a percentage of net sales in a particular period is not necessarily indicative of a trend. Selling, general and administrative expenses increased to $121.4 million in 1993 from $117.9 million in 1992, an increase of $3.5 million. As a percentage of net sales, selling, general and administrative expenses decreased slightly to 16.0% in 1993 compared with 16.3% in 1992. This was primarily due to a reduction in the provision for doubtful accounts, reflecting improvements in the collection of delinquent accounts, and also a result of reduced spending for the relocation of Company employees and for legal services. These changes more than offset an increase in labor costs related to staffing added during 1993 to improve billing customer service and expand the Company's information systems group. The increase in amortization of intangibles and other assets to $9.1 million in 1993 from $8.3 million in 1992 primarily resulted from the acquisition of several small clinical laboratory companies during 1993. Other gains and expenses include expense reimbursement and termination fees of $21.6 million received in connection with the Company's attempt to purchase Damon Corporation, less related expenses and the write-off of certain bank financing costs aggregating $6.3 million, resulting in a one-time pre-tax gain of $15.3 million. Investment income decreased to $1.2 million in 1993 from $2.2 million in 1992 and interest expense increased to $10.9 million in 1993 from $4.2 million in 1992. During 1993, cash in excess of operating requirements and increased borrowings were used to finance acquisitions of numerous small clinical laboratory companies and to finance purchases by the Company of its common stock. The provision for income taxes as a percentage of earnings before income taxes increased to 41.0% in 1993 from 34.6% in 1992, primarily due to the increase in the U.S. corporate tax rates and a result of a higher effective rate for state income taxes. Year Ended December 31, 1992 compared with Year Ended December -------------------------------------------------------------- 31, 1991 -------- Net sales increased by $117.5 million to $721.4 million in 1992, an increase of 19.5% over 1991. Approximately 15.3% of the increase was due to revenues generated by new accounts. In addition, net sales for 1992 increased approximately 4.2% because of the Company's annual price increases (effective in January of 1992). A net increase in Medicare fee schedules contributed approximately 0.6% to the increase in net sales, whereas changes in various state Medicaid fee schedules and reimbursement methodologies reduced the growth in net sales by approximately 0.6%. Revenues derived from tests performed for beneficiaries of Medicare and Medicaid programs were approximately 42% of net sales in both 1992 and 1991. Cost of sales primarily includes laboratory and distribution costs, a substantial portion of which varies directly with sales. Cost of sales increased to $395.1 million in 1992 from $332.5 million in 1991, although as a percentage of net sales, cost of sales decreased slightly to 54.8% in 1992 from 55.1% in 1991. This improvement was primarily attributable to laboratory supply cost decreases of approximately 0.2% of net sales due to cost control efforts, negotiation of favorable national supply contracts and implementation of the initial phase of a new inventory control system. Distribution expenses (which are incurred to deliver specimens from the physician's office to the laboratory) decreased approximately 0.5% of net sales, primarily due to favorable automobile lease rates. Additionally, labor costs increased approximately 0.5% of net sales, mainly as a result of higher employee benefit costs. Also, cost reduction efforts and operational efficiencies resulted in a slight decrease in several expense categories aggregating approximately 0.1% of net sales. Selling, general and administrative expenses increased to $117.9 million in 1992 from $97.9 million in 1991, an increase of $20.0 million. As a percentage of net sales, selling, general and administrative expenses increased slightly to 16.3% in 1992 compared with 16.2% in 1991. This was primarily due to a moderately higher provision for doubtful accounts as a percent of net sales due to the uncertain national economy. Amortization of intangibles and other assets increased $0.6 million to $8.3 million in 1992, primarily due to amortization of debt issuance costs associated with the revolving credit facility in existence during the year. In the fourth quarter of 1992, the Company took a one-time charge of $136.0 million to cover all estimated costs related to agreements that concluded a government investigation that primarily revolved around the government's contention that the Company improperly received reimbursement for tests for HDL cholesterol and serum ferritin (a measure of iron in the blood) included in its basic Health Survey Profile. The one-time charge reduced net earnings and earnings per share for the quarter and year ended December 31, 1992 by $80.3 million and $0.85, respectively. The Company will continue to receive reimbursements from all government third party reimbursement programs, including Medicare, Medicaid and CHAMPUS, under the settlement agreements. Investment income decreased to $2.2 million in 1992 from $3.6 million in 1991 and interest expense increased to $4.2 million in 1992 from $0.1 million in 1991. Both of these changes are directly related to the purchase of 4,808,000 shares of the Company's outstanding common stock in January 1992 pursuant to a tender offer. Such purchase was financed by approximately $25.8 million in cash on hand and $100.0 million borrowed under a revolving credit facility in existence at that time. Also, in April and October 1992, the Company prepaid $15.0 million and $10.0 million, respectively, of the outstanding balance of such revolving credit facility. The provision for income taxes as a percentage of earnings before income taxes decreased to 34.6% in 1992 from 38.6% in 1991, primarily due to a lower effective rate for state income taxes. Liquidity and Capital Resources The Company has generated cash flow in excess of its operating requirements in each of the three past fiscal years. Cash from operations was $57.2 million, $102.4 million and $135.3 million for the years ended December 31, 1993, 1992 and 1991, respectively. Of these amounts, cash used for capital expenditures was $33.6 million, $34.9 million and $25.4 million for the years ended December 31, 1993, 1992 and 1991, respectively. The Company expects capital expenditures to be approximately $30.0 million to $40.0 million in 1994 to accommodate expected growth, to further automate laboratory processes and improve efficiency. During 1993, the Company acquired thirty-four clinical laboratory companies in various locations of the United States for an aggregate amount of $78.2 million in cash plus $28.7 million of liabilities, comprised primarily of future contractual and contingent payments. Such future payments are expected to be funded with cash generated from operations. These laboratories, on an annual basis, are expected to generate approximately $80.6 million in net sales. During 1992, the Company acquired five clinical laboratories for a total of $2.3 million in cash plus $0.7 million of liabilities were assumed. In 1991, three laboratory companies were purchased for $1.2 million in cash plus $5.3 million of liabilities were assumed. It is the Company's intention to continue its acquisition program, although there can be no assurance that the Company will be able to acquire additional laboratories on terms the Company believes to be competitively advantageous. On August 27, 1993, the Company entered into the unsecured Revolving Credit Facility with Citicorp USA, Inc. as agent for a group of banks. The Revolving Credit Facility provides that the Company may borrow up to $350.0 million in order to refinance existing indebtedness; to finance repurchases from time to time by the Company of its common stock; to finance certain acquisitions; and to provide for the general corporate purposes of the Company. The Revolving Credit Facility matures on September 1, 1998, with commitment reductions of $50.0 million on September 1, 1996 and September 1, 1997. The terms and conditions of the Revolving Credit Facility contain, among other provisions, requirements for maintaining a defined level of stockholders' equity, various financial ratios, certain restrictions on repurchases by the Company of its common stock and certain restrictions on acquisitions made outside the Company's ordinary course of business. Interest rates are determined at the time of borrowing and are based on London Interbank Offered Rates plus 1% per annum, or other alternative rates. On September 1, 1993, the Company borrowed $139.0 million under the Revolving Credit Facility to permanently repay all amounts outstanding under revolving credit facilities in existence on such date. Net additional borrowings during 1993 aggregated $139.0 million and were used to finance acquisitions of several clinical laboratory companies and to finance repurchases by the Company of its common stock. In March 1993 and in June 1992, the Company announced plans to purchase from time to time up to 10 million and 2 million shares of its outstanding common stock, respectively, in the open market. Pursuant to these plans, during 1993 and 1992, the Company purchased 9,485,800 and 310,000 such shares, respectively, for an aggregate amount of $154.2 million and $6.1 million, respectively. In January 1992, pursuant to a self tender offer, the Company purchased 4,808,000 of its outstanding shares of common stock for $26 per share in cash, or $125.8 million. The purchase was financed by $25.8 million of cash on hand and $100.0 million borrowed under a revolving credit facility in existence at that time. Pursuant to the Government Settlement, a total of $55.8 million was paid for settlement and other expenses during 1993, including aggregate cash payments of $38.0 million made to the federal government. The remaining amount due the federal government, $27.0 million, is being paid in quarterly installments through September 1995, which installments are expected to be paid with cash generated from operations. During 1992, the Company paid $47.1 million for settlement and related expenses, including $35.0 million to the federal government and $10.4 million to state Medicaid programs. During 1991, the Company guaranteed a $9.0 million, 5 year loan to a third party for construction of a new laboratory to replace one of the Company's existing facilities. Following its completion in November 1992, the building was leased to the Company by this third party. Under the terms of this guarantee, as modified, the Company is required to maintain 105% of the outstanding loan balance including any overdue interest as collateral in a custody account established and maintained at the lending institution. As of December 31, 1993, 1992 and 1991, the Company had placed $9.5 million, $10.3 million and $11.3 million, respectively, of investments in the custody account. Impact of Statement of Financial Accounting Standards No. 115 -- Accounting for Certain Investments in Debt and Equity Securities SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", was issued in May 1993 and addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. SFAS No. 115 requires the Company to adopt this statement in 1994. The Company does not anticipate that the adoption of SFAS No. 115 will have a material impact on its financial position or results of operations as the Company's investments in such securities are expected to be classified as trading securities, and, as such, their carrying values are considered representative of their fair values. Item 8.

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ITEM 6. SELECTED FINANCIAL DATA. Item 6 is not required pursuant to the reduced disclosure requirements applicable to this Form 10-K. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. See the information in "Reliance Financial Services Corporation and Subsidiaries Financial Review" on pages 26 through 33 of the Reliance Financial 1993 Annual Report, which information is incorporated herein by reference. ITEM 8.

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Item 6. Selected Financial Data Entergy Corporation. Refer to information under the heading "Entergy Corporation and Subsidiaries Selected Financial Data - Five- Year Comparison," which information is incorporated herein by reference. AP&L. Refer to information under the heading "Arkansas Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. GSU. Refer to information under the heading "Gulf States Utilities Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. LP&L. Refer to information under the heading "Louisiana Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. MP&L. Refer to information under the heading "Mississippi Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. NOPSI. Refer to information under the heading "New Orleans Public Service Inc. Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. System Energy. Refer to information under the heading "System Energy Resources, Inc. Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference. Item 7.

Item 7 "Financial Statements and Exhibits". A current report on Form 8-K, dated January 18, 1994, was filed with the SEC on January 18, 1994, reporting information under Item 5 "Other Materially Important Events". A current report on Form 8-K, dated February 1, 1994, was filed with the SEC on February 8, 1994, reporting information under Items 2 and 7. Entergy Corporation, AP&L, GSU, LP&L, MP&L and NOPSI Current Reports on Form 8-K, dated December 31, 1993, were filed by these companies on January 3, 1994 reporting the consummation of the Entergy Corporation - GSU merger under Item 5 (in the case of AP&L, LP&L, MP&L and NOPSI), Items 2 and 7 (in the case of Entergy Corporation and GSU). EXPERTS All statements in Part I of this Annual Report on Form 10-K as to matters of law and legal conclusions, based on the belief or opinion of System Energy or any System operating company or otherwise, pertaining to the titles to properties, franchises and other operating rights of certain of the registrants filing this Annual Report on Form 10-K, and their subsidiaries, the regulations to which they are subject and any legal proceedings to which they are parties are made on the authority of Friday, Eldredge & Clark, 2000 First Commercial Building, 400 West Capitol, Little Rock, Arkansas, as to AP&L and as to Entergy Services in regards to flood litigation; Monroe & Lemann (A Professional Corporation), 201 St. Charles Avenue, Suite 3300, New Orleans, Louisiana, as to LP&L and NOPSI; and Wise Carter Child & Caraway, Professional Association, Heritage Building, Jackson, Mississippi, as to MP&L and System Energy. The 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. The 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. ENTERGY CORPORATION SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. ENTERGY CORPORATION By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Vice President and March 14, 1994 Lee W. Randall Chief Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); W. Frank Blount, John A. Cooper, Jr., Brooke H. Duncan, Lucie J. Fjeldstad, Kaneaster Hodges, Jr., Robert v.d. Luft, Kinnaird R. McKee, Paul W. Murrill, James R. Nichols, Eugene H. Owen, John N. Palmer, Robert D. Pugh, H. Duke Shackelford, Wm. Clifford Smith, Bismark A. Steinhagen, and Walter Washington (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) ARKANSAS POWER & LIGHT COMPANY SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. ARKANSAS POWER & LIGHT COMPANY By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, John A. Cooper, Jr., Cathy Cunningham, Richard P. Herget, Jr., Tommy H. Hillman, Donald C. Hintz, Kaneaster Hodges, Jr., Jerry D. Jackson, R. Drake Keith, Jerry L. Maulden, Raymond P. Miller, Sr., Roy L. Murphy, William C. Nolan, Jr., Robert D. Pugh, Woodson D. Walker, Gus B. Walton, Jr., Michael E. Wilson (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) GULF STATES UTILITIES COMPANY SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. GULF STATES UTILITIES COMPANY By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Vice President and March 14, 1994 Lee W. Randall Chief Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Robert H. Barrow, Frank F. Gallaher, Frank W. Harrison, Jr., Donald C. Hintz, Jerry L. Maulden, Paul W. Murrill, Eugene H. Owen, M. Bookman Peters, Monroe J. Rathbone, Jr., Sam F. Segnar, Bismark A. Steinhagen, James E. Taussig, II. (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) LOUISIANA POWER & LIGHT COMPANY SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. LOUISIANA POWER & LIGHT COMPANY By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, John J. Cordaro, Donald C. Hintz, William K. Hood, Jerry D. Jackson, Tex R. Kilpatrick, Joseph J. Krebs, Jr., Jerry L. Maulden, H. Duke Shackelford, Wm. Clifford Smith (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) MISSISSIPPI POWER & LIGHT COMPANY SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. MISSISSIPPI POWER & LIGHT COMPANY By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, Frank R. Day, John O. Emmerich, Jr., Norman B. Gillis, Jr., Donald C. Hintz, Jerry D. Jackson, Robert E. Kennington, II, Jerry L. Maulden, Donald E. Meiners, John N. Palmer, Sr., Clyda S. Rent, Walter Washington, Robert M. Williams, Jr. (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) NEW ORLEANS PUBLIC SERVICE INC. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. NEW ORLEANS PUBLIC SERVICE INC. By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer) Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, James M. Cain, John J. Cordaro, Brooke H. Duncan, Norman C. Francis, Donald C. Hintz, Jerry D. Jackson, Jerry L. Maulden, Anne M. Milling, John B. Smallpage, Charles C. Teamer, Sr. (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) SYSTEM ENERGY RESOURCES, INC. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof. SYSTEM ENERGY RESOURCES, INC. By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer Date: March 14, 1994 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. 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. Signature Title Date /s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer) Donald C. Hintz (President, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Edwin Lupberger (Chairman of the Board), Jerry D. Jackson, Jerry L. Maulden (Directors). By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact) EXHIBIT 23(a) INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Post-Effective Amendment 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 (which express an unqualified opinion and include explanatory paragraphs as to uncertainties because of certain regulatory and litigation matters), appearing in this Annual Report on Form 10-K of Entergy Corporation for the year ended December 31, 1993. We also consent to the incorporation by reference in Registration Statements Nos. 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 for the year ended December 31, 1993. We also consent to the incorporation by reference in Registration Statements Nos. 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 for the year ended December 31, 1993. We 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 for the year ended December 31, 1993. We also consent to the incorporation by reference in Registration Statement No. 33-57926 of New Orleans Public Service Inc. on Form S-3, and the related Prospectus, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of New Orleans Public Service Inc. for the year ended December 31, 1993. We also consent to the incorporation by reference in Registration Statement No. 33-47662 of System Energy Resources, Inc. on Form S-3, and the related Prospectus, of our reports dated February 11, 1994 (which express an unqualified opinion and include an explanatory paragraph as to an uncertainty resulting from a regulatory proceeding), appearing in this Annual Report on Form 10-K of System Energy Resources, Inc. for the year ended December 31, 1993. /s/ Deloitte & Touche DELOITTE & TOUCHE New Orleans, Louisiana March 14, 1994 EXHIBIT 23(b) CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements 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 11, 1994, on our audits of the financial statements and financial statement schedules of Gulf States Utilities Company as of December 31, 1993 and 1992, and for the years ended December 31, 1993, 1992 and 1991, which reports include explanatory paragraphs related to rate-related contingencies, legal proceedings and changes in accounting for income taxes, postretirement benefits, unbilled revenue and power plant materials and supplies and are included in this Annual Report on Form 10-K. /s/ Coopers & Lybrand Coopers & Lybrand Houston, Texas March 14, 1994 EXHIBIT 23(c) CONSENT OF EXPERTS We consent to the reference to our firm under the heading "Experts" in this Annual Report on Form 10-K. We further consent to the incorporation by reference of such reference to our firm into Arkansas Power & Light Company's ("AP&L") Registration Statements (Form S-3, File Nos. 33-36149, 33-48356 and 33-50289) and related Prospectuses, pertaining to AP&L's First Mortgage Bonds and Preferred Stock. Very truly yours, /s/ Friday, Eldredge & Clark FRIDAY, ELDREDGE & CLARK Date: March 14, 1994 EXHIBIT 23(d) CONSENT We 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.

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Item 6. Selected Financial Data ** The above financial information represents the consolidated operations of Cable TV Fund 12-BCD Venture, in which Cable TV Fund 12-D has an approximate 76 percent equity interest. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations CABLE TV FUND 12-D Results of Operations All of Cable TV Fund 12-D's ("Fund 12-D's") operations are represented by its approximate 76 percent interest in Cable TV Fund 12-BCD Venture (the " Venture"). Thus, Management's Discussion and Analysis of the Venture should be consulted for pertinent comments regarding Partnership performance. Financial Condition Fund 12-D's investment in the Venture has decreased by $8,751,100 when compared to the December 31, 1992 balance representing a deficit of $4,072,166. This deficit is due to Fund 12-D's share of Venture losses, which are principally the result of deprecation and amortization charges being greater than equity invested. These losses are expected to be recovered upon liquidation of the Venture. CABLE TV FUND 12-BCD VENTURE Results of Operations 1993 Compared to 1992 Revenues of Cable TV Fund 12-BCD Venture (the "Venture") increased $5,564,003, or approximately 7 percent, from $83,567,527 in 1992 to $89,131,530 in 1993. Between December 31, 1992 and 1993, the Venture added 7,498 basic subscribers, an increase of approximately 4 percent. This increase in basic subscribers accounted for approximately 32 percent of the increase in revenues. Basic service rate adjustments were responsible for approximately 38 percent of the increase in revenues. Advertising sales revenue accounted for approximately 12 percent of the increase in revenues. Increases in pay per view revenue accounted for approximately 14 percent of the increase. The increase in revenues would have been greater but for the reduction in basic rates due to new basic rate regulation issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. No other single factor significantly affected the increase in revenues. Operating, general and administrative expenses in the Venture's systems increased $3,941,804, or approximately 8 percent, from $48,132,180 in 1992 to $52,073,984 in 1993. Operating, general and administrative expense represented 58 percent of revenue in 1993 and in 1992. The increase in operating, general and administrative expense was due to increases in subscriber related costs, programming fees and marketing related costs. No other single factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $746,870, or approximately 8 percent, from $9,758,490 in 1992 to $10,505,360 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses. Depreciation and amortization expense decreased $1,113,583, or approximately 4 percent, from $26,764,820 in 1992 to $25,651,237 in 1993. The decrease is due to the maturation of the Venture's asset base. The Venture recorded operating income of $900,949 for 1993 compared to an operating loss of $1,087,963 for 1992. This change is the result of increases in revenue and the decreases in depreciation and amortization expenses exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable Inc. Operating income before depreciation and amortization increased $875,329, or approximately 3 percent, from $25,676,857 in 1992 to $26,552,186 in 1993. This increase is due to the increase in revenues exceeding the increase in operating, general, and administrative expenses and administrative fees and allocated overhead from Jones Intercable, Inc. Interest expense decreased $33,744, or less than 1 percent, from $12,022,874 in 1992 to $11,989,130 in 1993 due to lower interest rates on interest bearing obligations, which were offset, in part, by higher balances on such obligations. The Venture recorded other expense of $556,309 in 1993 compared to other expense of $2,708,833 in 1992. The 1992 expense primarily represented the Sunbelt litigation settlement as discussed in Note 6 of notes to financial statements of the Venture. The settlement was accrued by the Venture in 1992 and paid by the Venture in March 1993. Net loss decreased $3,299,949, or approximately 22 percent, from $14,884,365 in 1992 to $11,584,416 in 1993 due to the factors discussed above. These losses are expected to continue in the future. 1992 Compared to 1991 Revenues of the Venture increased $5,518,022, or approximately 7 percent, from $78,049,505 in 1991 to $83,567,527 in 1992. Between December 31, 1991 and 1992, the Venture added 3,670 basic subscribers, an increase of approximately 2 percent. This increase in basic subscribers accounted for approximately 17 percent of the increase in revenues. Basic service rate adjustments were responsible for approximately 46 percent of the increase in revenues. Advertising sales revenue accounted for approximately 14 percent of the increase in revenues. Increases in equipment rental revenue accounted for approximately 13 percent of the increase. No other single factor significantly affected the increase in revenues. Operating, general and administrative expenses in the Venture's systems increased $4,487,834, or approximately 10 percent, from $43,644,346 in 1991 to $48,132,180 in 1992. Operating, general and administrative expense represented 58 percent of revenue in 1992 compared to 56 percent in 1991. The increase in operating, general and administrative expense was due to increases in personnel related costs, programming fees and property taxes, which were partially offset by decreases in marketing related costs and copyright fees. No other single factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $1,215,796, or approximately 14 percent, from $8,542,694 in 1991 to $9,758,490 in 1992 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $4,028,233, or approximately 13 percent, from $30,793,053 in 1991 to $26,764,820 in 1992. The decrease is due to the maturation of the Venture's asset base. Operating loss decreased $3,842,625, or approximately 78 percent, from $4,930,588 in 1991 to $1,087,963 in 1992 as a result of the increase in revenues and the decreases in depreciation and amortization exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. Interest expense decreased $898,899, or approximately 7 percent, from $12,921,773 in 1991 to $12,022,874 in 1992 due primarily to lower interest rates on interest bearing obligations, despite higher balances on such obligations. The Venture recorded other expense of $2,708,833 in 1992 compared to other income of $23,761 in 1991. This increase was due to the Sunbelt litigation settlement as discussed above. This settlement was paid by the Venture in March 1993. Net loss decreased $2,944,235, or approximately 17 percent, from $17,828,600 in 1991 to $14,884,365 in 1992 due primarily to the reductions in operating loss and interest expense which were offset, in part, by the litigation settlement discussed above. These losses are the result of the factors discussed above and are expected to continue in the future. Financial Condition Capital expenditures for the Venture totaled approximately $18,711,600 during 1993. Service drops to homes accounted for approximately 29 percent of the capital expenditures. Approximately 18 percent of these capital expenditures related to plant extensions in all of the Venture's systems. The completion of a rebuild of the Venture's Palmdale, California system accounted for approximately 17 percent of capital expenditures. Approximately 12 percent of capital expenditures was for fiber upgrades. The remaining expenditures related to various system enhancements. These capital expenditures were funded primarily from cash generated from operations and borrowings under the Venture's credit facility. Expected capital expenditures for 1994 are approximately $25,914,000. The upgrade of the Albuquerque, New Mexico system is expected to account for approximately 31 percent. Plant extensions in all of the Venture's systems are expected to account for approximately 15 percent. Service drops to homes are anticipated to account for approximately 23 percent. The remainder of the expenditures are for various system enhancements in all of the Venture's systems. Funding for these expenditures is expected to be provided by cash on hand, cash generated from operations and borrowings from the Venture's credit facility. Subject to the regulatory matters discussed below and assuming successful renegotiation of its credit facility, the Venture has sufficient sources of capital available in its ability to generate cash from operations and to borrow under its credit facility to meet its presently anticipated needs. During the first quarter of 1992, the Venture renegotiated its debt arrangements, which increased the maximum amount of debt available to $183,000,000. Such new debt arrangements consist of $93,000,000 of Senior Notes placed with a group of institutional lenders and a renegotiated $90,000,000 revolving credit agreement with a group of commercial bank lenders. The Venture used the funds from the Senior Notes to repay approximately $88,000,000 of the $155,000,000 outstanding on its previous credit facility and to repay advances from Intercable. The Venture used borrowings under its new credit facility to repay the remaining balance on its previous credit facility. The Senior Notes have a fixed interest rate of 8.64 percent and a final maturity date of March 31, 2000. The Senior Notes call for interest only payments for the first four years, with interest and accelerating amortization of principal payments for the next four years. Interest is payable semi-annually. The Senior Notes carry a "make-whole" premium, which is a prepayment penalty, if they are prepaid prior to maturity. The make-whole premium protects the lenders in the event that the funds are reinvested at a rate below 8.64 percent, and is calculated per the note agreement. The Venture's current revolving credit facility has a maximum amount available of $90,000,000. As of December 31, 1993, $73,800,000 was outstanding under the Venture's revolving credit agreement, leaving the Venture with $16,200,000 of available borrowing capacity until March 31, 1994. The revolving credit period will expire on March 31, 1994, at which time the principal balance converts to a term loan payable in quarterly installments with a final maturity date of March 31, 2000. The General Partner is negotiating to to extend the revolving credit period for one year. Interest is at the Venture's option of LIBOR plus 1.25 percent to 1.75 percent, the CD rate plus 1.375 percent to 1.875 percent or the Base Rate plus 0 percent to .50 percent. An annual commitment fee of .5 percent is required on the unused portion of the facility until it converts to a term loan. Both lending facilities are equal in standing with the other, and both are equally secured by the assets of the Venture. Regulation and Legislation On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act") which became effective on December 4, 1992. This legislation has effected significant changes to the regulatory environment in which the cable television industry operates. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. Under the 1992 Cable Act's definition of effective competition, nearly all cable television systems in the United States, including those owned and managed by the General Partner, are subject to rate regulation of basic cable services. In addition, the 1992 Cable Act allows the FCC to regulate rates for non-basic service tiers other than premium services in response to complaints filed by franchising authorities and/or cable subscribers. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations, with which the Venture complied, became effective on September 1, 1993. See Item 1 for further discussion of the provisions of the 1992 Cable Act. Based on Intercable's assessment of the FCC's rulemakings concerning rate regulation under the 1992 Cable Act, the Venture reduced the rates it charged for certain regulated services. On an annualized basis, such rate reductions will result in an estimated reduction in the Venture's revenue of approximately $4,500,000, or approximately 5 percent, and a decrease in operating income before depreciation and amortization of approximately $4,300,000, or approximately 10 percent. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. Based on the foregoing, the General Partner believes that the new rate regulations will have a negative effect on the Venture's revenues and operating income before depreciation and amortization. The General Partner has undertaken actions to mitigate a portion of these reductions primarily through (a) new service offerings, (b) product re-marketing and re-packaging and (c)marketing efforts directed at non- subscribers. To the extent such reductions are not mitigated, the values of the Venture's cable television systems, which are calculated based on cash flow, could be adversely impacted. The 1992 Cable Act contains new broadcast signal carriage requirements, and the FCC has adopted regulations implementing the statutory requirements. These new rules allow a local commercial broadcast television station to elect whether to demand that a cable system carry its signal or to require the cable system to negotiate with the station for "retransmission consent." Additionally, cable systems also are required to obtain retransmission consent from all "distant" commercial television stations (except for commercial satellite-delivered independent "superstations"), commercial radio stations and certain low-power television stations carried by cable systems. The retransmission consent rules went into effect on October 6, 1993. In the cable television system owned by the Venture, no broadcast stations withheld their consent to retransmission of their signal. Certain broadcast signals are being carried pursuant to extensions offered to the General Partner by broadcasters, including a one-year extension for carriage of the CBS station owned and operated by the CBS network in Chicago. The General Partner expects to conclude retransmission consent negotiations with those stations whose signals are being carried pursuant to extensions, without having to terminate the distribution of any of those signals. However, there can be no assurance that such will occur. If any broadcast station currently being carried pursuant to an extension is dropped, there could be a negative effect on the system if a significant number of subscribers were to disconnect their service. Item 8.

789292

1993

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATING RESULTS 1993-1992 SALES AND REVENUES Sales and revenues from continuing operations declined 9% in 1993, primarily as a result of decreases at the Gas Turbine and Atlantic Research (ARC) propulsion units of the Aerospace segment and the overseas unit of the Specialty Chemicals segment. Aerospace segment sales declined 16% in 1993, principally as a result of a substantial fall-off in sales of Gas Turbine, the largest individual operation in the segment and in the Company as a whole. ARC propulsion sales, which represent a smaller portion of overall revenues, declined approximately 20%, and the Kollsman division, the smallest part of the segment, posted a 9% increase in sales. Gas Turbine sales declined 18% from 1992 levels. Over half the decline occurred at the unit's largest facility in Orangeburg, New York, which was severely affected by government investigations. In addition, other Gas Turbine installations were affected by sustained weakness in the jet engine component repair and new parts market, as well as by the continuing decline in the domestic defense market. Overall market sluggishness also affected locations specializing in the overhaul and repair of both aircraft engines and industrial turbines, as well as those serving the auxiliary power equipment market. Management anticipates that the commercial airline market will improve gradually, with only a modest upturn in demand for component repair in 1994. The investigations of the Orangeburg plant are discussed in detail in the Government Investigations section of this management discussion and analysis. From the standpoint of operations, the Federal Aviation Administration's restoration of the Orangeburg facility's repair station certificate in June 1993 was a first step in restoring the facility to full operation. Since that time, each individual repair process and procedure at the facility has been subject to review. By March 1, 1994, approvals had been received for the repair of parts representing approximately 85% of the facility's ongoing repair revenues. While the approval process has taken longer than originally anticipated, management expects that all approvals will be received by July 1994. As a result, revenues at the Orangeburg facility are expected to increase gradually in 1994. The 20% reduction in sales of the ARC propulsion unit was in line with management's previous estimates and primarily resulted from reduced revenues on several major rocket motor programs including Trident D-5, Stinger and MLRS, and the completion of two other programs (MK104 Standard Missile and MK30). Barring additional Defense Department spending cuts, management anticipates that sales will decline a further 5%-10% in 1994. Kollsman's sales increased 9% in 1993 principally as a result of higher sales of military electro-optics products, including the new domestic contract with the U.S. Marine Corps to upgrade the optical system on the Cobra helicopter. Sales of avionics products also increased in 1993, but the overall advance was partially offset by a reduction in the sale of medical instrumentation. Sales of the Machinery and Metal Coatings segment increased 7% in 1993, paced by a sharp advance at the metal coatings unit. The metal coating division posted a 15% increase in sales, primarily as a result of strong demand from the building products industry and improved market penetration of this key market. At the can machinery division, sales advanced 4%, as gains in can forming equipment were largely offset by reduced shipments of can decorating equipment and lower sales of spare parts and accessories. The European auxiliary press equipment supplier posted a small sales increase measured in local currency. However, after translation into U.S. dollars, reported sales were down 5%. Sales of the Specialty Chemicals segment declined 6% in 1993 with fourth-quarter increases at both units mitigating the effect of lower sales for the the first nine months of the year. At the overseas unit, an increase in local currency sales of TAED, a bleach activator, was more than offset by an unfavorable foreign currency translation swing of 15%. At the domestic unit, sales were down marginally, as continued weakness in the paper, textile and graphic arts markets was offset by a solid advance in the specialty polymer product line, and by the sales added through a paper specialties product line acquired in late 1992. At the domestic unit, 1993 sales trends are expected to continue in the early part of 1994, and overseas sales are expected to remain at a high level. Sales and revenues of the Professional Services and Other Products segment increased 5% in 1993, as two of the four units posted increases. Revenues of the ARC professional services unit, which was sold in December 1993, increased 3% to $162.6 million. Sales of the automotive products unit advanced sharply, a reflection of the overall health of the domestic automobile market, and the resulting increase in demand for automotive cigarette lighters and power outlets. The unit also improved its penetration of the automotive lighter market in Europe. Sales of Northern Can Systems (NCS) were on a par with 1992 levels, as a doubling of can lid sales more than offset the absence of sales from two can making plants which were sold in the first half of 1993. Revenues of Centor, the real estate company, declined modestly in 1993 primarily due to a lower occupancy rate in its office building in Clayton, Missouri. OPERATING INCOME Operating income declined 87% in 1993, primarily as a result of the operating loss posted by Gas Turbine and the recording of restructuring charges amounting to $26.6 million during the year. The Aerospace segment posted a $40.9 million loss in 1993 compared to a profit of $75.5 million in 1992. This swing was primarily due to losses at Gas Turbine. Gas Turbine was adversely impacted by three major factors: the interruption of operations at the Orangeburg facility; the charge to reflect implementation of a restructuring plan; and the legal fees, payments to the government and severance costs at the Orangeburg plant. Results of all other Gas Turbine units, in total, declined modestly from a 1992 base that was already severely affected by two years of turmoil in the commercial airline market. Management anticipates that Gas Turbine will return to profitability in the first quarter of 1994. ARC propulsion profits declined 28%, a reflection of lower sales and an unfavorable sales mix shift, partially offset by reduced general and administrative, and bid and proposal costs. Management of the unit anticipates that profits will decline modestly in 1994 as the unit continues to adjust to the restrictive market conditions. Kollsman's profits increased from a modest 1992 base, primarily as a result of improvements in electro optics, and reduced selling, general and administrative expenses. Conditions in the markets Kollsman serves are not expected to strengthen in 1994, nonetheless management expects Kollsman will be able to maintain its profit level in 1994 and plans to further shrink its asset base to improve returns. Operating profit in the Machinery and Metal Coatings segment decreased 3% in 1993, as strength at the metal coatings unit and a turnaround at the auxiliary press equipment unit were more than offset by a decline in the can machinery operation. Throughout 1993, the metal coating operation benefitted from increased sales and improved capacity utilization. Although this unit will incur start-up expenses when it brings a new facility on stream in mid- 1994, profits for the full year are currently expected to remain at least on a par with 1993, due to continued strong demand from the building products market. At the can machinery operation, reduced factory utilization, competitive pricing pressures in the can decorating market, a bad debt provision, and the recording of a restructuring charge combined to cause a significant profit decline in 1993. Based on year-end backlog, this operation is expected to have a weak first quarter in 1994. The auxiliary press equipment operation returned to profitability in 1993 due to a general program of cost reduction and the absence of unusual warranty, severance and bad debt provisions that had been recorded in 1992. Based on the current level of firm backlog, losses are expected in the first half of 1994. Operating income in the Specialty Chemicals segment declined 11% in 1993, with both units down from the preceding year. At the overseas unit, strong operating results were offset by the combination of unfavorable foreign currency exchange movements and the establishment of environmental clean-up and bad debt reserves related to the non-detergent chemicals portion of the business. The decline in operating income at the domestic unit resulted from three principal factors: the start-up of a new paper specialties product line; the cost to realign and expand the European sales and marketing effort; and the reduced gross profit that resulted from lower sales and an unfavorable sales mix shift. Operating income in the Professional Services and Other Products segment more than doubled in 1993. Both ARC professional services and the automotive products units achieved solid profit advances and NCS moved from a loss in 1992 to a modest profit in 1993. Profits of the automotive products unit advanced due to the increased volume of automotive cigarette lighters. At NCS, increased sales of can ends and the benefits of cost reductions and manufacturing improvements implemented in both 1992 and 1993 fueled a turnaround. In the second half, NCS recorded a small loss, as the unit adjusted to the downsizing that resulted from the sale of the can plants. Management anticipates that this unit will return to profitability in the first quarter of 1994 and will post a profit for the full year. At Centor, profit declined from a relatively low 1992 base, primarily as a result of lower rental income. During 1993, the Company recorded restructuring charges totaling $26.6 million primarily relating to plans adopted to reduce Gas Turbine's investment in plants that are engaged in activities other than the repair of components for flight engines, and to sell excess machinery and permanently reduce the number of employees in other Gas Turbine facilities. Included in the restructuring charges are: severance costs, $7.5 million; write- down of equipment to be sold, $4.1 million; write-down of inventory to net realizable value, $3.2 million; relocation of equipment, $1.8 million; write-down of other assets, $1.5 million; operating losses through date of sale, $6.5 million; other costs, $2.0 million. As of December 31, 1993, $20.7 million of these amounts remained in Accrued expenses. INTEREST EXPENSE In 1993, interest expense declined $6.6 million due to a lower level of average borrowings related to the Company's cash generation program. OTHER, NET In 1993, Other, net included a $6.6 million loss on interest rate options sold, $3.1 million of discount expense related to the sale of accounts receivable, a $3.1 million loss incurred on a sale and leaseback transaction, a $7.6 million equity loss in the Company's unconsolidated airbag business, amortization of capitalized debt costs in the amount of $4.2 million, and $2.5 million in charges for a minority shareholder's interest in the earnings of ARC. Based upon market interest rates on March 15, 1994, adjustment of the carrying value of interest rate options sold would result in an additional loss of approximately $3.5 million to be recorded in the first quarter of 1994. In 1992, Other, net included $3.9 million of discount expense related to the sale of accounts receivable, a $4.7 million equity loss in the Company's unconsolidated airbag business, amortization of capitalized debt costs in the amount of $3.1 million, and $1.7 million in charges for a minority shareholder's interest in the earnings of ARC. ENVIRONMENTAL MATTERS The Company's engineering and environmental department, under senior management direction, manages all activities related to the Company's involvement in environmental clean-up. This department establishes the projected range of expenditures for individual sites with respect to which the Company may be considered a potentially responsible party under applicable Federal or state law. These projected expenditures, which are reviewed periodically, include: remedial investigation and feasibility studies; outside legal, consulting and remediation project management fees; the projected cost of remediation activities; site closure and post-remediation monitoring costs. The assessments take into account known conditions, probable conditions, regulatory requirements, past expenditures, and other potentially responsible parties and their probable level of involvement. Outside technical, scientific and legal consulting services are used to support management's assessments of costs at significant individual sites. The Company has identified cost estimates for all sites it is involved with and has established reserves as required by generally accepted accounting principles. The Company anticipates that actual cash expenditures related to these sites will be in the $6 million to $12 million range in 1994 and in the $5 million to $7 million range during each of the following several years. Anticipated expenditure levels for 1994 reflect clean-up costs on sites where work will begin earlier than previously expected. Actual cash expenditures were $7.7 million in 1993, $6.2 million in 1992, and $4.7 million in 1991. AUTOMOTIVE AIRBAGS In 1989, Atlantic Research and AlliedSignal formed a 50/50 joint venture, called Bendix Atlantic Inflator Company (BAICO), to develop, produce and market hybrid inflators for automotive airbag systems. The joint venture has expended substantial sums on the development and marketing of both passenger- and driver-side inflators. As a result of these efforts, the joint venture has orders from seven car companies covering 13 models beginning with the 1994 model year. The first deliveries of production units were made in 1993 with total shipments of 319,000 units. Shipments in 1994 are expected to reach nearly one million units. In 1993, Atlantic Research, AlliedSignal and Gilardini (a unit of the Fiat Group) formed an Italian company to produce and market hybrid inflators for Fiat and other European car companies. Each participant owns a one-third interest in this venture. Atlantic Research expects to spend approximately $4 million over the next 12 months for its share of the cost to equip a leased facility in Colleferro, Italy. First deliveries from this plant to fill an order from a European customer are scheduled for June 1995. The Company's equity loss in its airbag business was $7.6 million in 1993 and $4.7 million in 1992. Management currently anticipates the airbag business will achieve profitability in late 1995 or early 1996. BACKLOG The businesses of Sequa for which backlogs are significant are the Kollsman division, the Turbine Airfoil, Caval Tool and Castings units of Gas Turbine, and the ARC propulsion operations of the Aerospace segment; and the Can Machinery and MEG operations of the Machinery and Metal Coatings segment. The aggregate dollar amount of backlog in these units at December 31, 1993 was $369.7 million ($435.2 million at December 31, 1992). The year-to-year decline is a reflection of the overall weakness in the domestic defense and the worldwide airline industries. At December 31, 1992, the professional services unit of ARC had $120.5 million of backlog which is excluded from the above comparison. CAPITAL SPENDING AND OTHER INVESTMENTS Capital expenditures amounted to $76.9 million in 1993, with spending concentrated in the Gas Turbine, metal coatings and overseas chemicals operations. These funds were primarily used to upgrade existing facilities and equipment and to expand capacity. The two largest projects were the installation of an electron beam physical vapor deposition coater in a United Kingdom Gas Turbine plant and the start of construction for a new metal coatings facility in Jackson, Mississippi. Both projects are expected to be operational by the third quarter of 1994. In addition, the Company invested $2.7 million for its share of capital costs in the airbag business. The Company accounts for its airbag investment using the equity method of accounting. Accordingly, these funds were accounted for as an increase in the Company's investment and are included in Non-current receivables and other investments in the Consolidated Balance Sheet. The Company anticipates that capital spending in 1994 will be approximately $85 million and will again be concentrated in the Gas Turbine, metal coatings and chemicals operations. The Company also anticipates investing approximately $10.5 million in the airbag business. LIQUIDITY AND CAPITAL RESOURCES Management anticipates that cash flow from operations, proceeds from the divestiture of the remaining discontinued operations and other assets, the $111 million of credit available at March 15, 1994 under the new revolving credit agreement, and dividends that management expects to receive from the Company's European subsidiaries will be more than sufficient to fund the Company's operations for the foreseeable future. During 1993, the Company lengthened debt maturities by successfully restructuring its long-term debt, and dramatically improved liquidity. In addition, the Company generated $127 million from its program to trim its asset base. The largest portion of these proceeds was used to reduce debt, which declined $96 million in 1993. In 1994, the Company plans to continue its program of asset disposals and debt reduction. As part of the restructuring plan at Gas Turbine, which was announced in the third quarter, the Company currently has signed letters of intent for the sale of two Gas Turbine units which would generate approximately $50 million in cash if the transactions are successfully completed. In addition, the Company is actively pursuing additional asset disposals under the Gas Turbine restructure program; marketing the remaining discontinued business assets either through outright sale; or, in the case of Sequa Capital's leveraged leases, a transaction designed to monetize the portfolio. At December 31, 1993, under the terms of the Company's senior subordinated notes due 1998, there is a $45.8 million deficiency in consolidated retained earnings available for the payment of cash dividends and the repurchase of the Company's stock. As a result, common and preferred stock dividends were not declared in the third and fourth quarters of 1993. Under the terms of the Company's preferred stock, upon the Company's failure to make six consecutive quarterly dividend payments, the holders thereof, voting as a class, will have the right to elect two members of the Board of Directors of the Company at the next annual meeting of shareholders. These special voting rights terminate when all dividends in arrears have been paid. In addition, as of December 31, 1993, the Company's earnings were not sufficient to maintain a consolidated interest coverage ratio of 2.0 to 1.0 which, pursuant to the terms of the Company's senior notes due 2001 and the senior subordinated notes due 2003, precludes the Company from paying dividends among other restricted activities. In the short term, the Company's objective is to return to profitability, to continue to improve its capital structure and to resume dividend payments. In the longer term, the Company's objective is to regain an investment grade rating from the major rating agencies. OTHER INFORMATION Statement of Financial Accounting Standards (SFAS) No. 112, "Employer's Accounting for Postemployment Benefits," was issued in November 1992 and must be implemented by the first quarter of 1994. This statement requires benefits to former employees after employment, but before retirement, to be accrued when it is probable that a liability has been incurred and the amount can be reasonably estimated. The impact of adopting SFAS No. 112 will not have a material effect on the Company's results of operations or financial position. GOVERNMENT INVESTIGATIONS During the second quarter of 1993, the Company entered into agreements with the U.S. Attorney's Office, Southern District of New York (SDNY), and the Federal Aviation Administration (FAA) in connection with investigations by these offices and other related governmental agencies of the Company's Orangeburg facility and certain of its then employees begun in November 1992. Management believes that the investigations were in connection with allegations that the Orangeburg facility had performed repairs on certain parts in a defective manner and in violation of applicable requirements. The investigations resulted in the Orangeburg facility voluntarily surrendering its FAA repair station certification and suspending FAA authorized repair operations in April 1993. Gas Turbine's other operating facilities, as well as work done for original equipment manufacturers at the Orangeburg facility, were unaffected by the suspension. Throughout the investigations, the Company and the Orangeburg facility cooperated fully with federal authorities. In addition, the Company instituted extensive changes in the management and operations of the facility. As a result of the Company's cooperation with the government and its good faith efforts to comply with all applicable FAA standards, the FAA restored the facility's FAA repair station certificate on June 10, 1993, ending the suspension of repair operations and resolving all FAA civil matters relating to the Orangeburg facility. Subsequently, the U.S. Attorney's Office, SDNY, entered into an agreement with the Company, under which it declined to prosecute the Company in connection with its investigation. In April 1993, the Company signed a consent order with the FAA providing for a non-punitive remedial payment by the Company of $5.0 million, representing the costs incurred by the FAA to investigate the Orangeburg facility and enforce its consent decree. In addition, under the terms of the agreement with the U.S. Attorney's Office, SDNY, the Company agreed to deposit $2.5 million into a fund (with up to an additional $2.5 million to be deposited, if needed) to cover the cost of testing and analyzing jet engine parts seized by federal authorities during an early stage of the investigations. Currently, the Company is in the process of obtaining recertification on certain repair processes and procedures. By March 1, 1994, approvals had been received for the repair of parts that represent approximately 85% of the facility's ongoing repair revenues. While it has taken longer than anticipated to obtain the required approvals, the process is continuing and the Company anticipates receiving the balance of the outstanding approvals during the second quarter of 1994. As a result, revenues of the Orangeburg facility are expected to increase gradually in 1994. At the same time, overall airline industry conditions remain depressed, affecting demand for new and repaired parts. Management does not anticipate significant improvement in market conditions in the near term, but believes the Orangeburg facility's repair operations are recovering from the effects of the investigations, and operating results are continuing to improve. As a result of the investigations and the related suspension, the Company incurred direct expenses in 1993 of $12.8 million. Direct expenses included the remedial payment to the FAA, the deposit of funds described above, severance payments and related legal fees and expenses. OPERATING RESULTS 1992-1991 Sales and Revenues Sales and revenues from continuing operations declined slightly in 1992, as advances at three of the Company's four operating segments largely offset a 4% decline in the Aerospace segment. The reduction in Aerospace sales reflects declines at ARC propulsion and Kollsman. Sales of Gas Turbine were unchanged from 1991, as increased activity in landbased turbines and flight engine overhaul offset declines in the repair and manufacture of parts for aircraft engines. ARC propulsion sales declined approximately 10% in 1992, as a result of continued defense spending cuts. The impact of reductions in four solid rocket motor programs and the cancellation of a development program was partially offset by a significant increase in the Trident D-5 program. Kollsman sales declined 22% in 1992, primarily due to a substantial drop in avionics products for the general aviation market, as well as the completion of low-margin electro-optics contracts for the U.S. Government. By contrast, sales of medical instrumentation increased 12%. Sales of the Machinery and Metal Coatings segment increased 9% in 1992, with strong advances at the metal coatings and can machinery units, partially offset by a decline in sales of auxiliary press equipment. The metal coatings operation experienced strong demand and increased its penetration of the building products and container markets. The can machinery units benefitted from a high level of demand from export markets and from the successful introduction of new can forming equipment. Sales of the overseas auxiliary press equipment operation declined in 1992 with a sharp decline in the first half of the year partially offset by improved second-half results. Sales of the Specialty Chemicals segment advanced 7% in 1992 with both the overseas and domestic units contributing to the increase. At the overseas unit, TAED sales advanced modestly, with strength concentrated in the first half of the year. Softness in the second half reflected the economic recession in Europe, and a slowdown in consumer demand for laundry detergents using TAED. Other overseas sales of chemicals advanced sharply in 1992, primarily due to a mid-1991 acquisition of a chemical sales distribution company. At the domestic unit, the sales improvement was primarily the result of increased penetration of the markets for specialty polymers, with the successful introduction of new roofing and filtration products. Sales of paper chemicals increased due to overall improved demand. Sales and revenues in the Professional Services and Other Products segment increased 3%, with advances at three of the four operating units in the segment. ARC professional services registered a small revenue increase, primarily as the result of efforts to increase foreign military consulting activities. In 1992, Casco's sales increased 9%, as both the original equipment market and the aftermarket for automotive cigarette lighters improved. The NCS unit experienced a small sales decline in 1992, and the revenues of Centor, a real estate company, increased 7%. OPERATING INCOME Operating income from continuing operations improved 6% in 1992, as improvements at Kollsman, Warwick, Precoat Metals and Casco Products more than offset declines at Gas Turbine, MEG, the domestic chemicals unit and the ARC propulsion and professional services units. Operating income of the Aerospace segment was down 1%, as a turnaround at Kollsman substantially offset a sharp decline at Gas Turbine and a more modest decline at ARC propulsion. Gas Turbine's profits declined 41%, primarily due to the poor conditions and severe pricing pressures in the markets it serves. The operation also incurred significant severance costs, as it reduced its workforce in response to the restrictive market conditions. Profits were further affected for the last six weeks of the year by a government investigation at the Gas Turbine Orangeburg facility, which began on November 19, 1992. Profits at ARC propulsion declined in 1992, although less than sales. Management has been able to "manage down," aggressively cutting costs in anticipation of lower government contract revenue. Kollsman recorded a modest profit in 1992, a significant improvement from 1991, when the unit recorded a large loss. The division benefitted from a downsizing program initiated in 1991, which was designed to generate profitability at a significantly lower sales level. Operating income for the Machinery and Metal Coatings segment was on a par with 1991 results. The effect of strong improvements at the Precoat Metals division was tempered by a loss at the auxiliary press equipment unit. Can machinery results were consistent with the prior year. Profit increases at metal coatings were due to higher sales and increased capacity utilization. The 1992 loss at the overseas auxiliary press equipment operation resulted from lower sales, combined with warranty, severance and bad debt provisions. At the can machinery operations, the benefits of increased sales were largely offset by increased development costs for new can forming equipment, and higher start-up and warranty costs related to the introduction of new can decorating equipment. Operating income for the Specialty Chemicals segment increased 10% in 1992. The operating performance of both units was ahead of the prior year, although a fourth-quarter environmental clean-up provision of $2.5 million reduced the domestic unit's results below 1991. Higher profits at the overseas unit resulted from increased sales and savings derived from improved manufacturing processes. Profits at the domestic unit, before the environmental provision, increased 16%, the result of improved sales and the continuing shift to a higher value-added sales mix. Operating income for the Professional Services and Other Products segment increased $3.4 million in 1992, as three of the four units registered improvement. A change in the method of allocating self-insurance losses to other operating segments also favorably affected this segment in 1992. The results of the ARC professional services units declined primarily as a result of higher development costs for imaging software products. Casco Products profits were up, the result of increased sales, improved manufacturing efficiencies and tight cost controls. Losses at NCS narrowed in 1992, as costs were reduced and manufacturing improvements were implemented. Centor profits were up 27% in 1992, from a low 1991 base. INTEREST EXPENSE In 1992, interest expense declined $9.7 million due to both a lower level of average borrowings and a reduction in the average cost of funds. The reduction of debt was directly related to the Company's cash generation program, while the average cost of borrowings declined due to lower prevailing short-term interest rates. OTHER, NET Other, net registered a $4.7 million increase in expense in 1992, primarily due to a $4.2 million increase in the Company's share of start-up costs in the airbag joint venture and a $2.2 million increase in the amortization of capitalized debt costs. A $2.5 million reduction in expenses related to the sale of accounts receivable, which partially offset these increases, resulted primarily from lower discount rates. DISCONTINUED OPERATIONS During 1992, the Company completed the sale of Valley Line, Sabine Towing and Transportation and the Gemoco division of the engineered services group for gross cash proceeds of $197.2 million. In addition, $112.6 million of cash from asset sales and portfolio run-off was generated by Sequa Capital. In the fourth quarter of 1992, the Company recorded a $35.0 million pre-tax charge to recognize larger than expected losses from Sequa Capital, a greater than expected loss on the fourth- quarter sale of a discontinued business, higher projected litigation expenses and recent adverse developments related to contingent lease liabilities associated with an operation discontinued and sold in an earlier year. ITEM 8.

95301

1993

Item 6. Selected Financial Data. The following table sets forth certain selected consolidated financial data and should be read in conjunction with the company's consolidated financial statements and related notes appearing elsewhere in this Annual Report. Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. For 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. Included in the 1993 consolidated results is Spoerle Electronic, which had been accounted for under the equity method prior to January 1993 when the company acquired an additional 15% share, increasing its holdings to a majority interest. The 1993 consolidated results also include the acquired businesses of Zeus Components, Inc., a distributor of high- reliability electronic components and value-added services, Microprocessor & Memory Distribution Limited, a focused U.K. distributor of high- technology semiconductor products, and Components Agent Limited, one of the largest distributors in Hong Kong. In addition, the 1993 results include Amitron-Arrow S.A. and ATD Electronica S.A., distributors serving the Spanish and Portuguese markets, and CCI Electronique, a distributor serving the French marketplace. On February 28, 1992, the company acquired the electronics distribution businesses of Lex Service PLC ("Lex") in the U.K. and France (the "European businesses"), and Spoerle Electronic acquired the electronics distribution business of Lex in Germany. On September 27, 1991, the company acquired Lex Electronics Inc. and Almac Electronics Corporation, the North American electronics distribution businesses of Lex (the "North American businesses"), the third largest electronics distribution business in the United States. See Note 2 of the Notes to Consolidated Financial Statements for information with respect to the 1993 and 1992 acquisitions and the pro forma effect of these transactions on the company's statement of operations. Sales In 1993, consolidated sales of $2.5 billion were 56% ahead of the 1992 sales of $1.6 billion. Excluding Spoerle, sales were $2.2 billion, an advance of 34% 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 Pacific Rim, offset in part by weaker currencies in Europe. Consolidated sales of $1.6 billion in 1992 were 55% higher than 1991 sales of $1 billion. This increase principally reflects the acquisitions of the North American and European businesses in September 1991 and February 1992, respectively, and increased North American sales. In 1991, consolidated sales of $1 billion were 7.5% higher than 1990 sales of $971 million. The increase in sales primarily reflects the inclusion of the North American businesses during the fourth quarter of 1991, which more than offset the 5% decrease in sales for the nine months ended September 30, 1991 principally resulting from declining sales of commercial computer products and related systems owing to soft market conditions. Operating Income In 1993, the company's consolidated operating income increased to $181.5 million, compared with 1992 operating income of $103.8 million. The significant improvement in operating income reflects 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. Excluding Spoerle, operating income was $146.2 million in 1993, and operating expenses as a percentage of sales were 12.4%, the lowest in the company's history. The company's 1992 consolidated operating income increased to $103.8 million, compared with operating income of $34.4 million in 1991. Operating income in 1991 included the recognition of approximately $9.8 million of costs associated with the integration of the North American businesses. The significant improvement in operating income in 1992 primarily reflected the impact of the company's acquisition of the North American businesses, improved gross profit margins reflecting a product mix now more heavily weighted to semiconductor products, and improved North American sales. The rapid and successful integration of the North American businesses resulted in the realization of sizable economies of scale which, when combined with increased sales, enabled the company to reduce operating expenses as a percentage of sales from 17.6% in 1991 to 14.7% in 1992, the then lowest level in the company's history. Such economies of scale principally resulted from reductions in personnel performing duplicative functions and the elimination of duplicative administrative facilities, selling and stocking locations, and computer and telecommunications equipment. In 1991, the company's consolidated operating income increased to $34.4 million, an advance of 5% over 1990. This improvement was principally the result of increased sales and reduced operating expenses as a percentage of sales in the fourth quarter of 1991. The improved fourth quarter operating results, combined with lower operating expenses through September 1991, more than offset the special charge of $9.8 million reflecting integration expenses associated with the North American businesses, the effect of a 5% decrease in sales through September 1991, and a decrease in the company's gross profit margin as a result of competitive pricing pressures in the commercial computer products and related systems markets. Interest In 1993, interest expense decreased to $25 million from $30.1 million in 1992. The decrease principally reflects 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. Interest expense of $30.1 million in 1992 increased by $.9 million from the 1991 level, reflecting the company's borrowings to finance the cash portion of the purchase price of the North American and European businesses, to pay fees and expenses relating to the acquisitions, to refinance existing credit facilities of the company, and to provide the company with working capital. Such increased borrowings were partially offset by the company's redemption in May of $46 million of its 13-3/4% subordinated debentures with the proceeds from the public offering of 4.7 million shares of common stock and lower effective interest rates. In 1991, interest expense of $29.1 million increased $.1 million from 1990's level as the financing expense for the purchase of the North American businesses offset lower interest rates and reduced borrowings resulting from operating cash flow and improvements in asset management. Income Taxes In 1993, the company's effective tax rate was 40.7% compared with 37.4% in 1992. The higher effective tax rate reflects increased U.S. taxes as a result of higher statutory rates and the consolidation of Spoerle. The company recorded a provision for taxes at an effective tax rate of 37.4% in 1992 compared with 20.4% in 1991. The higher effective tax rate reflects the depletion of the company's remaining $5.8 million U.S. net operating loss carryforwards in 1991. The company's effective tax rate in 1991 was 20.4%, principally as a result of the utilization of the remaining $5.8 million of U.S. net operating loss carryforwards. Net Income Net income in 1993 was $81.6 million, an advance from $44.8 million in 1992 (after giving effect to 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 is due principally to the increase in operating income and lower interest expense offset in part by higher taxes. The company recorded net income of $50.2 million in 1992, before extraordinary charges aggregating $5.4 million, compared with net income of $8.7 million in 1991. Including these charges, net income in 1992 was $44.8 million. Included in 1991's results was a special charge of $9.8 million ($6.5 million after taxes) associated with the integration of the acquired businesses. The improvement in net income was principally the result of the increase in operating income offset in part by the higher provision for income taxes. The company's net income in 1991 of $8.7 million decreased 14% from $10.1 million in 1990. The decrease in net income was principally the result of the $9.8 million special charge ($6.5 million after taxes) reflecting integration expenses associated with the North American businesses and the provision for income taxes. Excluding the special charge, net income was $15.2 million, an increase of 50% over 1990. Net income also included the company's equity in earnings of affiliated companies of $1.7 million in 1993, $6.6 million in 1992, and $5.7 million in 1991. The decrease in the company's equity in earnings of affiliated companies in 1993 was due to the consolidation of Spoerle. In 1993, the earnings of Silverstar, the company's Italian affiliate, advanced as a result of significant sales growth offset in part by a weaker lira. The increase in the company's equity in earnings of affiliated companies in 1992 was the result of Silverstar's profitability. The decrease in 1991 was the result of lower earnings in Germany and a loss in Italy. Liquidity and Capital Resources The company maintains a high level of current assets, primarily accounts receivable and inventories. Consolidated current assets as a percentage of total assets were 73% in 1993 and 70% in 1992. Working capital increased in 1993 by $160 million, or 43%, compared with 1992, as a result of increased sales, the consolidation of Spoerle, and acquisitions. Working capital increased by $42 million in 1992, as a result of the acquisition of the European businesses and increased sales. The net amount of cash provided by operations in 1993 was $41.7 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 in 1993 amounted to $111.7 million, including $87.9 million for various acquisitions. Cash flows from financing activities were $100.3 million, principally resulting from increased borrowings to finance the 1993 acquisitions in the U.S., Europe, and the Pacific Rim (see Notes 2 and 4 of the Notes to Consolidated Financial Statements for additional information regarding these acquisitions). In 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. The net amount of cash provided by operating activities in 1992 was $71.5 million, attributable primarily to the higher net earnings of the company. The net amount of cash used by the company for investing activi- ties in 1992 amounted to $45.8 million, including $37.2 million for the acquisition of the European businesses. The aggregate cost of the company's acquisition of the electronics distribution businesses of Lex in the U.K. and France, and Spoerle's acquisition of the Lex electronics distribution business in Germany, was $52 million, of which $32 million was paid in cash and $20 million was paid in the form of a senior subordinated note due in June 1997. The company financed the cash portion of the purchase price through the sale of 66,196 shares of newly-created series B preferred stock and U.K. bank borrowings. In addition, a portion of the proceeds from the company's public offering of common stock and the issuance of the 5-3/4% convertible subordinated debentures was used to repay the senior subordinated note. The German business was purchased by Spoerle for cash (see Notes 2, 4, and 6 of the Notes to Consolidated Financial Statements for additional information regarding these acquisitions). The net amount of cash used for financing activities in 1992 was $23.9 million, principally reflecting the redemption of high-yield subordinated debentures, repayment of long-term debt, and the payment of preferred stock dividends and financing fees, offset by the public offering of 4,703,500 shares of common stock and the 5-3/4% convertible subordinated debentures, the issuance of the senior secured notes, and U.K. bank borrowings. In September 1992, the company completed the conversion of all of its outstanding depositary shares, each representing one-tenth share of its $19.375 convertible exchangeable preferred stock, into 3,615,056 shares of its common stock. This conversion eliminated the company's obligation to pay $4.6 million of annual dividends relating to the depositary shares. Early in 1994, the company purchased an additional 15% share in Spoerle for approximately $23 million in cash. The company financed the acquisition through its U.S. credit agreement and German bank borrowings. Additionally, the company increased its holdings in Silverstar to a majority share and acquired the electronic component distribution business of Field Oy, the largest distributor of electronic components in Finland, and TH:s Elektronik, a leading distributor in Sweden and Norway. Item 8.

7536

1993

ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected consolidated financial information for the Company and the Predecessor for the periods and at the dates indicated. Information denoted "Predecessor" relates to dates or periods prior to the Acquisition. The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in connection with the Acquisition. Such method of accounting has resulted in increased depreciation. In addition, the capital structure of the Company is different from that of its Predecessor, resulting in increased interest and prior to the Recapitalization, preferred dividends. Accordingly, the financial statements for periods and dates after July 24, 1989 are not comparable in all material respects to the financial statements for periods and dates prior to July 24, 1989. As explained in Note 1(f) to the Consolidated Financial Statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions and effective January 1, 1991, the Company changed its method of accounting for income taxes. The historical financial information (other than operating data) for each of the five years in the period ended December 31, 1993 was derived from consolidated financial statements, of which the three most recent years are incorporated by reference herein and were audited by Arthur Andersen & Co., independent public accountants, whose reports thereon are incorporated by reference herein. Years Ended December 31, 1993 1992 1991 1990 1989 Operating Data: Revenue ton miles (millions) 4/ 46,114 40,986 40,601 37,705 35,687 Operating ratio (%) 5/ 80.0 82.3 92.3 84.3 87.3 December 31, 1993 1992 1991 1990 1989 (Dollars in millions) Balance Sheet Data: Working capital $ (51.9) $ (72.2) $ (75.6) $ (48.3) $ (31.9) Total assets 2,135.9 2,072.0 2,089.0 1,905.1 1,937.5 Long-term debt 1,142.8 1,227.9 1,224.3 1,213.1 1,313.3 Preferred Stock - - 207.4 177.1 157.5 Common stockholders' equity 226.2 144.0 (98.5) 4.4 80.5 1/ Special charges included in operating expenses consist of employee reduction and relocation costs in 1993, 1992, 1991, 1990 and 1989, a charge in 1993 for management fees payable to a previous principal stockholder, and environmental and personal injury costs in 1991. Such special charges totaled $5.0 million in 1993; $30.0 million in 1992; $115.8 million in 1991; $13.4 million in 1990; $6.3 million for the period July 24 to December 31, 1989; and $18.4 million for the period January 1 to July 23, 1989. 2/ Net income for 1993 has been reduced by a $10.8 million extraordinary loss related to the refinancing of long-term debt. The 1992 net loss includes a $91.0 million extraordinary loss related to the Recapitalization and a $2.6 million charge for the cumulative effect of a change in the method of accounting for other postretirement benefits. The 1991 net loss includes a $25.6 million charge for the cumulative effect of a change in the method of accounting for income taxes and a $3.4 million extraordinary loss on prepayment of long-term debt. 3/ Income (loss) per share is calculated after deducting preferred stock dividends and accretion to liquidation value from net income (loss). Such amounts totalled $58.7 million in 1992; $30.3 million in 1991; $19.7 million in 1990; $7.3 million for the period July 24 to December 31, 1989; and $3.0 for the period January 1 to July 23, 1989. 4/ Revenue ton miles equals the product of the weight in tons of freight carried for hire and the distance in miles carried on the Company's lines. 5/ Operating ratio is the ratio of operating expenses to operating revenues. Special charges increased the operating ratio by 0.5, 3.0, 11.8, 1.4, and 2.6 percentage points for the years ended December 31, 1993, 1992, 1991, 1990 and 1989, respectively. PART II The following items are incorporated into this report by reference to the sections of the Company's 1993 Annual Report to Stockholders shown below: Annual Report Section Title (If Applicable) Item Description and Page Number 5 Market for the Registrant's Stock Listing, Common Equity and Related inside back cover Stockholders Matters. 7 Management's Discussion and Management Discussion and Analysis of Financial Condition Analysis of Financial and Results of Operations. Condition and Results of Operations, pages 16 through 21. 8 Financial Statements, Supplementary Pages 22 through 32. Data and the Report of Independent Public Accountants. Item 9.

854884

1993

ITEM 6. SELECTED FINANCIAL DATA. Incorporated by reference from the Annual Report, inside back cover, section entitled "Six-Year Summary of Selected Financial Data." - -------------------------------------------------------------------------------- ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Incorporated by reference from the Annual Report, pages 35-46, section entitled "Financial Review." Also incorporated by reference is the section of this Form 10-K, Part I captioned "Recent Developments," "Health Care Environment" and "Legal Proceedings" on pages 3 to 4, 5 and 9 to 13, respectively. - -------------------------------------------------------------------------------- ITEM 8.

10456

1993

Item 6. Selected Financial Data SUMMARY OF SELECTED FINANCIAL DATA (In Thousands Except Per Share Information) 1993 1992 1991 1990 1989 Operating income before effect of initial application of FAS 106 $ 181,952 $ 171,240 $ 153,128 $ 138,962 $ 126,264 Accumulated post- retirement benefit obligation at 1-1-93, net (24,109) 0 0 0 0 Operating income 157,843 171,240 153,128 138,962 126,264 Realized investment gains, net of appli- cable income taxes 37,329 31,998 22,559 18,675 11,427 Net income $ 195,172 $ 203,238 $ 175,687 $ 157,637 $ 137,691 =========== =========== =========== =========== =========== Income per share of common stock: Operating income before effect of initial application of FAS 106 $ 3.62 $ 3.36 $ 2.98 $ 2.59 $ 2.23 Effect of initial application of FAS 106 (.48) .00 .00 .00 .00 Realized investment gains, net of taxes .74 .63 .44 .35 .20 Net income $ 3.88 $ 3.99 $ 3.42 $ 2.94 $ 2.43 =========== =========== =========== =========== =========== Average shares outstanding 50,251,676 50,952,147 51,319,143 53,636,223 56,588,878 =========== =========== =========== =========== =========== Total assets $ 5,640,621 $ 5,256,762 $ 4,945,396 $ 4,474,523 $ 4,543,474 =========== =========== =========== =========== =========== Stockholders' equity $ 1,733,071 $ 1,668,210 $ 1,544,461 $ 1,334,434 $ 1,456,109 =========== =========== =========== =========== =========== Stockholders' equity per share of common stock $ 35.04 $ 33.07 $ 30.11 $ 25.77 $ 25.98 =========== =========== =========== =========== =========== II-2 Selected Financial Data (continued) Total assets prior to 1993 were adjusted to reflect the adoption of Financial Accounting Standard (FAS) 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The amounts shown for 1992 to 1989 were increased by $20,925,000, $20,176,000, $19,615,000, and $13,886,000, respectively, compared to amounts previously reported. Stockholders' equity was adjusted to reflect adoption of FAS 109 "Accounting for Income Taxes." The amounts shown for 1992 to 1989 were all decreased by $18,555,000 compared to amounts previously reported. Stockholders' equity per share reflects these adjustments, also. REVENUE BY SOURCES (In Thousands) 1993 1992 1991 1990 1989 Life and accident and health insurance $ 986,972 $ 965,862 $ 956,426 $ 946,262 $ 936,599 Casualty and title insurance 51,462 53,907 53,472 55,164 50,307 Communications 144,961 129,734 125,045 127,330 126,990 Other 6,282 4,656 4,570 5,656 9,074 Realized investment gains 56,947 48,170 33,963 28,201 17,228 Revenues $1,246,624 $1,202,329 $1,173,476 $1,162,613 $1,140,198 ========== ========== ========== ========== ========== NET INCOME BY SOURCES (In Thousands) 1993 1992 1991 1990 1989 Life and accident and health insurance $ 158,242 $ 156,588 $ 146,205 $ 128,153 $ 109,329 Casualty and title insurance 7,957 7,027 2,554 6,232 4,927 Communications 17,335 14,169 10,327 10,019 12,505 Other ( 1,582) ( 6,544) ( 5,958) ( 5,442) ( 497) Realized investment gains, net of taxes 37,329 31,998 22,559 18,675 11,427 Accumulated post- retirement benefit obligation, net ( 24,109) 0 0 0 0 Net income $ 195,172 $ 203,238 $ 175,687 $ 157,637 $ 137,691 ========== ========== ========== ========== ========== II-3 Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity The Company's liquidity requirements are met primarily by cash flows from the operations of Jefferson-Pilot Life Insurance Company (JPLIFE) and other consolidated subsidiaries. Primary sources of cash from subsidiary operations are premiums, other insurance considerations, investment income and communications revenue. Primary uses of cash in subsidiary operations include payment of insurance benefits, operating expenses and costs related to acquiring new insurance business. Net cash provided by operations on a consolidated basis approximated $160 million, $156 million and $177 million in 1993, 1992 and 1991, respectively. Dividends paid to the parent company approximated $103 million in 1993, $128 million in 1992 and $129 million in 1991. While all significant subsidiaries generally pay dividends to the parent company, JPLIFE continues to be its primary source of dividends, and therefore of cash. Dividends that the insurance subsidiaries may pay without prior regulatory approval are subject to statutory limitation. In addition, life insurance companies became subject to risk-based capital requirements beginning in 1993. Neither of these factors are expected to represent practical restrictions on the dividend payment practices or other activities of the parent company in the foreseeable future. Proceeds from maturities, redemptions and sales of debt securities, mortgage loan repayments and proceeds from sales of equity securities are the primary sources of cash from investing activities. Continuing a trend related to overall interest rate declines, issuer calls and prepayments increased in 1993. This circumstance, combined with scheduled maturities and sales of certain debt securities expected to be called, resulted in cash proceeds from debt securities transactions approximating $940 million in 1993, compared to $375 million in 1992 and $266 million in 1991. Scheduled maturities for 1994 are less than the levels experienced in the three most recent years. While prediction of future calls and prepayments is complicated by interest rate uncertainties, the Company expects them to continue at some level during 1994. Net cash used in investing activities approximated $400 million in 1993, $221 million in 1992 and $228 million in 1991. Reflected for each year are reinvestment of the proceeds from investment transactions, investment of net proceeds from JPLIFE's policyholder contract deposits and investment of net cash provided by current operating activities over that used to pay stockholder dividends and reacquire the Company's common stock. During 1993, the Company also redirected certain short-term investments, primarily cash equivalents, into longer duration investments. The Company continues to select investments based on a disciplined strategy focused on long-term performance objectives. Consistent with that strategy, investments acquired during 1993 consisted primarily of investment II-4 grade debt securities, mortgage loans of quality and diversification comparable to those previously held, and common stock issues offering acceptable relationships between risk and potential total return. Continuing a three-year trend, the Company increased its investment in new mortgage loans during 1993 to approximately $86 million, compared to $60 million in 1992 and $41 million in 1991. The trend reflects an increase in lending opportunities that are acceptable under the Company's standards. The cost of common stock investments acquired in 1993 approximated $65 million. This increase over 1992 and 1991 levels is primarily due to a dividend-roll program. Provision has been made for declines in value of debt securities considered other than temporary and for estimated unrecoverable amounts related to the mortgage loan portfolio. Debt securities and mortgage loans representing credit problems continue to fall below industry averages. The Company's overall investment management strategy encompasses both internal objectives and external circumstances. Its business plan emphasizes growth of the life insurance and other core businesses, achievement of which will require investment of liquid resources. The Company monitors and evaluates securities market conditions and specific external circumstances that may impact individual investment holdings. Asset/liability management strategies may require action in response to such factors as interest rate changes and the effect thereof on prepayment risk. The above-described factors may result in future sales of selected debt securities prior to maturity. In connection with a process begun in 1993, and continuing into 1994, the Company expects that a significant portion of its debt securities will be designated as available for sale in response to these factors. In the first quarter of 1994, the Company will adopt SFAS 115. Under SFAS 115, all equity securities and debt securities classified as available for sale will be stated at value in the consolidated balance sheets. Since classification of the Company's debt securities is not complete, the effect of SFAS 115 on the stated amount of debt securities and the corresponding effects on deferred income tax liabilities, equity and other balance sheet amounts have not yet been determined. Adoption of SFAS 115 will increase the stated amount of equity securities held by the parent company as of January 1, 1994 by $70 million, with associated increases of $28 million in deferred income tax liabilities and $42 million in stockholders' equity. During 1993, the Company utilized an uncommitted bank line of credit in application of its asset/liability management strategies. The line permits the Company to request aggregate advances totaling up to $100 million until October 1994. Maximum utilization of the line approximated $40 million during the year and interest expense was not material. Management expects to increase the utilization of external financing sources as considered appropriate and consistent with its investment management and growth strategies. The Company has historically reacquired its own common stock whenever management considers it prudent. Cash used in connection with that strategy approximated $51 million in 1993, $36 million in 1992 and $18 million in 1991. The Company expects to continue reacquiring its common stock when considered appropriate, with the extent of those acquisitions to be determined based on securities market conditions and other relevant factors. II-5 Capital Resources Consolidated stockholders' equity as of December 31, 1993 amounted to $1.733 billion, compared to $1.668 billion in 1992 and $1.544 billion in 1991 as restated for the effect of adopting SFAS 109 on deferred income tax liabilities. After tax unrealized gains on equity securities included in the preceding amounts approximated $332 million in 1993, $335 million in 1992 and $311 in 1991. The Company regards the regulatory capital status of its insurance subsidiaries, with due consideration to the risk-based capital requirements which became effective for life insurance companies in 1993, to be extremely strong. Management considers existing capital resources to be adequate for the Company's present needs and its business plan places priority on redirecting capital resources presently considered under-utilized into more productive business activities. The Company has no outstanding long-term debt and is not a party to an agreement under which significant long-term financing might be provided by an outside party in the future. The Company leases data processing equipment and field office locations, generally under noncancelable lease terms of three to five years. Financing and capital resources considerations are not critical to the decision making process involving leasing activities. Cash dividends to stockholders amounted to $78.1 million in 1993, $69.1 million in 1992 and $57.4 million in 1991. The Company has consistently returned cash dividends to its stockholders and expects to continue to do so in the future. Capital resources requirements are not expected to represent practical restrictions on future dividend payment plans. Results of Operations - 1993 Compared to 1992 Premiums and other insurance considerations increased by $11.4 million in 1993, to approximately $670 million. The 1993 growth is attributable to individual life premiums and related considerations which increased by 8% over 1992 amounts and improved upon a recent annual growth trend of less than 2% per year. The increase results from implementation of various aspects of the Company's current business plan. Accident and health and casualty and title premiums remained substantially stable during 1993, with the former increasing and the latter decreasing modestly. Net investment income increased by $8.7 million (2.4%) during 1993, with the increase in the debt securities investment base offsetting the effects of a lower interest rate environment. Communications revenue increased by $15.2 million over 1992, to about $145 million, due primarily to a combination of the improved economic environment and measures taken to strengthen the market position of certain broadcast properties, including acquisitions in new and previously existing markets. Realized investment gains increased to $56.9 million in 1993, compared to $48.2 million in 1992, with call premiums and gains from sales of debt securities expected to be called more than offsetting a provision for other than temporary decline in value of certain debt securities ($8 million) and reduced gains on sales of common stocks. Life insurance benefits and other credits to policyholders increased from $279 million in 1992 to $296 million in 1993 (6%), with much of the II-6 increase attributable to interest credited on interest-sensitive products. Accident and health benefits continued to decline, decreasing from approximately $318 million in 1992 to approximately $306 million in 1993 and reflect the continued emphasis on underwriting and claims management effectiveness. Casualty and title claims decreased by about $2 million in 1993, as reinsurance recoveries on incurred losses more than offset an increase in incurred losses before reinsurance. Expenses other than those related to communications operations remained basically flat in 1993 as compared to 1992, reflecting the ongoing benefit of the Company's containment program. A significant consolidation of field offices undertaken in 1993 helped to reduce field office expenses for the year in addition to improving marketing efficiency. Expenses of the communications businesses increased by approximately $12 million due primarily to promotional expenses incurred to strengthen market position, charges related to aged syndicated programming and operating costs of newly acquired properties. Income taxes as a percent of before tax income increased to 31.9% in 1993, compared to 28.8% in 1992. The increase resulted from a combination of an increase in the federal tax rate (from 34% to 35%) prescribed by the 1993 Act and the beneficial effect on 1992 income taxes of recoveries and reductions of previously provided amounts related to prior tax assessments. Consolidated net income for 1993 reflects a charge of $24.1 million, net of deferred tax benefit, for the cumulative effect of adopting SFAS 106, which required the Company to provide for the cost of postretirement health care and life insurance benefits provided to retirees during the period of their service to the Company instead of on a cash basis after their retirement. The amount of this charge is consistent with the Company's previously reported estimate. Before the cumulative effect charge, consolidated after-tax income increased by approximately $16 million during 1993, to $219.3 million. Each of the Company's significant business activities made some contribution to the current year increase. Approximate increases by major business activity, exclusive of realized investment gains were as follows: life and accident and health insurance $2 million, casualty and title insurance $1 million, communications $3 million, and corporate level activities $5 million (primarily through expense reductions). The balance of the 1993 increase in consolidated pre-SFAS 106 income ($5 million) is attributable to the increase in realized investment gains. Results of Operations - 1992 Compared to 1991 Premiums and other insurance considerations were $658 million in both 1992 and 1991, with revenue from life, accident and health and other insurance products remaining substantially stable. Net investment income for 1992 increased by $8.1 million over 1991, due primarily to increased investment in debt securities. Revenue from communications operations increased by $4.7 million, to $129.7 million during 1992 due to overall improvement in advertising market conditions and the 1992 elections. Call premiums on debt securities and an increase of $20.3 million in gains from sales of common stocks contributed to a net increase in realized investment gains of $14.2 million, to $48.2 million, during 1992. II-7 Insurance benefits decreased 2.4% from $642.5 million in 1991 to $627.1 million in 1992. The primary contributing factors were a reduction in surrender benefits of $8.7 million and a reduction in casualty benefits of $6.6 million. The reduction in surrender benefits during 1992 continued a trend which began in 1985, and was favorably affected by declining interest rates. The reduction in casualty benefits reflects an improvement in loss experience, which was due in part to more selective underwriting practices. Increases in general and administrative expenses of the insurance businesses and communications operating expenses during 1992 were modest, reflecting ongoing aggressive expense management. Effective income tax rates for 1992 and 1991 were consistent, with each year benefitting from recoveries of amounts paid and reductions of amounts previously provided for prior year tax assessments. On a consolidated basis, net income increased from $175.7 million in 1991 to $203.2 million in 1992 ($27.5 million). Each of the Company's principal business activities contributed to the increase in net income, with net income from the core business of life and accident and health insurance increasing by $10.4 million, net income from other insurance operations increasing by $4.5 million and net income from communications operations increasing by $3.8 million. The balance of the increase in net income during 1992 is attributable to realized investment gains. II-8 Item 8.

53347

1993

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Each of the Grantor Trusts, listed in the table as shown below, was formed by GMAC Auto Receivables Corporation (the "Seller") pursuant to a Pooling and Servicing Agreement between the Seller and The First National Bank of Chicago, as trustee. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for certificates representing undivided ownership interests in each Trust. Each Trust's property includes a pool of retail instalment sale contracts secured by new, and in some Trust's used, automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby. The certificates for each of the following Trusts consist of two classes, entitled Asset Backed certificates, Class A and Asset Backed certificates, Class B. The Class A certificates represent in the aggregate an undivided ownership interest that ranges between approximately 91% and 94.5% of the Trusts and the Class B certificates represent in the aggregate an undivided ownership interest that ranges between approximately 5.5% and 9% of the Trusts. Only the Class A certificates have been remarketed to the public. The Class B certificates have not been offered to the public and initially are being held by the Seller. The rights of the Class B certificateholder to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders. Original Aggregate Amount ----------------------------------- Date of Pooling Retail Asset Backed Certificates Grantor and Servicing Finance ------------------------- Trust Agreement Receivables Class A Class B - ------- ----------------- --------- -------- ------- (In millions of dollars) GMAC 1990-A December 20, 1990 $1,162.6 $1,057.9 $104.7 GMAC 1991-A March 14, 1991 891.7 811.4 80.3 GMAC 1991-B September 17, 1991 1,007.4 916.7 90.7 GMAC 1991-C December 16, 1991 1,326.4 1,207.0 119.4 GMAC 1992-A January 30, 1992 2,001.4 1,851.3 150.1 GMAC 1992-C March 26, 1992 1,100.3 1,012.3 88.0 GMAC 1992-D June 4, 1992 1,647.6 1,499.3 148.3 GMAC 1992-E August 20, 1992 1,578.0 1,436.0 142.0 GMAC 1992-F September 29, 1992 1,644.6 1,496.6 148.0 GMAC 1992-G November 19, 1992 1,379.4 1,303.5 75.9 GMAC 1993-A March 24, 1993 1,403.0 1,297.8 105.2 GMAC 1993-B September 16, 1993 1,450.6 1,341.8 108.8 II-1 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded) General Motors Acceptance Corporation, the originator of the retail receivables, continues to service the receivables for each of the aforementioned Grantor Trusts and receives compensation and fees for such services. Investors receive monthly payments of the pro rata portion of principal and interest for each Trust as the receivables are liquidated. ------------------------ II-2 ITEM 8.

882240

1993

Item 6. Selected financial data Incorporated herein by reference from the caption "Selected Financial Information" appearing on page 7 of the Trust's preliminary prospectus dated March 29, 1994, included in the Form S-3 Registration Statement (Registration No. 33-52521) filed with the Securities and Exchange Commission on March 7, 1994 and amended on March 29, 1994 included in Exhibit 99(ii). Item 7.

Item 7. Management's discussion and analysis of financial condition and results of operations. Incorporated herein by reference from the caption "Management's Discussion of Financial Condition and Operations" appearing on pages 8 through 10 of the Trust's preliminary prospectus dated March 29, 1994, included in the Form S-3 Registration Statement (Registration No. 33-52521) filed with the Securities and Exchange Commission on March 7, 1994 and amended on March 29, 1994 included in Exhibit 99(ii). Item 8.

74208

1993

352363

1993

ITEM 6. SELECTED FINANCIAL DATA The following information sets forth, for the past five years, selected financial data. (All amounts in thousands, except per unit information.) Summary Income Statement Data: 1993 1992 1991 1990 1989 Revenues $631,452 $549,612 $411,588 $316,503 $280,429 Net income 66,211 62,282 40,875 22,553 15,703 Net income per weighted average $1,000 equivalent limited partnership unit outstanding $194.62 $238.41 $185.92 $130.52 $82.50 Weighted average $1,000 equivalent limited partnership units outstanding 50,381 41,160 42,616 25,874 27,274 Net income per weighted average $1,000 equivalent subordinated limited partnership unit outstanding $350.32 $418.21 $322.38 $212.86 $154.82 Weighted average $1,000 equivalent subordinated limited partnership units outstanding 16,936 12,941 10,624 10,190 9,779 Summary Balance Sheet Data: 1993 1992 1991 1990 1989 Total assets $800,478 $653,253 $513,730 $422,257 $387,618 ======= ======= ======= ======= ======= Long-term debt $ 33,317 $ 23,847 $ 24,769 $ 19,977 $ 20,075 Other liabilities, exclusive of subordinated liabilities 514,386 414,110 326,229 250,772 234,732 Subordinated liabilities 73,000 78,000 48,000 50,400 52,800 Total partnership capital 179,775 137,296 114,732 101,108 80,011 ________ ________ ________ ________ ________ Total liabilities and partnership capital $800,478 $653,253 $513,730 $422,257 $387,618 ======== ======== ======== ======== ======== ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table summarizes the changes in major categories of revenues and expenses for the last two years (Dollar amounts in thousands.) 1993 vs. 1992 1992 vs. 1991 Increase - (Decrease) Amount % Amount % Revenues Commissions $ 124,510 41 $ 104,176 52% Principal transactions (38,895) (30) 26,940 26 Investment banking (15,634) (26) (6,741) (10) Interest and dividends 7,564 25 4,987 20 Other 4,295 19 8,662 60 _________ ___ _________ ___ 81,840 15 138,024 34 _________ ___ _________ ___ Expenses Employee and partner compensation and benefits 53,859 16 88,142 37 Occupancy and equipment 10,069 20 3,867 8 Communications and data processing 4,898 17 3,556 14 Interest 3,632 23 2,155 16 Payroll and other taxes 1,767 11 3,192 24 Floor brokerage and clearance fees 781 15 691 15 Other operating expenses 2,905 7 15,014 53 ________ ___ ________ ___ 77,911 16 116,617 31 ________ ___ ________ ___ Net income $ 3,929 6% $ 21,407 52% ======== === ======== === RESULTS OF OPERATIONS (1993 VERSUS 1992) Revenues increased 15% ($82 million) over 1992 to $631 million. Expenses increased by 16% ($78 million) resulting in net income of $66 million, an increase of 6% ($4 million) over 1992. These results were significantly influenced by the Partnership's activities in connection with the expansion of its salesforce. The number of investment representatives increased 24% in 1993 to 2,745. By comparison, 1992's growth in investment representatives was 22%. The vast majority of these new investment representatives are beginners in the industry who generally achieve profitability after about 30 months. In the interim, the Partnership incurs significant training, salary and support costs. The net impact of these direct expenses amounted to nearly $21 million during 1993 ($14 million in 1992). Additionally, the Partnership made significant increases in home office overhead to support the increased salesforce. Commission revenues increased $125 million fueled by a $85 million (45%) increase in mutual fund commissions and service fees. Listed and over-the-counter agency commissions increased $18 million or 24% over 1992. Insurance commissions increased 51%, with variable annuity commissions increasing $20.6 million and fixed annuities decreasing by $5 million. The increasing level of securities prices along with lower interest rates turned individual investors to equity markets and equity based investments in search of more attractive returns. The continued strength of the securities markets led to solid increases in commission generated from the sales of securities products. Principal transaction revenues decreased 30% ($39 million). Collateralized mortgage obligations (CMOs) revenues decreased $11.3 million, government and municipal bond revenues decreased by $9.7 million and $3.7 million, respectively. Prior to 1993, municipal bond syndicate revenues were included in principal transaction revenues. In 1993, these revenues, totalling $10.3 million, were included in investment banking revenues. The majority of the principal transaction revenue decreases largely resulted from historically low interest rates and the resulting popularity of equity based investments. Investment banking revenues declined $15.6 million resulting from decreases in certificate of deposit revenues ($8 million), CMO revenues ($11 million), and equity and debt originations. Interest and dividend revenues increased 25% or $7.6 million. Customers' margin loan balances increased 36% in 1993 ($120 million) ending the year at $451 million. The increase in customers' loan balances was attributable to higher securities prices, continuation of marketing efforts targeting individuals to view their securities as access to a personal line of credit and lower interest rates. The increase in loan balances more than offset the decline in short term interest rates during the year resulting in increased interest earnings. Other revenues increased $4 million (19%) over 1992. Revenues from non-bank custodian IRA accounts resulted in an increase of $1 million in 1993. Overall expenses increased 16% ($78 million). The Partnership's compensation structure for its investment representatives is designed to expand or contract substantially as a result of changes in revenues, net income and profit margins. Similarly, non-sales personnel compensation from bonuses and profit sharing contributions expands and contracts in relation to net income. The Partnership's non-compensation related expenses are less responsive to changes in revenues and net income. Rather, these expenses are influenced by the number of salespeople, growth of the salesforce, the number of customer accounts and, to a lesser extent, the volume of transactions. As a result of its expense structure, the Partnership's compensation expense increase of 16% matched the overall increase in expenses of 16%. The Partnership's expenses other than compensation increased 15%. The increase in other expenses resulted from several items. Increased expense levels related to supporting a larger number of investment representatives and branch offices were primarily responsible for the increase in operating expenses. RESULTS OF OPERATIONS (1992 VERSUS 1991) Revenues increased 34% ($138 million) over 1991 to $550 million. Expenses increased by 31% ($117 million) resulting in net income of $62 million, an increase of 52% ($21 million) over 1991. The number of investment representatives increased 22% in 1992 to 2,216. By comparison, 1991's growth in investment representatives was 9%. The increased size of the salesforce and higher securities prices along with a very steeply sloped yield curve were significant factors contributing to 1992's financial results. Commission revenues increased $104 million fueled by a $77 million (70%) increase in mutual fund commissions and service fees. Listed and over-the-counter agency commissions increased $19 million or 36% over 1991. Insurance commissions increased 22%, with variable annuity commissions increasing $10 million and fixed annuities decreasing by $4 million. The increasing level of securities prices along with lower interest rates turned individual investors to equity markets and equity based investments in search of more attractive returns. Principal transaction revenues increased 26% ($27 million) with taxable and tax free fixed income securities increasing $21 million. At the same time, O-T-C principal stock sales increased by $3 million. Individual investors were attracted to longer term fixed income products to increase or maintain their returns compared to other shorter term alternatives. Additionally, tax free bonds experienced relatively high yields during the year when compared to treasury securities with similar maturities. The increase in O-T-C stock sales resulted from higher equity prices and investors directing their investment dollars into smaller capitalization companies. The returns experienced during the year from investing in smaller capitalization companies was higher than the investment returns of larger exchange listed securities. Investment banking revenues declined $6.7 million from substantial decreases in certificate of deposit revenues ($6 million) and CMOs revenues ($4 million). These decreases were partially offset by equity originations and syndicate equity participation increases of $3 million. Initial public offerings continued to be popular during the year along with investor interest in utility unit investment trust underwritings. The decrease in investment banking CMO revenues was partially offset by increased sales of CMOs on a principal basis. Interest and dividend revenues increased 20% or $5 million. Customers' margin loan balances increased 66% in 1992 ($132 million) ending the year at $331 million. The increase in customers' loan balances was attributable to higher securities prices, continuation of marketing efforts targeting individuals to view their securities as access to a personal line of credit and lower interest rates. The increase in loan balances more than offsets the decline in short term interest rates during the year resulting in increased interest earnings. Other revenues increased $9 million (60%) over 1991. During the last quarter of 1991, the Partnership qualified as a non-bank custodian for its IRA accounts resulting in an increase of $2.3 million in 1992 from IRA service fee revenues. Revenues for fees and services received from the Edward D. Jones & Co. Daily Passport Cash Trust money market account and a related tax free money market account offered through Edward D. Jones & Co. increased $1.4 million over 1991. Overall expenses increased 31% ($117 million). The Partnership's compensation structure for its investment representatives is designed to expand or contract substantially as a result of changes in revenues, net income and profit margins. Similarly, non-sales personnel compensation from bonuses and profit sharing contributions expands and contracts in relation to net income. The Partnership's non-compensation related expenses tend to be less responsive to changes in revenues and net income. Rather, these expenses tend to be more influenced by the number of salespeople, growth of the salesforce, the number of customer accounts and, to a lesser extent, the volume of transactions. As a result of its expense structure, the Partnership's compensation expense increase of 37% exceeded the overall increase in expenses of 31%. The Partnership's expenses other than compensation increased 22%. Other operating expenses increased 53% or $15 million over 1991. The increase in other operating expenses resulted from several items. Increased expense levels related to supporting a larger number of investment representatives and branch offices were primarily responsible for the increase in operating expenses. THE EFFECTS OF INFLATION The Partnership's net assets are primarily monetary, consisting of cash, securities inventories and receivables less liabilities. Monetary net assets are primarily liquid in nature and would not be significantly affected by inflation. Inflation and future expectations of inflation influence securities prices, as well as activity levels in the securities markets. As a result, profitability and capital may be impacted by inflation and inflationary expectations. Additionally, inflation's impact on the Partnership's operating expenses may affect profitability to the extent that additional costs are not recoverable through increased prices of services offered by the Partnership. LIQUIDITY AND CAPITAL ADEQUACY The Partnership's equity capital at December 31, 1993, was $179.8 million compared to $137.3 million at December 31, 1992. Overall, equity capital increased 31%, primarily due to the retention of earnings and issuance of partnership interests. The Partnership issued additional limited partnership interests in August 1993 of $24.8 million and additional subordinated limited partnership interest of $4.4 million in January 1993. At December 31, 1993, the Partnership had a $28.8 million balance of cash and cash equivalents. Lines of credit are in place at nine banks aggregating $445 million ($420 million of which are through uncommitted lines of credit), of which $310 million was available at December 31, 1993. The Partnership believes that the liquidity provided by existing cash balances and borrowing arrangements will be sufficient to meet the Partnership capital and liquidity requirements. As a result of its activities as a broker/dealer, EDJ, the Partnership's principal subsidiary, is subject to the Net Capital provisions of Rule 15c3-1 of the Securities Exchange Act of 1934 and the capital rules of the New York Stock Exchange. Under the alternative method permitted by the rules, EDJ must maintain minimum Net Capital, as defined, equal to the greater of $150,000 or 2% of aggregate debit items arising from customer transactions. The Net Capital rule also provides the partnership capital may not be withdrawn if resulting Net Capital would be less than 5% of aggregate debit items. Additionally, certain withdrawals require the consent of the SEC to the extent they exceed defined levels even though such withdrawals would not cause Net Capital to be less than 5% of aggregate debit items. At December 31, 1993, EDJ's Net Capital of $89,790,000 was 20% of aggregate debit items and its net capital in excess of the minimum required was $80,681,000. Net Capital and the related capital percentage may fluctuate on a daily basis. CASH FLOWS Cash and cash equivalents decreased $8,932,000 from December 31, 1992, to December 31, 1993. Cash flows were primarily provided from net income, decreases in securities owned, short and long term bank loans and the issuance of partnership interests. Cash flows were primarily used to increase net receivables from customers and brokers, purchase equipment, property and improvements, and fund withdrawals and distributions. Cash and cash equivalents increased $5,308,000 from December 31, 1991, to December 31, 1992. Cash flows were primarily provided from net income, short term bank loans and the issuance of subordinated debt. Cash flows were primarily used to increase net receivables from customers, increase securities owned, purchase equipment, property and improvements, and fund withdrawals and distributions. Cash and cash equivalents increased $5,078,000 from December 31, 1990, to December 31, 1991. Cash flows were primarily provided from net income, an increase in accounts payable and accrued expenses, short term bank loans and the issuance of long term debt. Cash flows were primarily used to increase net receivables from customers, increase securities owned, purchase equipment, property and improvements, and fund withdrawals and distributions. There were no material changes in the Partnership's overall financial condition during the year ended December 31, 1993, compared with the year ended December 31, 1992. The Partnership's consolidated statement of financial condition is comprised primarily of cash and assets readily convertible into cash. Securities inventories are carried at market value and are readily marketable. The firm carried lower trading inventory levels in 1993 as compared to 1992. Customer margin accounts are collateralized by marketable securities. Other customer receivables and receivables and payables with other broker/dealers normally settle on a current basis. Liabilities, including amounts payable to customers, checks and accounts payable and accrued expenses are non-interest bearing sources of funds to the Partnership. These liabilities, to the extent not utilized to finance assets, are available to meet liquidity needs and provide funds for short term investments, which favorably impacts profitability. The Partnership's growth in recent years has been financed through sales of limited partnership interest to its employees, retention of earnings and private placements of long-term and subordinated debt. ITEM 8.

815917

1993

ITEM 6. SELECTED FINANCIAL DATA Selected Financial Data on pages 22 and 23 of the annual report to shareholders for the year ended December 31, 1993 is incorporated herein by reference. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Brush Wellman's engineered materials are comprised of five product lines: BERYLLIUM ALLOYS, principally beryllium copper; BERYLLIUM and materials rich in beryllium; beryllia CERAMICS; SPECIALTY METAL SYSTEMS, principally clad metals; and PRECIOUS METAL PRODUCTS. All five product lines have items that contain the element beryllium. SPECIALTY METAL SYSTEMS are produced and sold by a wholly owned subsidiary, Technical Materials, Inc. Another wholly owned subsidiary, Williams Advanced Materials Inc., specializes in PRECIOUS METAL PRODUCTS. Worldwide sales in 1993 were $295 million as compared to $265 million in 1992 and $267 million in 1991. Sales of BERYLLIUM ALLOYS increased in 1993. Solid increases domestically and in Asia offset lower sales in Europe. The improvement was led by automotive electronics and telecommunications applications, although most markets enjoyed higher volume. An increased and more focused marketing effort is the driving force behind the development of new applications as well as growth in existing applications. For example, growth in undersea telephone cable products is a result of increased market penetration and an expanding market. A significant influence was the start of the TPC-5 transpacific fiber optic cable project. This market is anticipated to continue its growth as new cable projects that have recently been announced are brought on line. A second example is in the aircraft industry. Working with the airframe manufacturers and airline maintenance facilities as "demand generators" has resulted in an increasing number of bushings and bearings being designed using beryllium copper as an enabling technology to allow lower flying weight and improved performance. This process is showing success in both new aircraft component designs and in the retrofit of the installed base of landing gear on older aircraft. Due to these and other favorable trends, continued growth of BERYLLIUM ALLOYS is expected in 1994. BERYLLIUM sales increased in 1993 from the year ago period due to AlBeMet(TM) sales of a computer disk drive component. Absent the AlBeMet(TM) sales, there was a reduction in BERYLLIUM sales due largely to lower defense spending. In 1994, sales will be lower due to completion of the Defense Logistics Agency (DLA) supply contract and reduced AlBeMet(TM) sales due to the end of an application at a computer disk drive manufacturer. To counter this reduction in volume, process improvement and cost containment are being emphasized. Marketing and product development efforts are being focused on materials and designs for the aerospace and avionics industries. CERAMIC sales increased in 1993 as compared to 1992. Demand for beryllia ceramic products was strong in United States automotive markets as well as from telecommunications growth worldwide. Sales of direct bond copper products increased 40% because of new applications in power electronics such as solid state motor controls. These products of mainly alumina and copper are bonded without the use of brazing materials. Continued growth is anticipated in 1994 from new applications in automotive electronics and additional penetration of Asian markets coupled with use of direct bond copper products in power conversion and wireless communications. SPECIALTY METAL SYSTEMS had a sizable sales increase in 1993 as compared to 1992 and exceeded the sales level of 1991. The increase resulted from recently developed applications, primarily in the automotive electronics, telecommunications and computer industries. In the telecommunications industry, for example, a precious metal clad on beryllium copper offered superior performance in a requirement in cellular telephone connector contacts. Additionally, a proprietary ductile nickel coating on beryllium copper Alloy 174 will be utilized in battery chargers for cellular telephones and other products. In 1994, the continued development of new applications, along with an effort to improve manufacturing response time, are necessary for the growth of SPECIALTY METAL SYSTEMS. PRECIOUS METAL PRODUCTS had a significant sales increase in 1993 as compared to 1992. High demand for frame lid assemblies from semiconductor manufacturers, along with added sales of a new line of vapor deposition targets, accounted for much of the increase. Sales are expected to be lower in 1994 because semiconductor demand is expected to slow. In addition, first-time vapor deposition target sales have a large precious metal content; as these spent targets are recycled and refurbished, the customer maintains ownership of the material, resulting in lower sales, but similar profit from value-added services. International sales were $86 million in 1993, $71 million in 1992 and $76 million in 1991. The increase in 1993 is primarily due to deliveries of disk drive components to Asia and the start-up of PRECIOUS METAL PRODUCT assemblies in Singapore. The distribution of BERYLLIUM ALLOYS is the major component of international sales. Lower demand in Europe, due principally to economic conditions, precluded any growth. International sales are likely to be lower in 1994 due to the end of the previously mentioned disk drive application. However, BERYLLIUM ALLOY sales should increase as economic conditions in Europe improve and marketing efforts in Asia are strengthened. Worldwide sales in 1992 were slightly under those of 1991. Gains in BERYLLIUM ALLOYS, CERAMIC and PRECIOUS METAL PRODUCTS were offset by declines in BERYLLIUM and SPECIALTY METAL SYSTEMS. The increases were primarily in automotive and semiconductor markets with the decreases primarily in defense-related applications. Gross margin (sales less cost of sales) was 22.9%, 27.2%, and 24.4% of sales in the years 1993, 1992 and 1991, respectively. The two primary factors affecting margins were a product mix shift to lower margin products, particularly those with a high precious metal content, and manufacturing problems associated with the AlBeMet(TM) disk drive component. In addition, competitive conditions limit the ability to cover cost increases. However, the Company continues to be encouraged by the favorable impact on margins from manufacturing yield and productivity improvements, especially in BERYLLIUM ALLOY strip products. Margin percentages are expected to improve in 1994 due to an anticipated shift in product mix to high value-added products, manufacturing improvements and the significant reduction of low margin AlBeMet(TM) disk drive sales. The higher gross margin in 1992 was due to improved manufacturing performance, primarily in BERYLLIUM ALLOYS, coupled with cost reduction efforts. This was in spite of relatively low capacity utilization. Other favorable factors included about $4 million in lower depreciation and amortization due to the asset impairment charge taken in 1991 and about $2 million from a weaker dollar. Selling, administrative and general expenses in 1993 were $47.8 million (16.2% of sales) compared to $46.6 million (17.6% of sales) in 1992. The increase was primarily in worldwide marketing, selling and customer service activities that support the critical issue of sales growth. This category of expense increased over 6% in 1993 from 1992 while administrative and general expenses, which include lower incentive compensation, decreased. Selling, administrative and general expenses in 1992 were down from 1991. Increased marketing, selling and distribution were more than offset by a reduction in administrative expenses. Research and Development (R&D) expenses of $7.1 million in 1993 were slightly lower than the $7.3 million spent in 1992. The Company's marketing efforts are leading to changes in R&D resource utilization. Cross-functional marketing teams, which include R&D representation, bring more focus to those activities and opportunities that offer the greatest sales and margin potential to the Company. In 1991, R&D expenses were $7.6 million. Interest expense was $3.0 million in 1993, $3.2 million in 1992 and $3.8 million in 1991. All amounts are net of interest capitalized on active construction and mine development projects. Lower interest rates and less debt, on average, favorably impacted interest costs in 1993 and 1992. The impairment and restructuring charges in 1991 had a pre-tax income impact of $39.3 million. These charges consisted of a writedown of the carrying value of the assets of Technical Materials, Inc. and Williams Advanced Materials Inc. and provisions for early retirement, severance and environmental matters. In 1991, the Company adopted Statement of Financial Accounting Standard No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS 106). This accounting change was effective as of January 1, 1991 and resulted in recording a transition obligation that reduced earnings by $1.02 per share. In addition, the ongoing effect of adopting FAS 106 was to increase net periodic postretirement cost and reduce earnings by $.08 per share in 1991. Other-net expense was $2.2 million in 1993, $1.3 million in 1992 and $3.0 million in 1991. This category includes such expenses as amortization of goodwill and other intangibles, the effect of currency exchange and translation and other non-operating items. Included in all three years are the postretirement benefit costs pursuant to FAS 106 for a divested operation. In 1993, the Company made an adjustment to the FAS 106 demographic assumptions for the divested operation. This resulted in a reduction of the liability and resulting income of $1.3 million. The carrying value of a building from the divested operation was reduced by $0.9 million. Included in 1992 was about $1.4 million of nonrecurring gains. Income before income taxes in 1993 of $7.7 million was significantly lower than the 1992 pre-tax income of $13.7 million. The reduction is due to the lower gross margin, owing principally to the manufacturing problems with the disk drive component and lower sales of BERYLLIUM for defense related applications. The increase in selling, general and administrative expense was also a contributing factor to the lower pre-tax income. On the positive side was improved manufacturing performance in BERYLLIUM ALLOYS and CERAMICS. In 1992, pre-tax income of $13.7 million was significantly higher than the 1991 pre-tax income of $3.2 million, exclusive of the impairment and restructuring charges. The combination of better manufacturing performance, cost reduction and the ongoing effects of the previously mentioned 1991 asset impairment charges accounted for the gain. The effective tax rate employed for 1993 was 16.2% of pre-tax income as compared to a rate of 23.6% of pre-tax income in 1992. The lower pre-tax income, coupled with relatively fixed tax credits and allowances, results in the significantly lower tax rate for 1993 as compared to 1992 and to statutory rates. As shown in Note H to the consolidated financial statements, the tax credit for percentage depletion in excess of cost depletion from mining operations, along with the tax benefit of the Company-owned life insurance program, account for almost the entire reduction from statutory rates in both 1993 and 1992. In 1991, a tax benefit of 23.8% on the pre-tax loss was utilized. Earnings per share were $0.40 in 1993 and $0.65 in 1992. Loss per share of $2.74 in 1991 includes $2.93 per share of non-recurring items for the impairment and restructuring charges and the accounting change. Comparable per share earnings in 1991 were $0.19. FINANCIAL POSITION CAPITAL RESOURCES AND LIQUIDITY Cash flow from operating activities totaled $18.3 million in 1993. Cash balances increased by $3.5 million while total debt decreased by $13.4 million. Capital expenditures for property, plant and equipment amounting to $12 million in 1993 were focused on upgrades and additions to improve quality and productivity. Capital expenditures in 1994 are expected to approach $20 million with a significant portion devoted to projects at the Company's extraction facilities in Utah, including extending the life and capacity of the tailings pond. Long-term financial resources available to the Company include $60 million of medium-term notes and $40 million under a bank credit agreement (unused at December 31, 1993). In the fourth quarter of 1993, the Company borrowed the $15 million cash surrender value from a group of Company-owned life insurance policies. The proceeds were used to repay all borrowings under the bank credit agreement. Long-term debt at December 31, 1993 was $24 million or 12% of total capital. Short-term debt at December 31, 1993 was $16 million and is denominated principally in gold, yen, marks and sterling to provide hedges against assets so denominated. In addition, credit lines amounting to $54 million are available. Funds 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 collateralized repurchase agreements and other high quality instruments. Cash flow from operating activities in 1992 was $31 million. Total debt was reduced $5.4 million while capital and mine development expenditures totaled $14 million and dividends totalled $3.2 million. Long-term debt at December 31, 1992 was 17% of total capital. ORE RESERVES The 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. INFLATION AND CHANGING PRICES The prices of major raw materials, such as copper, nickel and gold, purchased by the Company were mixed during 1993. 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. ITEM 8.

14957

1993

Item 7. Management's Discussion and Analysis of Results of Operations and of Financial Conditions General Bard is a leading multinational developer, manufacturer and marketer of products for the large and growing health care industry. Worldwide health care expenditures approximated $1.9 trillion in 1993 with about half that amount spent in the United States. Bard's segment of this industry, itself a multi-billion dollar market, is primarily specialized products used primarily in hospitals, in outpatient centers and in physician's offices to meet the needs of the medical profession in caring for their patients. The Company seeks to focus and concentrate on selected markets with cost-effective, innovative products and specialized sales forces to maximize the opportunities in these markets. Operating Results Net sales decreased 2% in 1993, reflecting the sale of the MedSystems division, the impact of foreign currency translations and the dramatic changes in the industry. Net income decreased 25%, reflecting several nonrecurring items, primarily the $61 million pretax provision for the settlement with the Justice Department. 1993 Sales Data Consolidated net sales totaled $970.8 million in 1993, a decrease of $19.4 million or 2% for the year. Sales were lowered a total of 4% by the impact of the sale of the Bard MedSystems division in February 1993 (3%) and the impact of generally lower foreign currency values (1%). Sales in 1993 were also negatively affected by a slowdown in U.S. procedural rates, consolidations of health care providers, limited FDA approvals, increasingly conservative medical practices fostered by the growth of managed care and weaker European economies. Worldwide sales increased 1% in the urological product group. Good increases in several relatively new specialty devices were partially offset by declines in other areas. Sales of surgical products decreased 1% but increased 8% after adjusting for the sale of the MedSystems division. Specialty access, endoscopic, laparo- scopic and blood management products contributed significantly to this increase. Cardiovascular product sales decreased 5% worldwide with most product areas in this group showing declines. Sales in the United States decreased 1% in 1993 to $687.9 million, representing 71% of total sales. Urological product sales increased while sales of surgical products (due to the sale of MedSystems) and cardiovascular products decreased. II-3 Sales outside the U.S. were $282.9 million in 1993, a decline of 3% from 1992 and represented 29% of total sales. Changes in foreign currency values in 1993 lowered these sales by nearly 5%. Growth in sales of surgical products were more than offset by decreases in urological and cardiovascular sales. Sales increases were good in Japan and Germany. The geographic breakdown of sales outside the U.S. for 1993 is: Europe, Middle East, Africa - 56%; Japan, Asia/Pacific - 37% and Western Hemisphere, excluding the United States - 7%. 1992 Sales Data In 1992 consolidated net sales totaled $990.2 million, an increase of $114.2 million or 13% from the prior year. U.S. sales, which were 70% of total consolidated sales, increased 13% while sales outside the U.S. increased 12% for the year. Changes in foreign currency values in 1992 accounted for approximately 2 percentage points of the sales growth outside the U.S. Operating Income Gross profit margins rose in 1993 for the third straight year. The rates were 50.9% in 1993, 48.4% in 1992 and 46.6% in 1991. Productivity gains, cost reductions and a favorable product mix in many product areas contributed to this improvement in the last three years. A pretax charge of $2.6 million for severance costs related to a plant closing is included in 1993 cost of goods sold. Bard uses the LIFO method of valuing substantially all U.S. inventories, which results in current costs (higher in a period of inflation) being charged to cost of goods sold. Bard generally has been able to recover these costs through its strong product position in its markets. The Company also strives to offset the effect of inflation through its cost reduction programs. Marketing, selling and administrative expenses (which exclude research and development) increased $2.9 million in 1993, or less than 1%. R&D expenses increased nearly 10% in 1993 as the Company works toward new technologies and enhancements for the future. Operating income of $128.5 million increased 5.0% in 1993, reflecting the increased gross profit margin and, as a percent of net sales, was 13.2% compared with 12.4% in 1992. Operating income in 1992 increased 31.6% from 1991 due primarily to a higher gross profit margin. II-4 Other Expense, Net The 1993 results included a third quarter pretax provision for the Justice Department settlement of $61 million, a fourth quarter pretax gain of $32.7 million from the sale of shares of the common stock of Ventritex, Inc., and a first quarter pretax gain of $10.9 million from the sale of the MedSystems division net of several nonrecurring charges. The 1992 results included a gain of $5.9 million from the sale of common stock of Ventritex and a comparable amount for provisions for expenses associated with legal and regulatory matters. Income Tax The effective income tax rate was 37.2% in 1993, 29.9% in 1992 and 25.6% in 1991. The increase in 1993 was primarily due to the $61 million Justice Department settlement, which was not fully deductible, and a 1% tax rate increase to 35% effective January 1, 1993. The increase in the 1992 rate was primarily due to a reduction in the portion of Bard's taxable income being generated outside the United States at lower effective tax rates. The tax benefit from operations in Puerto Rico and Ireland favorably affected the tax rate in each year. As a result of the Omnibus Tax Reconciliation Act of 1993, the effective tax rate in 1994 will be affected slightly, primarily due to a reduction in the tax benefit derived from the Company's manufacturing operations in Puerto Rico. Income Net income for 1993 totaled $56 million, or $1.07 per share, which was 25% lower than in 1992. As a percent of sales, net income was 5.8% in 1993 compared with 7.6% in 1992 and 6.5% in 1991. Nonrecurring items that affected net income in 1993 were (in millions): Gain on sale of Ventritex stock $ 19.4 Gain on sale of MedSystems division and other one-time charges 6.0 Severance costs related to plant closing (1.8) Effect of accounting change for postretirement benefits (6.1) Provision for the Justice Department settlement agreement (45.4) Net income effect of nonrecurring items $(27.9) After adjusting for these items, net income would have been higher than reported by $27.9 million, or $.53 per share. In 1992 net income was $1.42 per share, or $75 million in total, which was 31% higher than 1991. II-5 Financial Condition Bard's financial condition remained strong in 1993. Net cash provided by operating activities increased to $124 million in 1993 from $103.6 million in 1992. While the Company had cash outlays totaling $101.4 million for acquisitions of businesses, patents, trademarks and other long-term investments, total debt increased a modest $20 million from $133 million to $153 million in 1993. The ratio of total debt to total capitalization increased from 25.3% to 28.5% with total capitalization increasing $10.7 million to $536.1 million. Long-term debt was essentially unchanged at $68.5 million at the end of 1993, with $60 million of it at a fixed rate of 8.69% until scheduled repayment in September 1999. Bard maintains credit lines with banks for short-term cash needs. These facilities were used as needed during 1993. The current unused lines of credit total $141 million. As now structured, the Company should generate substantially all funds needed for operations and capital expenditures. The Company believes it could borrow adequate funds at competitive terms and rates, should it be necessary, including the payments to the Justice Department required as a result of the plea agreement reached in October 1993. Under the terms of the settlement, $30.5 million is payable 30 days after court approval plus two annual instalments of $15.25 million each. As presented in the Consolidated Statements of Cash Flows on page II-11 of this report, net cash flows from operating activities totaled $124 million in 1993. Net income, depreciation and amortization provided a total of $91.5 million, and included the gain on disposal of assets of $50.4 million. Increases in current liabilities, excluding debt, provided a total of $27 million, including $30.5 million of the $61 million payable under the Justice Department settlement. Other long-term liabilities increased by $46.2 million, of which $30.5 million is the balance of the settlement amount and $10 million is the accumulated postretirement benefit obligation charged to income in the first quarter of 1993. All other operating activities provided $9.7 million net including a total of $12.9 million provided from decreases in accounts receivable and inventories. Investing activities used $67.1 million in 1993. Capital expenditures totaled $30.7 million and proceeds from the sale of assets provided $65 million. $101.4 million was used for the acquisition of businesses, patents, trademarks and other related items, and long-term investments. Financing activities in 1993 used a total of $30.4 million. Common stock purchases used $24.4 million and dividends used $28.2 million. Other financing activities, primarily proceeds from short-term borrowings, provided $22.2 million net. II-6 Total cash flows, including a $1.3 million translation adjustment, resulted in an increase in cash and short-term investments of $25.2 million. As noted, capital expenditures in 1993 were $30.7 million compared with $30 million in the prior year. Expenditures for 1994 are anticipated at $35-$40 million. Research and development spending was $66.3 million in 1993, up 9.6% from 1992. Planned expenditures for 1994 are about $80 million, a 20% increase. Purchases of Bard common stock by the Company totaled (in millions) $24.4, $14.0 and $6.4 in 1993, 1992 and 1991, respectively. In January 1993 the Board of Directors authorized the purchase from time to time of up to 2 million shares of which 1 million were purchased in 1993. The Board of Directors declared dividends of 13 cents per share for the first two quarters of 1993 and in July 1993 increased the dividend to 14 cents per share. At February 1994 the indicated annual dividend rate is 56 cents per share. Dividends for 1993 of 54 cents per share were up from 50 cents per share paid in 1992. Legal Proceedings For a discussion of pending legal proceedings and related matters, please see Note 5, Commitments and Contingencies, of the Notes to Consolidated Financial Statements on page II-16. Acquisitions and Dispositions In 1993 the Company acquired the operations of Solco Hospital Products Group, Inc., Pilot Cardiovascular Systems, Inc. and Bainbridge Sciences, Inc. in separate transactions for a total of $70 million. The Bard MedSystems division was sold in 1993 with a pretax gain of $15.9 million. The 1993 acquisitions, and several other investments and acquisitions in 1993, 1992 and 1991 were not significant to the Company's operations as a whole. II-7 Item 8.

9892

1993

ITEM 6. SELECTED FINANCIAL DATA The following table presents selected financial and operating information for each of the five years ended December 31, 1993. Share and per share amounts refer to common shares. The following information should be read in conjunction with the financial statements presented elsewhere herein. The following table sets forth unaudited summary financial results on a quarterly basis for the two most recent years. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Comparison of 1993 results to 1992. Total revenues rose 91% in 1993 to $229.9 million. Net income before taxes and extraordinary items more than doubled to reach $34.9 million in 1993. The increase was led by a rapid rise in production and assisted by an increase in gas processing and transportation margins. Before the effect of a favorable $3.8 million income tax accounting change in 1992 and a $1.9 million 1993 extraordinary charge on early retirement of debt, earnings per common share were $.80 in 1993 compared to $.53 in 1992, a 51% increase. The gross margin from production operations for 1993 increased 62% to $79.7 million, which was primarily related to a 65% growth in oil and gas production. The price received per equivalent barrel decreased by 3% to $13.41. Total operating expenses including production taxes increased 60% during 1993 although operating cost per equivalent barrel ("BOE") decreased to $4.83 from $4.99 in 1992. Expense reductions gained from wells added in the DJ Basin, where operating costs averaged $2.76 per BOE, were partially offset by the late 1992 acquisition of Wyoming wells from ARCO where 1993 operating costs averaged $7.45 per BOE. For the year ended December 31, 1993, average daily production per BOE was 25,472 Bbls, a 65% increase from 1992. Average daily production in the fourth quarter of 1993 climbed to 10,314 barrels and 105.6 MMcf (27,917 barrels of oil equivalent). The production increases resulted primarily from acquisitions and continuing development drilling in the DJ Basin of Colorado. Domestically, $51.0 million in properties were acquired in 1993, primarily in and around existing hubs in Colorado and Wyoming. The acquisitions included a significant number of development locations and should continue to add to production into 1994. In 1993, 311 wells were placed on production in the DJ Basin, with 51 wells in various stages of drilling and completion at yearend. Because the majority of the wells were added in the latter part of the year, production will not be fully impacted until 1994. Additionally, significant downtime was experienced in the fourth quarter at the major processing plant in the area and much of the gas had to be diverted, which increased line pressures and hampered production. To a lesser extent, this situation continued into early 1994. The gross margin from gas processing, transportation and marketing activities for 1993 increased 23% to $10.0 million from $8.1 million in 1992. The increase was primarily attributable to a $3.0 million (33%) rise in transportation and processing margins as a result of additional DJ Basin production and the recent expansion of the related facilities. Gas marketing margins for 1993 decreased by $1.1 million due to reduced margins on the Oklahoma cogeneration supply contract, which declined as a result of an imposed limitation of the contract sales price and rising gas purchase costs. In 1993 the net contract margin was a loss of $267,000, which was $1.8 million less than 1992. At present gas price levels, the Company foresees continued negative or breakeven margins for the cogeneration contract through July 1994. At that time, the share of the sales price minimum attributable to gas will increase from 45% to 65% and the margin should improve. The cogeneration margin reduction was partially offset by a $667,000 (126%) rise in other gas marketing margins resulting from increased third party marketing. Other income was $10.4 million during 1993, compared to $4.2 million in 1992. The $6.2 million increase resulted from a $3.5 million gas contract settlement received in April, a $1.7 million litigation judgment and greater gains on the sales of securities. General and administrative expenses, net of reimbursements, for 1993 represented 3% of revenues compared to 5.6% in 1992 as expenses were held essentially flat while revenues grew 91%. Interest and other expenses increased 28% primarily as a result of a rise in outstanding debt balances. Senior debt was paid down in April 1993 with proceeds from a preferred offering, but increased through yearend as a result of development expenditures, acquisitions, the investment in Command Petroleum and the retirement of the $25.0 million in subordinated debt. Depletion, depreciation and amortization during 1993 increased 60% from the prior year. The increase was the direct result of the 65% rise in equivalent production between years. The producing depletion rate per equivalent barrel for 1993 was reduced to $4.75 from $4.79 in 1992. The rate was reduced by an ongoing drilling cost reduction program, partially offset by an increase from the discontinuation of converting Thomasville production to equivalent quantities based on relative gas prices. The Company adopted FASB Statement No. 109, "Accounting for Income Taxes," effective January 1, 1992. Net income for 1992 was increased by $3.8 million for the cumulative effect of the change in method of accounting for income taxes. In 1992 the income tax provision was reduced from the statutory rate of 34% by $5.5 million due to the elimination of deferred taxes as a result of tax basis in excess of financial basis. In 1993 the income tax provision was reduced from the newly enacted rate of 35% by $4.7 million upon full realization of the excess basis benefit. The Company anticipates deferred taxes will be provided in 1994 and beyond based on the full statutory rate. Comparison of 1992 results to 1991. Revenues rose 30% in 1992 to $120.2 million, compared to $92.5 million in 1991. Net income for 1992 was $20.6 million, a 134% jump from the $8.8 million in 1991. The increases resulted from greater oil and gas production volumes, lower interest expense, reduced general and administrative expenses and a $3.8 million reversal of the cumulative effect of prior year deferred taxes with the adoption of a change in the method of accounting for income taxes. Average daily production for 1992 rose 24% to 15,408 equivalent barrels due mostly to development drilling in the DJ Basin of Colorado as 189 wells were placed on production there. As a result, the gross margin from production increased 22% to $49.3 million in 1992. The price per equivalent barrel of oil and gas production decreased 4% during 1992. The gross margin from gas processing, transportation and marketing activities for 1992 increased 12% to $8.1 million from $7.3 million in 1991. The growth was primarily the result of increased marketing of third party gas in New Mexico, Colorado and Wyoming. Gas processing and transportation margins increased moderately as volumes were increased late in the year by expansions of pipeline and plant facilities to take advantage of increasing DJ Basin production. Other income for 1992 decreased 26% to $4.2 million from a reduction in gains on sales of securities and lower interest on notes receivable. Direct operating expenses including production taxes increased only 13% during 1992 as the operating cost per equivalent barrel decreased to $4.99 from $5.47 in 1991, due to increased DJ Basin production where operating costs have been significantly lower than average. General and administrative expenses, net of reimbursements, for 1992 represented less than 6% of revenues compared to 8% in 1991, as revenues rose 30%. Interest and other expenses dropped 39% in 1992 due to lower average outstanding senior debt after the application of proceeds from a preferred stock offering in late 1991. Development, Acquisition and Exploration During 1993 the Company incurred $93.1 million for oil and gas property development and exploration, $51.0 million for acquisitions and $22.6 million for gas facility expansion and other assets, for a total of $166.7 million in property and equipment expenditures. Additionally, the Company made an $18.2 million investment in an Australian based exploration and production company. The Company has concentrated a significant portion of its development activities in the DJ Basin of Colorado. Capital expenditures for DJ Basin development totalled $75.4 million during 1993. A total of 311 newly drilled wells were placed on production there in 1993 and 51 were in progress at yearend. Additionally, 42 recompletions were performed in 1993, with seven in process at yearend. In December 1993, 16 drilling rigs were in operation in the DJ Basin. The Company anticipates putting 500 or more wells per year on production in the DJ Basin for the next few years. With additional leasing activity and through drilling costs reductions that add infill locations as proven as they become economic, the Company has increased the inventory of available drillsites. In December, the Company entered into a letter of intent with Union Pacific Resources Corporation whereby the Company will gain the right to drill wells on UPRC's previously uncommitted acreage throughout the Wattenberg area. This transaction significantly increased the Company's undeveloped Wattenberg inventory. UPRC will retain a royalty and the right to participate as a 50% working interest owner in each well, and received grants for warrants to purchase two million shares of Company stock. Of the warrants, one million expire three years from the date of grant, and are exercisable at $25 per share, while the other one million expire in four years and are exercisable at $27 per share. One year from the date of grant (February 8, 1994), the exercise prices may be reduced to 120% of the average closing price of the Company stock for the preceding 20 consecutive trading days, but not to lower than an exercise price of $21.60 per share. At that time the expiration date of the warrants may also be extended one year if the average closing price over the 20 day trading period is less than $16.50 per share. The Company expended $14.8 million for other development and recompletion projects and $2.9 million for exploration during 1993. In Nebraska, 29 wells were added to production in 1993 as an extension of a drilling program initiated in 1992. An additional 20 wells are planned in Nebraska for 1994. In southern Wyoming, 11 wells in the East Washakie Basin development program were successfully drilled and completed during the last half of 1993 with three in process at yearend. In this program, significant cost- cutting measures were applied based on the experience gained in the DJ Basin. In central Wyoming on the properties acquired from ARCO in late 1992, efforts have been focused on increasing operating efficiency with limited development drilling and workover activity. In 1993, three successful wells were drilled in the fourth quarter and selected development and recompletion activity is scheduled for 1994. In the Piceance Basin of western Colorado, a three well test program was started in December of 1993 on acreage acquired there during the year, with one well undergoing completion, the second in progress and a third scheduled for early 1994. Current plans include a minimum of 25 wells in the basin during 1994. In South Texas, a combined operated and non-operated program was initiated, with nine wells completed in 1993 and one well abandoned. A total of 25 additional horizontal locations have been identified and drilling should continue with as many as 15 wells planned in 1994. In its domestic exploration efforts, the Company initiated a seismic program in Louisiana and began drilling early in the fourth quarter. Advanced seismic techniques are being used to identify further prospects in Louisiana and expectations are to drill up to 20 wells in 1994. A total of $51.0 million in domestic acquisitions were completed in 1993. In May 1993, the Company purchased an interest in 121 producing wells and over 70 drilling locations in the DJ Basin area for $3.3 million. In July, an incremental 25% interest in the Company's Barrel Springs and Duck Lake Fields in Wyoming was purchased for $6.1 million. The properties are 90% gas and include 44 producing wells and 46 undeveloped locations. In August, the Company acquired interests in 225 producing wells and 272 proved undeveloped locations in the DJ Basin for $19.7 million. The proved reserves are 70% gas with more than two-thirds requiring future development to produce. Late in the year, two acquisitions were completed in the Piceance and Uinta Basins of Western Colorado for a total of $12.5 million. The majority of the value was in undeveloped locations as only 128 wells were currently producing. Numerous other producing and undeveloped acquisitions totalling $9.4 million were completed, mostly in or close to the Company's principal operating areas. The Company's gas gathering and processing facilities have been undergoing significant transformation since late 1992. In 1993, the Company expended $20.1 million to further develop its gas related assets. The Company spent $9.4 million toward the second phase of its DJ Basin gathering expansion to construct a high pressure line to deliver gas directly to the major gas processing plant in the area and expand its gathering network for the increased drilling activity. An additional $2.6 million was expended to expand the Roggen Plant for the production increases. A total of $5.6 million in additional transportation and gathering facilities were constructed in the DJ Basin including a nine mile 16" interconnect line completed in October to relieve high line pressures, a 20" western gathering extension and numerous other extensions and connections. A gathering system that delivers third party gas to the Roggen Plant was purchased for $703,000. The Company expended $1.4 million to complete construction of a system to gather gas from its Nebraska drilling project. These projects are intended to take advantage of the significant increase in drilling activity in these areas. In the international arena, progress continues as well. In May 1993, the Company acquired 42.8% of the outstanding shares of Command Petroleum Holdings N.L., an Australian exploration and production company, for $18.2 million. The Sydney based company is listed on the Australian Stock Exchange, and at December 31, 1993 had 950,000 barrels of proven oil reserves and $19.9 million of working capital. In addition, it holds interests in more than 20 exploration permits and licenses and a 28.7% interest in a Netherlands exploration and production company whose assets are located primarily in the North Sea. In Russia, the Permtex joint venture received central government approval in August and the Company executed a finance and insurance protocol with the Overseas Private Investment Corporation ("OPIC"), a United States government agency. Current plans call for 25 of the existing 45 shut-in wells to be placed on production in 1994, and that 400 development wells will be drilled over the next ten years. Extensive seismic work began in the fourth quarter of 1993 for 400 kilometers of data in Tunisia and 500 kilometers in Mongolia. Financial Condition and Capital Resources At December 31, 1993, the Company had total assets of $480 million and working capital of $1.3 million. Total capitalization was $412 million, of which 28% was represented by senior debt and the remainder by stockholders' equity. During 1993, the Company fully retired its $25 million of 13.5% subordinated notes and the related cumulative participating interests. During 1993, cash provided by operations was $68.3 million, an increase of 43% over 1992. As of December 31, 1993, commitments for capital expenditures totalled $7.5 million, primarily for DJ Basin drilling. The level of future expenditures is largely discretionary, and the amount of funds devoted to any particular activity may increase or decrease significantly, depending on available opportunities and market conditions. The Company plans to finance its ongoing development, acquisition and exploration expenditures using internally generated cash flow, proceeds from property dispositions and existing credit facilities. In addition, joint ventures or future public and private offerings of securities may be utilized. In 1992, an institutional investor agreed to contribute $7 million to a partnership formed to monetize Section 29 tax credits to be realized from the Company's properties, mainly in the DJ Basin. The initial $3 million was contributed in October 1992, and at first payout in June 1993 the second contribution of $1.5 million was received. An additional $1.5 million was received in October 1993. This transaction should increase the Company's cash flow and net income through 1994. A revenue increase of more than $.40 per Mcf is realized on production generated from qualified Section 29 properties in this partnership. The Company recognized $3.8 million of this revenue during 1993. Discussions are in progress to expand this transaction so that the benefits would be extended through at least 1996. In April 1993, the Company sold 4.1 million depositary shares (each representing a one quarter interest in one share of $100 liquidation value stock) of convertible preferred stock through an underwriting for $103.5 million. A portion of the net proceeds of $99.3 million was used to retire the entire outstanding balance under the revolving credit facility at that time. The preferred stock pays a 6% dividend and is convertible into common stock at $21.00 per share. At the Company's option, the preferred stock is exchangeable into 6% convertible debentures on any dividend payment date on or after March 31, 1994. The stock is redeemable at the option of the Company on or after March 31, 1996. Effective July 1, 1993, the Company renegotiated its bank credit facility and increased it from $150 million to $300 million. The new facility is divided into a $50 million short-term portion and a $250 million long-term portion that expires on December 31, 1997. However, management's policy is to renew the facility annually. Credit availability is adjusted semiannually to reflect changes in reserves and asset values. At December 31, 1993, the elected borrowing base was $150 million. The majority of the borrowings currently bear interest at LIBOR plus 1.25% with the remainder at prime. The Company also has the option to select CD plus 1.375%. Financial covenants limit debt, require maintenance of minimum working capital and restrict certain payments, including stock repurchases, dividends and contributions or advances to unrestricted subsidiaries. Based on such limitations, $86.5 million would have been available for the payment of dividends and other restricted payments as of December 31, 1993. The Company does not currently plan to make, and is not committed to make, any advances or contributions to unrestricted subsidiaries that would materially affect its ability to pay dividends under this limitation. During 1993, the Company fully retired its $25.0 million of 13.5% subordinated notes and the related cumulative participating interests. An extraordinary charge to earnings of $1.9 million (net of income taxes) was made in 1993, representing the amount paid in excess of principal and accrued interest through the retirement dates. These notes were retired early in order to reduce the Company's ongoing cost of debt. The Company maintains a program to divest marginal properties and assets which do not fit its long range plans. For 1992 and 1993, proceeds from these sales were $3.0 million and $5.5 million, respectively. Included in the 1993 proceeds were $4.0 million of cash receipts previously accrued for late 1992 sales. The Company intends to continue to evaluate and dispose of nonstrategic assets. In 1990, the Company was granted a judgment in litigation regarding a leasehold assignment from the early 1980's. The Oklahoma Supreme Court refused certiorari and the judgment was upheld. As a result, a total of $1.7 million was accrued and reported in other income in 1993. The full amount was collected in January 1994. In April 1992, a jury found for the plaintiffs in a gas contract dispute related to an offshore property. In April 1993, the dispute was settled by an agreement to pay the Company a net of $5.3 million. The initial $3.5 million was received and reflected as other income in second quarter 1993. The remaining $1.8 million was received in third quarter 1993, but reflected as a reserve for possible contingencies. In April 1993, the Company was granted a $2.7 million judgment in litigation involving the allocation of proceeds from a pipeline dispute. The judgment has been appealed. The financial statements reflect these judgments only upon receipt of cash or final judicial determination. The Company believes that its capital resources are more than adequate to meet the requirements of its business. However, future cash flows are subject to a number of variables including the level of production and oil and gas prices, and there can be no assurance that operations and other capital resources will provide cash in sufficient amounts to maintain planned levels of capital expenditures or that increased capital expenditures will not be undertaken. Inflation and Changes in Prices While certain of its costs are affected by the general level of inflation, factors unique to the petroleum industry result in independent price fluctuations. Over the past five years, significant fluctuations have occurred in oil and gas prices. While such fluctuations have had, and will continue to have a material effect, the Company is unable to predict them. The following table indicates the average oil and gas prices received over the last five years and highlights the price fluctuations by quarter for 1992 and 1993. Average gas prices exclude the Thomasville gas production. During 1993, the Company renegotiated its Thomasville gas contract and beginning in January 1994, the Company will receive a somewhat higher than market price for its Thomasville gas sales, significantly below its 1993 average price of $12.16 per Mcf. Average price computations exclude contract settlements and other nonrecurring items to provide comparability. Average prices per equivalent barrel indicate the composite impact of changes in oil and gas prices. Natural gas production is converted to oil equivalents at the rate of 6 Mcf per barrel. Equivalent prices prior to 1993 have been restated to reflect elimination of the conversion of Thomasville gas volumes based on its price relative to the Company's other gas production. In December 1993, the Company was receiving an average of $12.54 per barrel and $2.27 per Mcf (excluding the Thomasville contract) for its production. Beginning in December 1992, the average oil price was effectively reduced by the oil production added from the Wyoming acquisition, which sells at a significant discount to West Texas Intermediate posting due to the presence of low gravity sour crude in two of the fields. ITEM 8.

860713

1993

ITEM 6. SELECTED FINANCIAL DATA SOUTHERN. Reference is made to information under the heading "Selected Consolidated Financial and Operating Data," contained herein at pages II-38 through II-49. ALABAMA. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-78 through II-91. GEORGIA. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-123 through II-137. GULF. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II- 166 through II-179. MISSISSIPPI. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-207 through II-220. SAVANNAH. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-245 through II-258. ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION SOUTHERN. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-8 through II-15. ALABAMA. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-53 through II-58. GEORGIA. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-95 through II-101. GULF. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-141 through II-147. MISSISSIPPI. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-183 through II-189. SAVANNAH. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-224 through II-230. II-2 ITEM 8.

66904

1993

ITEM 6. SELECTED FINANCIAL DATA ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Net income decreased by $2,605,000 or $.32 per share in 1993 as compared to 1992. Net income in 1993 was decreased by $1,320,000 (net of $880,000 income tax benefit) or $.18 per share to increase reserves for claims filed by former employees, and by $200,000, or $.03 per share for the cumulative effect of changes in accounting principles. Note 9 to the consolidated financial statements more fully discusses the claims filed by former employees, while Notes 3 and 6 discuss the cumulative effect of changes in accounting principles. Excluding the charges, net income and earnings per share decreased 12% and 9%, respectively, in 1993 as compared to 1992 on a revenue decrease of 3%. The unfavorable relationship between the change in net income and revenue relates primarily to overhead expenses remaining at the same level as last year despite a decline in revenue volume. The decline in net income was greater than the decline in earnings per share due to a fewer number of shares outstanding. After excluding the 1991 charge as described in Note 9, net income and earnings per share increased 11% and 12%, respectively, in 1992 as compared to 1991 on a revenue increase of 7%. The favorable relationship between the change in net income and earnings per share and revenue resulted from lower overhead expenses in the engineering and consulting segment. The engineering and consulting segment reported an 8% decrease in revenue in 1993 compared to 1992. The decrease is due primarily to declines in the volume of services provided to the nuclear power market. These declines are partially offset by increases in U.S. defense related revenue. The gross profit percentage was 24% in 1993 and 1992. Revenue increased 9% in 1992 compared to 1991 after excluding $3,125,000 associated with the 1991 charge. The increase was due primarily to the acquisition of GENSYS Corporation and Digital Engineering, Inc. and a U.S. defense contract relating to a job assistance program. The increased revenue was partially offset by the loss of an engineering services contract with Tennessee Valley Authority late in 1991. Gross profit declined to 24% in 1992 from 25% in 1991, excluding the 1991 charge. The communication equipment segment revenue increased 30% in 1993 as compared to 1992. The increase relates primarily to revenue derived from the acquisition of the Femco Division of Mark IV Industries in late 1992. The gross profit percentage decreased 2% in 1993 to 34% due primarily to sales of lower margin products. Revenue volume increased 3% in 1992 as compared to 1991 due to a higher level of goods sold. The gross profit percentage was 36% in both 1992 and 1991. Interest and other income, net, increased 31% in 1993 compared to 1992 due primarily to fees earned on a joint venture within the engineering and consulting segment. Interest and other income, net, decreased 26% in 1992 as compared to 1991 after exclusion of $250,000 associated with the 1991 charge. The decrease relates primarily to lower interest rates on lower investment balances offset in part by fees earned on a joint venture. Selling, general and administrative expenses were substantially unchanged in 1993 compared to 1992 after exclusion of expenses related to the claims filed by former employees. Selling, general and administrative expenses decreased 2% in 1992 from 1991 after excluding $3,975,000 associated with the 1991 charge. The decrease is related primarily to lower overhead payroll expenses within the engineering and consulting segment. Depreciation and amortization increased 12% in 1993 compared to 1992 due primarily to depreciation on the office facility completed in late 1992. Depreciation and amortization increased 12% in 1992 as compared to 1991 after excluding $50,000 associated with the 1991 charge due primarily to additions to property, plant and equipment within the engineering and consulting segment. Interest expense was not significant in either 1993 or 1992. Interest expense decreased in 1992 from 1991 due to the capitalization of interest, as well as prepayment of debt in early 1992. Income before provision for taxes on income and cumulative effect of changes in accounting principles decreased 11% compared to the prior year after excluding expenses related to the claims filed by former employees. The decrease relates primarily to lower volume in the engineering and consulting segment, particularly the nuclear services market, offset in part by higher volume in the communication equipment segment. In order to improve results, higher revenue volume must be attained within the engineering and consulting segment and overhead cost reductions must be made where appropriate. Income before provision for taxes on income and cumulative effect of changes in accounting principles increased 17% in 1992 compared to the prior year after excluding $7,400,000 associated with the 1991 charge. The increase relates primarily to improved performance within the engineering and consulting segment offset in part by a decline in interest and other income, net. The provision for taxes on income increased from an effective tax rate of 39% in 1992 to 40% in 1993 due primarily to the enacted increase in the statutory federal income tax rate to 35%. The provision for taxes on income increased from an effective tax rate of 36% in 1991 to 39% in 1992 after exclusion of the $2,480,000 tax benefit relative to the 1991 charge. The increase relates primarily to a decline in utilization of capital losses to reduce federal income taxes during 1992 offset in part by a lower effective state income tax rate. Working capital decreased $10,088,000, or 18% in 1993. Cash and cash equivalents and short-term investments declined $2,365,000 during the year. The declines relate primarily to the recent acquisitions of SRA Technologies, Inc., and Instrument Associates, Inc. (IAI), as well as payments to repurchase company stock. The company does not anticipate requiring long-term financing during the next year. Available cash and cash equivalents, combined with amounts generated from operations, should provide adequate working capital to satisfy operating requirements and the contingent payouts to former GENSYS stockholders and IAI principals. Unused lines of credit with three banks aggregating $11,475,000 are also available for short-term cash needs. No material restrictions on cash transfers between the company and its subsidiaries exist. In 1992 the FASB issued Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" (SFAS 112), which requires companies under certain circumstances to recognize costs currently for postemployment benefits. This statement becomes effective in 1994. The company's current method of accounting for these costs is in accordance with SFAS 112. ITEM 8.

740763

1993