SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2006
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number: 1-5721
LEUCADIA NATIONAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
New York 13-2615557
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(State or Other Jurisdiction of Incorporation (I.R.S. Employer
or Organization) Identification No.)
315 Park Avenue South
New York, New York 10010
(212) 460-1900
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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Common Shares, par value $1 per share New York Stock Exchange
7-3/4% Senior Notes due August 15, 2013 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [x] No [ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large Accelerated Filer [x] Accelerated Filer[ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
Aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant at June 30, 2006 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $4,751,155,000.
On February 15, 2007, the registrant had outstanding 216,351,466 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
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Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2007 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
1
PART I
Item 1. Business.
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The Company
The Company is a diversified holding company engaged in a variety of
businesses, including manufacturing, real estate activities, medical product
development, winery operations and residual banking and lending activities that
are in run-off. The Company also owns equity interests in operating businesses
and investment partnerships which are accounted for under the equity method of
accounting, including gaming entertainment, land based contract oil and gas
drilling, real estate activities and development of a copper mine in Spain. The
Company concentrates on return on investment and cash flow to maximize long-term
shareholder value. Additionally, the Company continuously evaluates the
retention and disposition of its existing operations and investigates possible
acquisitions of new businesses. In identifying possible acquisitions, the
Company tends to seek assets and companies that are out of favor or troubled
and, as a result, are selling substantially below the values the Company
believes to be present.
Shareholders' equity has grown from a deficit of $7,700,000 at December
31, 1978 (prior to the acquisition of a controlling interest in the Company by
the Company's Chairman and President), to a positive shareholders' equity of
$3,893,300,000 at December 31, 2006, equal to a book value per common share of
the Company (a "common share") of negative $.04 at December 31, 1978 and $18.00
at December 31, 2006. Shareholders' equity and book value per share amounts have
been reduced by the $811,900,000 special cash dividend paid in 1999.
In July 2006, the Company sold Symphony Healthcare Services, LLC
("Symphony") to RehabCare Group, Inc. for approximately $107,000,000. After
satisfaction of Symphony's outstanding credit agreement by the buyer
($31,700,000 at date of sale) and certain sale related obligations, the Company
realized net cash proceeds of $62,300,000 and recorded a pre-tax gain on sale of
discontinued operations of $53,300,000.
In September 2006, the Company sold ATX Communications, Inc. ("ATX") to
Broadview Networks Holdings, Inc. for aggregate cash consideration of
approximately $85,700,000, and recorded a pre-tax gain on sale of discontinued
operations of $41,600,000.
During 2006, the Company recorded net security gains of approximately
$117,200,000, principally from the sale of publicly traded debt and equity
securities that had been classified as available for sale securities. These
gains include a gain of $37,400,000 from the sale of 115,000,000 common shares
of Level 3 Communications, Inc. ("Level 3"), which were received in December
2005 in connection with Level 3's purchase of WilTel Communications Group, LLC
("WilTel").
In August 2006, pursuant to a subscription agreement with Fortescue
Metals Group Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd
("FMG"), the Company invested an aggregate of $408,000,000, including expenses,
in Fortescue's Pilbara iron ore and infrastructure project in Western Australia.
Fortescue is a publicly traded company on the Australian Stock Exchange (Symbol:
FMG).
The Company's manufacturing operations are conducted through Idaho
Timber, LLC ("Idaho Timber") and Conwed Plastics, LLC ("Conwed Plastics").
Acquired in May 2005, Idaho Timber is headquartered in Boise, Idaho and
primarily remanufactures dimension lumber and remanufactures, packages and/or
produces other specialized wood products. Conwed Plastics manufactures and
markets lightweight plastic netting used for a variety of purposes including,
among other things, building and construction, erosion control, packaging,
agricultural, carpet padding, filtration and consumer products.
2
The Company's gaming entertainment operations are conducted through its
controlling interest in Premier Entertainment Biloxi, LLC ("Premier"), which is
the owner of the Hard Rock Hotel & Casino Biloxi ("Hard Rock Biloxi"), located
in Biloxi, Mississippi. The Hard Rock Biloxi was severely damaged by Hurricane
Katrina and is currently being rebuilt. As discussed below, in September 2006,
Premier and its subsidiary filed voluntary petitions for reorganization under
chapter 11 of title 11 of the United States Bankruptcy Code (the "Bankruptcy
Code").
The Company's domestic real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale. In February 2006, Square 711 Developer, LLC ("Square 711"), a 90% owned
subsidiary of the Company, completed the sale of 8 acres of unimproved land in
Washington, D.C. for net cash proceeds of approximately $75,700,000, and
recorded a pre-tax gain of $48,900,000.
The Company's medical product development operation is conducted through
Sangart, Inc. ("Sangart"), which became a majority-owned subsidiary of the
Company in 2005. Sangart is developing a product called Hemospan(R), which is a
form of cell-free hemoglobin that is designed for intravenous administration to
treat a wide variety of medical conditions, including use as an alternative to
red blood cell transfusions.
The Company's winery operations consist of Pine Ridge Winery in Napa
Valley, California and Archery Summit in the Willamette Valley of Oregon. These
wineries primarily produce and sell wines in the luxury segment of the premium
table wine market.
The Company's land based contract oil and gas drilling investment is
conducted by Goober Drilling, LLC, ("Goober"), in which the Company acquired a
30% interest in April 2006. In January 2007, the Company increased its interest
in Goober to 42% for additional cash consideration of $25,000,000. The Company
has also agreed to lend to Goober, on a secured basis, up to $171,000,000 to
finance new equipment purchases and construction costs, repay existing debt and
finance working capital needs ($126,000,000 was outstanding at December 31,
2006).
The Company owns 30% of Cobre Las Cruces, S.A. ("CLC"), a former
subsidiary of the Company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. During 2005, the Company
sold a 70% interest in CLC to Inmet Mining Corporation ("Inmet"), a
Canadian-based global mining company, in exchange for 5,600,000 newly issued
Inmet common shares, representing approximately 11.6% of Inmet's current
outstanding common shares.
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
Investor Information
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the Company
files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 450 Fifth Street, NW, Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov)
that contains reports, proxy and information statements and other information
regarding the Company and other issuers that file electronically. In addition,
material filed by the Company can be inspected at the offices of the New York
Stock Exchange, Inc. (the "NYSE"), 20 Broad Street, New York, NY 10005, on which
the Company's common shares are listed. The Company has submitted to the NYSE a
certificate of the Chief Executive Officer of the Company, dated May 16, 2006,
certifying that he is not aware of any violations by the Company of NYSE
corporate governance listing standards.
The Company's website address is www.leucadia.com. The Company makes
available, without charge, through its website copies of its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act, as soon as reasonably practicable after such reports
are filed with or furnished to the SEC.
3
Financial Information about Segments
The Company's reportable segments consist of the operating units
identified above, which offer different products and services and are managed
separately. At acquisition, the Company's investment in Premier was reported as
the gaming entertainment segment; however, it was deconsolidated and classified
as an investment in an associated company upon its filing with the bankruptcy
court in September 2006. Although Premier is not currently reported as an
operating segment, an expanded description of its activities is presented below
due to the size of this investment and the Company's expectation that it will be
reported as an operating segment in the future. Other operations primarily
consist of the Company's wineries, Caribbean-based telecommunications services
and residual banking and lending activities that are in run-off.
In addition to Premier, associated companies include equity interests in
other entities that the Company accounts for on the equity method of accounting.
Investments in associated companies include HomeFed Corporation ("HomeFed"), a
corporation engaged in real estate activities, Goober, CLC, Jefferies Partners
Opportunity Fund II, LLC ("JPOF II"), EagleRock Capital Partners (QP), LP
("EagleRock"), Wintergreen Partners Fund, L.P. ("Wintergreen") and Safe Harbor
Domestic Partners L.P. ("Safe Harbor"). JPOF II, EagleRock, Wintergreen and Safe
Harbor are engaged in investing and/or securities transactions activities.
Corporate assets primarily consist of investments and cash and cash
equivalents and corporate revenues primarily consist of investment income and
securities gains and losses. Corporate assets include the Company's investment
in Fortescue. Corporate assets, revenues, overhead expenses and interest expense
are not allocated to the operating units.
Conwed Plastics has a manufacturing facility located in Belgium, which
is the only foreign operation with non-U.S. revenue or assets that the Company
consolidates, and it is not material. Unconsolidated non-U.S. based investments
include 38% of Light and Power Holdings Ltd., the parent company of the
principal electric utility in Barbados, the 30% ownership of CLC and the
investment in Fortescue. From time to time the Company invests in the securities
of non-U.S. entities or in investment partnerships that invest in non-U.S.
securities.
Certain information concerning the Company's segments for 2006, 2005 and
2004 is presented in the following table. Consolidated subsidiaries are
reflected as of the date of acquisition, which was May 2005 for Idaho Timber and
November 2005 for Sangart. Associated Companies are only reflected in the table
below under identifiable assets employed.
4
2006 2005 2004
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(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 345.7 $ 239.0 $ --
Conwed Plastics 106.4 93.6 64.4
Domestic Real Estate 86.7 29.9 63.5
Medical Product Development .7 .1 --
Other Operations 42.8 59.0 70.8
Corporate (b) 280.4 268.3 180.9
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Total consolidated revenues and other income $ 862.7 $ 689.9 $ 379.6
========= ========= =========
Income from continuing operations before income taxes and equity in in income
(losses) of associated companies:
Manufacturing:
Idaho Timber $ 12.0 $ 8.2 $ --
Conwed Plastics 17.9 14.2 7.9
Domestic Real Estate 44.0 4.1 20.7
Medical Product Development (21.1) (1.4) --
Other Operations (14.4) 7.5 18.6
Corporate (b) 95.4 101.8 59.6
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Total consolidated income from continuing operations before income
taxes and equity in income (losses) of associated
companies $ 133.8 $ 134.4 $ 106.8
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 132.3 $ 162.7 $ --
Conwed Plastics 83.6 81.9 50.4
Domestic Real Estate 198.1 182.7 253.2
Medical Product Development 12.2 7.0 --
Other Operations 257.8 245.0 403.7
Investments in Associated Companies 773.0 375.5 460.8
Corporate 3,846.8 4,062.0 2,070.1
Assets of discontinued operations -- 144.1 1,562.2
--------- --------- ---------
Total consolidated assets $ 5,303.8 $ 5,260.9 $ 4,800.4
========= ========= =========
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains on the Company's
consolidated statements of operations.
(b) Net securities gains for Corporate aggregated $116,600,000, $199,500,000
and $123,100,000 during 2006, 2005 and 2004, respectively, which primarily
resulted from the sale of publicly traded debt and equity securities that
had been classified as available for sale securities. Security gains
include a gain from the sale of Level 3 of $37,400,000 in 2006 and a gain
from the sale of White Mountains Insurance Group, Ltd. ("WMIG") of
$146,000,000 in 2005. For 2006, 2005 and 2004, security gains include
provisions of $12,900,000, $12,200,000 and $4,600,000, respectively, to
write down investments in certain available for sale securities. The
write-downs of the available for sale securities resulted from declines in
market value determined to be other than temporary.
(c) For the years ended December 31, 2006, 2005 and 2004, income from
continuing operations has been reduced by depreciation and amortization
expenses of $39,500,000, $32,600,000 and $28,700,000, respectively; such
amounts are primarily comprised of Corporate ($11,600,000, $10,700,000 and
$11,400,000, respectively), manufacturing ($17,500,000, $14,200,000 and
$5,200,000, respectively) and other operations ($6,400,000, $5,700,000 and
$8,200,000, respectively). Depreciation and amortization expenses for other
segments are not material.
5
(d) For the years ended December 31, 2006, 2005 and 2004, income from
continuing operations has been reduced by interest expense of $79,400,000,
$65,500,000 and $60,600,000, respectively; such amounts are primarily
comprised of Corporate ($70,900,000, $63,200,000 and $55,300,000,
respectively) and other operations ($8,000,000, $1,200,000 and $3,300,000,
respectively). In 2006, interest expense for other operations was comprised
of Premier during the period it was a consolidated subsidiary. Interest
expense for other segments is not material.
At December 31, 2006, the Company and its consolidated subsidiaries had
1,323 full-time employees.
Manufacturing
Idaho Timber
Business Description
In May 2005, the Company acquired Idaho Timber for total cash
consideration of $133,600,000, including working capital adjustments and
expenses. Idaho Timber is headquartered in Boise, Idaho and is engaged in the
manufacture and/or distribution of various wood products. Idaho Timber's
principal product lines include remanufacturing dimension lumber;
remanufacturing, bundling and bar coding of home center boards for large
retailers; and production of 5/4" radius-edge, pine decking. Idaho Timber also
manufactures and/or distributes a number of other specialty wood products. Idaho
Timber has over 25 years of operating experience in its industry. The Company's
investment in Idaho Timber was $123,200,000 at December 31, 2006.
Remanufactured dimension lumber is Idaho Timber's largest product line.
Dimension lumber is used for general construction and home improvement,
remodeling and repair projects, the demand for which is normally a function of
housing starts and home size. All dimension lumber is assigned a quality grade,
based on the imperfections in the wood, and higher-grade lumber is sold at a
higher price than lower-grade lumber. Idaho Timber purchases low-grade dimension
lumber from sawmills located in North America and Europe and upgrades it into
higher-grade dimension lumber products. The remanufacturing process includes
ripping, trimming and planing lumber to reduce imperfections and produce a
variety of lumber sizes. These products are produced at plants located in
Florida, North Carolina, Texas, Kansas, Idaho and New Mexico. Each plant
distributes its product primarily by truck to lumber yards and contractors
within a 300 mile shipping radius from the plant site.
Idaho Timber's next largest product line is home center board products,
which are principally sold to large home improvement retailers. Idaho Timber
purchases high-grade boards from sawmills in the western United States, South
America and New Zealand (primarily pine but other wood species are also used),
performs minor re-work on those boards to upgrade the quality, and then packages
and bar codes those boards according to customer specifications. Services
provided include managing delivery to off-site inventory positions at
customer-owned distribution centers near retail locations so that adequate stock
is available for the customers to draw upon when needed. Production takes place
in owned plants in Idaho and Montana, and goods are shipped nationwide by rail
and truck to customer-owned distribution centers. The sale is not completed and
revenue is not recognized until the customer takes the product from the
distribution center.
Idaho Timber also operates a sawmill in Arkansas that produces 5/4"
radius-edge, pine decking cut to a variety of lengths. Rights to cut timber are
purchased from private land owners located near the sawmill, known as timber
deeds, and Idaho Timber employs third-party contractors to cut the timber and
transport the logs to the sawmill. Logs are also acquired in the spot market
(gate logs) when trucks loaded with logs arrive at the sawmill, are inspected
for quality and purchased if an agreement can be reached on price. Idaho Timber
performs traditional sawmill processes (cutting, drying and planing) to
manufacture the final product. The product is shipped to various regions
throughout the central and eastern parts of the United States via truck and rail
to lumber treaters and others for resale to the final consumer.
6
Idaho Timber's profitability is dependent upon its ability to manage
manufacturing costs and process efficiency, minimize capital expenditures
through the purchase of used, lower-cost equipment and repairing its existing
equipment, and effective management of the spread between what it pays for
dimension lumber and boards and the selling prices of the remanufactured
products. Selling prices for remanufactured products may rise quicker than
supplier prices in strong markets creating greater spread; however, during
periods of declining product demand and reduced selling prices, supply price
declines may lag behind resulting in lower spreads. Idaho Timber's business is
generally not seasonal, except in those locations that have weather related
construction slowdowns.
The dimension lumber product does not require significant build up of
inventory to cover peak periods of activity, nor are there any other unusually
significant needs for working capital. Home center board products experience a
longer cycle to convert raw material to product sales due to cross country
shipping and consignment inventory programs, resulting in an investment in
working capital. Working capital requirements are greater for the sawmill
operation. In addition to cash outlays for timber deeds, the sawmill will have a
seasonal build up of log inventory.
Idaho Timber owns nine plants, one sawmill that principally produces
decking products and one sawmill that produces split-rail fencing. These eleven
facilities in the aggregate have approximately 941,000 square feet of
manufacturing and office space, covering approximately 230 acres. Two plants are
principally dedicated to home center board products and the remaining plants
principally produce remanufactured dimension lumber products. All plant
locations can produce and distribute specialty wood products. Idaho Timber has
the capacity to ship approximately 70 million board feet per month; during 2006
actual shipments averaged approximately 59 million board feet per month.
Idaho Timber believes that its diverse remanufacturing, sawmill, and
distribution operations provide it with purchasing power to secure sources of
supply from multiple suppliers while minimizing freight costs. Idaho Timber's
diverse geographic footprint also mitigates geographic concentration risk.
Sales and Marketing
Idaho Timber primarily markets to local, regional and national lumber
retailers for its dimension lumber products, home improvement centers for its
home center board products and decking treaters for its sawmill product, and
other resellers of home construction materials. Demand for its products is
dependent, in part, upon the strength of the U.S. housing market and the
do-it-yourself home improvement market which are subject to cyclical
fluctuations. Its success in attracting and retaining customers depends in large
part on its ability to provide quicker delivery of specified customer products
than its competitors. For dimension lumber products, sales are primarily
generated at each of the plants, with a dedicated sales force located in the
same geographic region as the customers the plant serves. Board and decking
products are sold and managed centrally. The home center board product is
heavily dependent on two customers, Lowe's and The Home Depot, which account for
approximately 92% of that product line. The combined revenue of these two
customers in this product line was 18% of Idaho Timber's total revenue for the
year ended December 31, 2006. The customer base for the dimension lumber
business is much less concentrated; no customer accounts for more than 6% of
revenue. Idaho Timber's sales are somewhat concentrated in regions where its
facilities are located, with the largest being Florida, 22%; North Carolina,
17%; and Texas, 12%.
Competition
Idaho Timber sells commodity products, and operates in an industry that
is currently oversupplied and very competitive. Idaho Timber competes against
domestic and foreign sawmills and intermediate distributors for its dimension
lumber and decking products. In some cases, Idaho Timber competes on a limited
basis with the same sawmills that are a source of supply of low-grade dimension
lumber. Foreign suppliers have been growing their sales in the U.S. market,
particularly European competitors, which has added to the current oversupply
condition in the industry and may continue to do so. The home center board
business has many competitors, and suppliers to large home centers are always
under pressure to reduce prices.
7
Idaho Timber also competes for raw material purchases needed for its
remanufactured dimension lumber and home center board products, and in the past
the availability and pricing of certain raw materials has been adversely
affected by import duties (tariffs) imposed on Canadian imports, the largest
source of these supplies. A decades old trade dispute between the U.S. and
Canada resurfaced with the expiration of the Softwood Lumber Agreement on March
31, 2001. The dispute involved claims that lumber from government-owned land in
Canada is subsidized and sold into the U.S. market for less than fair value, the
effect of which is to injure or threaten to injure U.S. competitors. The U.S.
argued for the right to impose antidumping and countervailing duties to prevent
cheap Canadian wood from harming U.S. manufacturers. However, the North American
Free Trade Agreement ("NAFTA") review panel rejected claims that U.S. lumber
producers had suffered damage as a result of Canadian imports. On September 10,
2004, the U.S. International Trade Commission complied with the NAFTA ruling and
issued a statement saying that the U.S. lumber industry is not threatened by
Canadian softwood imports; however, the Commission expressed some disagreement
with the panel's decision.
In October 2006, this trade dispute over Canadian imports was resolved
and a new Softwood Lumber Agreement between Canada and the U.S. became
effective. The new agreement terminated all ongoing administrative agency
reviews and litigation, revoked the antidumping and countervailing duty orders
and imposed a graduated export tax ranging from zero to 15 percent based on the
Random Length Composite Index ("RLCI"), which is calculated using the current
market value of a combination of lumber products. A larger RLCI will result in a
smaller export tax with the tax decreasing to zero if the RLCI exceeds $355 per
thousand board feet. In addition, the agreement also provides that the export
tax can increase by 50% if shipments exceed a certain level (expressed as a
percentage of total U.S. shipments) for each Canadian export region. Each
Canadian export region can also make an election to pay a smaller export tax,
zero to five percent, if they agree to abide by certain export volume
restrictions that are determined based on a percentage of U.S. consumption. The
agreement has a seven year term and may be extended for an additional two years.
Currently, restrictions on Canadian imports are not adversely affecting Idaho
Timber's operations; however, if tariffs increase or import limitations are
imposed in the future, it is possible that raw material costs could increase or
supplies could be constrained. Idaho Timber is examining alternative sources of
supply to increase its raw material purchasing flexibility.
Idaho Timber's manufacturing process is very labor intensive, and its
labor force is not unionized. Idaho Timber's low cost labor force allows it to
be competitive and flexible in its operating activities; however, its labor
force is in high demand in its own industry and also from non-industry
employers. If Idaho Timber is unable to continue to attract and retain a cost
efficient labor force, sales volumes and profitability could suffer.
Government Regulation
Lumber and decking are identified at Idaho Timber facilities with a grade
stamp that shows the grade, moisture content, mill number, species and grading
agency. All lumber is graded in compliance with the National Grading Rule for
Dimension Lumber, which is published by the U.S. Department of Commerce. Idaho
Timber facilities are subject to regular inspection by agencies approved by the
American Lumber Standards Committee. Idaho Timber believes that its procedure
for grading lumber is highly accurate; however, Idaho Timber could be exposed to
product liability claims if it can be demonstrated its products are
inappropriately rated. Currently, Idaho Timber does not have any material
product liability claims outstanding.
Since Idaho Timber's sawmills do not treat its wood with chemicals, and
since timber deeds purchased from private land owners do not impose a
re-planting obligation, Idaho Timber does not have any unusual environmental
compliance issues.
Plastics Manufacturing
Business Description
Through Conwed Plastics, the Company manufactures and markets lightweight
plastic netting used for a variety of purposes including, among other things,
building and construction, erosion control, packaging, agricultural, carpet
padding, filtration and consumer products. These products are primarily used for
containment purposes, reinforcement of other products, packaging for produce and
meats, various types of filtration and erosion prevention. Conwed Plastics
believes it is a market leader in netting products used in carpet cushion, turf
reinforcement, erosion control and packaging. Packaging, agricultural and
building and construction markets tend to be seasonal, with peak periods in the
second and third quarters of the calendar year. Carpet padding, filtration and
consumer product markets are not usually subject to seasonal fluctuations
resulting in sales that tend to be evenly spread throughout the year. The
Company's investment in Conwed Plastics was $65,500,000 at December 31, 2006.
8
Conwed Plastics has completed five acquisitions since 2004 and continues
to look for additional acquisition opportunities that provide synergies with
existing customers, its manufacturing capacity, processes and technology, and/or
raw material needs. In May of 2006, Conwed Plastics acquired Polynet Inc. for
$2,300,000 in cash thereby increasing its market share in the packaging
business. Polynet's business was completely integrated into the division's
existing Roanoke manufacturing facility; post-acquisition revenues from this
acquisition were approximately $1,600,000.
Certain of Conwed Plastics' products are proprietary, protected by
patents and/or trade secrets. The Company holds patents on certain improvements
to the basic manufacturing processes it uses and on applications thereof. The
Company believes that the expiration of these patents, individually or in the
aggregate, is unlikely to have a material effect on its operations.
Sales and Marketing
Conwed Plastics' manufacturing revenues were $106,300,000, $93,300,000
and $64,100,000 for the years ended December 31, 2006, 2005 and 2004,
respectively. Products are marketed both domestically and internationally with
approximately 13.7% of 2006 revenues generated by customers from Europe, Latin
America, Japan and Australia. Products are sold primarily through an employee
sales force, located in the United States and Europe. Conwed Plastics emphasizes
development of new products and new applications of existing products to sustain
revenue growth. New product development focuses on market niches where
proprietary technology and expertise can lead to sustainable competitive
economic advantages. This targeted product development at times is carried out
in partnership with a prospective customer or industry where the value of the
product has been recognized. Conwed Plastics also focuses on developing new
products which provide an upgrade to a current product used by an existing
customer. Over the last several years, Conwed Plastics has spent approximately
2% to 5% of annual sales on the development and marketing of new products and
new applications of existing products.
Approximately half of Conwed Plastics' revenues are generated on a make
to order basis. The remainder of Conwed Plastics' sales requires a more
substantial investment in inventory that is stored at various locations to
service customers with short lead time requirements. In the aggregate, inventory
is turned over between 6 and 7 times per year. The top 10 customers with
multiple locations represent approximately 30% - 37% of total sales. The largest
single customer typically represents 5% - 8% of total sales; for the year ended
December 31, 2006, the largest single customer represented 6% of total sales.
Order backlog generally ranges from 6% - 12% of annual sales throughout the
year.
Competition
Conwed Plastics is subject to domestic and international competition,
generally on the basis of price, service and quality. Additionally, certain
products are dependent on cyclical industries, including the construction
industry. The cost of the principal raw material used in its products,
polypropylene, has increased by approximately 90% from 2002. Conwed Plastics has
been able to raise prices to its customers during this period to offset the
higher raw material costs. High oil and natural gas prices along with high
capacity utilization in the polypropylene industry are expected to keep raw
material costs higher than historical levels for the next few years.
Conwed Plastics has had excess manufacturing capacity over the past few
years, principally in its Belgium facility which became operational during 2001.
Utilization of this capacity improved in 2006 as the manufacturing capacity in
Belgium was used to meet sales growth in the U.S. In addition, manufacturing
production for customers in Australia and Asia has been moved away from domestic
facilities to the Belgium facility. Conwed Plastics believes that its
manufacturing capacity is appropriate for its current level of business and will
be sufficient to meet expected demand over the next few years.
Conwed Plastics has 3 to 5 competitors in most of its market segments
but the size and type of its competition varies by market segment.
9
Gaming Entertainment
Acquisition
During 2006, the Company indirectly acquired a controlling voting
interest in Premier for an aggregate purchase price of $90,800,000, excluding
expenses. The Company owns approximately 46% of the common units of Premier and
all of Premier's preferred units, which accrue an annual preferred return of
17%. The Company also acquired Premier's junior subordinated note due August
2012, with an outstanding balance at acquisition of $13,400,000, and has made an
$8,100,000 12% loan to Premier that matures in May 2007. All of Premier's equity
interests are pledged to secure repayment of Premier's outstanding $160,000,000
principal amount of 10 3/4% First Mortgage Notes due February 1, 2012 (the
"Premier Notes"). In addition, the Company agreed to provide up to $40,000,000
of construction financing to Premier's general contractor by purchasing the
contractor's receivables from Premier if the receivables are more than ten days
past due ($11,300,000 is outstanding at December 31, 2006). At acquisition, the
Company consolidated Premier as a result of its controlling voting interest.
Premier owns the Hard Rock Hotel & Casino Biloxi, located in Biloxi,
Mississippi, which was severely damaged by Hurricane Katrina and which is
currently being rebuilt. The Hard Rock Biloxi was scheduled to be fully opened
to the public on August 31, 2005; two days prior to opening, Hurricane Katrina
hit the Mississippi Gulf Coast. Located on an 8.5 acre site on the Mississippi
Gulf Coast, upon reconstruction the resort will have approximately 1,500 slot
machines and 50 table games, five restaurants (including a Hard Rock Cafe and
Ruth's Chris Steakhouse), a full service spa, a 5,200 square foot pool and beach
area, 3,000 square feet of retail space, an eleven-story hotel with 318 rooms
and suites and a Hard Rock Live! entertainment venue with a capacity of 1,200
persons. Premier expects to complete reconstruction and re-open to the public in
July 2007.
Prior to Hurricane Katrina, Premier purchased a comprehensive blanket
insurance policy providing up to $181,100,000 in coverage for damage to real and
personal property, including business interruption coverage. Premier has
received payments from various insurance carriers aggregating $160,900,000 with
respect to $168,200,000 face amount of coverage; the remaining $12,900,000 face
amount of coverage has not been settled and is currently in litigation. All
insurance settlements have been placed on deposit into restricted accounts under
the control of the indenture trustee of the Premier Notes.
Bankruptcy Filing
On September 19, 2006, Premier and its subsidiary filed voluntary
petitions for reorganization under the Bankruptcy Code, before the United States
Bankruptcy Court for the Southern District of Mississippi, Southern Division
(the "Court"). Premier filed its petitions in order to seek the Court's
assistance in gaining access to Hurricane Katrina-related insurance proceeds
which had been denied to Premier by its pre-petition secured bondholders.
Premier continues to operate its business as "debtors in possession" under the
jurisdiction of the Court and in accordance with the applicable provisions of
the Bankruptcy Code and orders of the Court.
The Bankruptcy Court issued an interim order granting Premier the right
to use approximately $34,000,000 of the funds that are under the control of the
indenture trustee of the Premier Notes to fund ongoing construction costs and
operations. As of December 31, 2006, $20,200,000 has been released to Premier
pursuant to this order and $133,200,000 remains in the restricted accounts under
the control of the indenture trustee. Premier believes that the remaining funds
in the restricted accounts together with permitted equipment financing will be
sufficient to rebuild the Hard Rock Biloxi similar to its condition immediately
preceding Hurricane Katrina.
Premier filed an amended disclosure statement and plan of reorganization
on February 22, 2007. Voting on the plan of reorganization is not expected to
occur until the second quarter of 2007. The Company has also committed to
provide up to $180,000,000 to finance Premier's plan of reorganization, which
would principally be used to pay-off the Premier Notes.
The Company deconsolidated Premier effective with the filing of the
voluntary petitions, and has classified its net investment in Premier as an
investment in an associated company ($125,600,000 as of December 31, 2006,
including all loans and equity interests). The bankruptcy filings were made to
give Premier access to the insurance proceeds, the proceedings are not expected
to last for an extended period and creditors are expected to receive the amounts
owed to them. For these reasons, the Company believes that the application of
the equity method of accounting during the pendency of the bankruptcy
proceedings is appropriate. Upon its emergence from bankruptcy proceedings, the
Company expects that Premier will be accounted for as a consolidated subsidiary.
10
Marketing
Premier's marketing strategy is to position the resort as a full service
gaming, boutique hotel and entertainment resort catering to the Mississippi Gulf
Coast marketplace and the southern region of the United States. Premier believes
it will benefit from the "Hard Rock" brand name and from being within walking
distance to the Beau Rivage, an MGM Mirage property and the largest hotel and
casino in the Mississippi Gulf Coast market. In the future, once Premier
establishes a regular customer base, it intends to expand its marketing
activities and attempt to present the resort as a full-service destination
resort. Premier believes that the Hard Rock concept and unique brand of
entertainment will appeal to a broad range of customers.
Competition
The devastation caused by Hurricane Katrina has dramatically changed the
competitive nature of the Gulf Coast gaming market. All twelve casinos in the
Gulf Coast gaming market were severely damaged and shut down by the impact of
Hurricane Katrina. Currently ten casinos are operating in the market and all
that had planned to reopen have reopened except for the Hard Rock Biloxi. Since
the Hard Rock Biloxi has no operating history, its ability to compete against
larger, better financed and/or more established resorts with existing customer
bases is uncertain. Premier anticipates its competitive position will be
strengthened by the worldwide familiarity of the Hard Rock brand, but it has no
prior operating history to rely upon.
Insurance Matters
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino,
which was a facility built on floating barges, and caused significant damage to
the hotel and related structures. The threat of hurricanes remains a risk to the
existing facilities and to the new casino, which will be constructed over water
on concrete pilings that will greatly improve the structural integrity of the
facility. In July 2006, Premier purchased a new insurance policy providing up to
$149,300,000 in coverage for damage to real and personal property and up to the
lesser of six months or $30,000,000 of business interruption and delayed opening
coverage. The coverage is syndicated through several insurance carriers, each
with an A.M. Best rating of A- (Excellent) or better. The policy provides
coverage for the existing structures, as well as for the repair and rebuild of
the hotel, low rise building and parking garage and the construction of the new
casino.
Although the insurance policy is an "all risk" policy, weather
catastrophe occurrence ("WCO"), which is defined to include damage caused by a
named storm, is limited to $50,000,000 with a deductible equal to the greater of
$7,000,000 or 5% of total insured values at risk. WCO coverage is subject to
mandatory reinstatement of coverage for an additional pre-determined premium.
Premier's current insurance policy expires in July 2007; Premier expects
it will purchase new insurance coverage that will be in effect for the balance
of the 2007 hurricane season. Premiums for WCO policies have increased
dramatically as a result of Hurricane Katrina, and the amount of coverage that
can be purchased has also been reduced as insurance companies seek to reduce
their exposure to such events. Premier cannot currently estimate how much
insurance will be available to it at an acceptable premium.
Environmental
Premier will operate its business near and over the water on the
Mississippi Gulf Coast. Premier is, and upon reconstruction of the resort will
be, subject to various federal, state and local laws, ordinances and regulations
that (1) govern activities or operations that may have adverse environmental
effects, such as discharges to air and water, as well as the handling and
disposal of hazardous material or solid or hazardous wastes, and (2) may impose
joint and several liability on current and former property owners or operators
for the costs of investigation, removal and remediation of hazardous substances
or wastes related to the environment without regard to fault. Premier currently
has not identified any such issues associated with its property that could
reasonably be expected to have an adverse effect on Premier or its results of
operations. However, it is possible that historical or neighboring activities
have affected, or the reconstruction and operation of the resort could affect
Premier's property and, as a result, material obligations or liabilities under
environmental laws could arise in the future.
11
Domestic Real Estate
At December 31, 2006, the Company's domestic real estate properties had a
book value of $176,700,000. The real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale. The Company owns a 15 story, 740,000 square foot office building located
in downtown Tulsa, Oklahoma that was formerly WilTel's headquarters building,
but which was not sold to Level 3. The building is currently 37% occupied with
tenants primarily under short-term leases and is being marketed for sale. The
property has a book value of approximately $52,000,000 at December 31, 2006.
Certain of the Company's other real estate investments and their
respective carrying values as of December 31, 2006 include: approximately 104
acres of land located in Myrtle Beach, South Carolina, which is fully entitled
for a large scale mixed-use development of various residential, retail and
commercial space ($35,300,000); approximately 76 acres of land located on the
island of Islesboro, Maine, and approximately 120 acres of land located in
Rockport, Maine, each of which have submitted plans for residential subdivisions
($27,700,000 in the aggregate); a fifteen acre, unentitled air rights parcel
above the train tracks behind Union Station in Washington, D.C. ($10,100,000);
an operating shopping center on Long Island, New York that has 71,000 square
feet of retail space ($9,500,000); and an approximate 540 acre parcel located in
San Miguel County, Colorado which the Company is attempting to have re-zoned
into a mixture of estate lots, cabins and a lodge site ($5,700,000). The 540
acre parcel is located near Mountain Village, Colorado, a ski resort bordering
Telluride, Colorado.
The Company owns approximately 30% of the outstanding common stock of
HomeFed. In addition, as a result of a 1998 distribution to all of the Company's
shareholders, approximately 7.3% and 8.2% of HomeFed is owned by the Company's
Chairman and President, respectively. HomeFed is currently engaged, directly and
through subsidiaries, in the investment in and development of residential real
estate projects in the State of California. Its current development projects
consist of two master-planned communities located in San Diego County,
California: San Elijo Hills and a portion of the larger Otay Ranch planning
area. The Company accounts for its investment in HomeFed under the equity method
of accounting. At December 31, 2006, its investment had a carrying value of
$45,700,000 which is included in investments in associated companies. HomeFed is
a public company traded on the NASD OTC Bulletin Board (Symbol: HOFD); at
December 31, 2006, the market value of the Company's investment was
$163,300,000.
In February 2006, Square 711, a 90% owned subsidiary of the Company,
completed the sale of 8 acres of unimproved land in Washington, D.C. The Company
received net cash proceeds of approximately $75,700,000, and recorded a pre-tax
gain of $48,900,000.
The real estate development industry is subject to substantial
environmental, building, construction, zoning and real estate regulations that
are imposed by various federal, state and local authorities. In order to develop
its properties, the Company must obtain the approval of numerous governmental
agencies regarding such matters as permitted land uses, density, the
installation of utility services (such as water, sewer, gas, electric, telephone
and cable television) and the dedication of acreage for various community
purposes. Furthermore, changes in prevailing local circumstances or applicable
laws may require additional approvals or modifications of approvals previously
obtained. Delays in obtaining required approvals and authorizations could
adversely affect the profitability of the Company's projects.
Medical Product Development
Business
At December 31, 2006, the Company owned approximately 69% of Sangart, a
biopharmaceutical company principally engaged in developing an oxygen transport
agent for various medical uses. From 2003 through December 31, 2006, the Company
invested an aggregate of $49,200,000 in Sangart, principally to help fund
Sangart's ongoing product development activities (as a development stage
company, Sangart does not have any revenues from product sales). The Company
expects to invest up to an additional $50,000,000 in March 2007, which would
increase its ownership interest up to 89%, and the Company would also receive
warrants for the right (but not the obligation) to invest up to another
$50,000,000 on the same terms. Sangart became a consolidated subsidiary of the
Company in 2005; the book value of the Company's investment in Sangart was
$6,800,000 at December 31, 2006.
12
In 2002, Sangart commenced human clinical trials of its current product
candidate, Hemospan(R), a form of cell-free hemoglobin administered
intravenously to treat a variety of medical conditions, including use as an
alternative to red blood cell transfusions. A principal function of human blood
is to transport oxygen throughout the body, the absence of which can cause organ
dysfunction or death. The basis for Sangart's technology is the result of more
than 20 years of research in the understanding of how hemoglobin (the oxygen
carrier in red blood cells) functions outside of red blood cells in a cell-free
environment. Hemospan offers universal compatibility with all blood types and,
as compared to red blood cell transfusions, reduced risk of infectious disease
transmission and a longer storage life. Hemospan is made from human hemoglobin
that is extracted from outdated human blood obtained from accredited blood
centers, which is then combined with polyethylene glycol using Sangart's
proprietary processes. Sangart's manufacturing process is able to generate
approximately three units of Hemospan using a single unit of blood, which serves
to expand the supply of donated blood. Sangart owns or exclusively licenses
twelve U.S. patents and has more than thirty applications pending worldwide
covering product composition, manufacturing or methods of use.
Sangart has completed three clinical studies involving 132 patients, of
whom 93 were administered Hemospan. These trials were Phase I and Phase II
studies designed to assess product safety and gather early indications of the
product's effectiveness. Sangart is currently conducting an additional Phase II
clinical trial in the U.S., and in February 2007 commenced two Phase III
clinical trials in Europe that are designed to demonstrate Hemospan's safety and
effectiveness in preventing and treating low blood pressure during surgery and
in reducing the incidence of operative and postoperative complications. The
Phase III studies are expected to involve over 800 patients, and will not be
completed until 2008. Upon completion, Sangart plans to submit an application
for marketing approval to the appropriate regulatory authorities in Europe in
late 2008, with a U.S. application to follow. The initial application for
marketing approval may be for a relatively narrow subset of elective surgery
procedures; subsequent clinical trials will likely be required to evaluate and
demonstrate the safety and effectiveness of Hemospan in additional elective
surgeries, trauma care, and other circumstances in which delivery of oxygen to
tissue provides clinical benefit (e.g., sickle cell disease, strokes and heart
attacks). Obtaining the requisite regulatory approvals is outside of Sangart's
control, and regulatory agencies could require expanded or additional clinical
trials resulting in additional development cost expenditures and delays. The
Company cannot state with certainty when, if ever, such approvals will be
received.
Substantially all of the funding needed for Hemospan development has come
from sales of Sangart's equity securities. The anticipated $50,000,000
investment to be made in March 2007 is expected to be sufficient to fund
Sangart's activities through the completion of its Phase III trials, after which
additional funds (which could come from the exercise of the Company's warrants)
will be required to fund activities prior to commercial launch.
Competitive Environment
Hemospan is intended to address the needs of the blood market. Currently
there are more than 14,000,000 units of packed red blood cells transfused each
year in the U.S., the majority of which are used in treating trauma and elective
surgery patients for whom Hemospan may be an alternative. Currently there are no
similar products approved for sale in the U.S. or the European Union. Other
companies are developing products that could potentially compete with Hemospan,
some of which have already completed Phase III clinical trials. One company
currently has a pending marketing approval application in the United Kingdom and
another has announced its intention to apply for marketing approval in the U.S.
in 2007. As such, it is possible that competing products could obtain marketing
approval in the U.S. and/or Europe prior to Hemospan obtaining approval.
Any successful commercialization of Hemospan will depend on an adequate
supply of raw materials, principally blood and polyethylene glycol, at an
acceptable quality, quantity and price. Sangart is currently working with
potential suppliers of raw materials; however, commitments from suppliers of
blood and polyethylene glycol to support a commercial launch are not yet in
place and competitors may seek commitments from the same blood suppliers.
Sangart leases a 56,700 square foot combination office and manufacturing
facility that currently produces Hemospan for its clinical trials. Sangart
believes that its current manufacturing facility will have more than enough
capacity to support a commercial launch, but capital improvements and
engineering designs will be required. In addition to obtaining requisite
regulatory approvals and increasing manufacturing capacity for the manufacture
and sale of Hemospan, Sangart would have to create sales, marketing and
distribution capabilities prior to any commercial launch of this product, either
directly or in partnership with a service provider.
13
Government Regulation
As a product intended for medical use, clinical trials, marketing
approval, manufacturing and distribution of Hemospan is highly regulated. An
application for marketing approval may only be made after the safety and
effectiveness of the product has been demonstrated, including through human
clinical trial data. In the United States, the U.S. Food and Drug Administration
regulates medical products, including the category known as "biologics" which
includes Hemospan. The Federal Food, Drug and Cosmetic Act and the Public Health
Service Act govern the testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of Hemospan.
In Europe, each country has its own agency that regulates clinical
trials. However, the Committee for Medicinal Products for Human Use ("CHMP"),
which is administered by the European Agency for the Evaluation of Medicinal
Products, is an EU-wide regulatory body. Following completion of clinical
trials, marketing approval can be granted either by a centralized application
through CHMP, or on a country-by-country basis. The trend is for centralized
applications, and it is likely that Sangart will make a centralized filing for
Hemospan through CHMP.
Other Operations
Wineries
The Company owns two wineries, Pine Ridge Winery in Napa Valley,
California and Archery Summit in the Willamette Valley of Oregon. Pine Ridge,
which was acquired in 1991, has been conducting operations since 1978, while the
Company started Archery Summit in 1993. Since acquisition, the Company's
investment in winery operations has grown, principally to fund the acquisition
of land for vineyard development and to increase production capacity and storage
facilities at both of the wineries. It can take up to five years for a new
vineyard property to reach full production and, depending upon the varietal
produced, up to three years after grape harvest before the wine can be sold. The
Company controls 229 acres of vineyards in Napa Valley, California and 116 acres
of vineyards in the Willamette Valley of Oregon, substantially all of which are
owned and producing grapes. The Company believes that its vineyards are located
in some of the most highly regarded appellations of the Napa and Willamette
Valleys. At December 31, 2006, the Company's combined net investment in these
wineries was $69,900,000. The wineries sold approximately 81,000 9-liter
equivalent cases of wine generating revenues of $19,500,000 during 2006, and
76,900 9-liter equivalent cases of wine generating revenues of $17,800,000
during 2005.
These wineries primarily produce and sell wines in the luxury segment of
the premium table wine market. The Company's wines are primarily sold to
distributors, who then sell to retailers and restaurants. The distributors used
by the Company also offer premium and luxury table wines of other producers that
directly compete with the Company's products. As permitted under federal and
local regulations, the wineries have also been placing increasing emphasis on
sales direct to consumers, which they are able to do through the internet, wine
clubs and at the wineries' tasting rooms. During 2006, direct sales to consumers
represented 22% of case sales and 44% of wine revenues. Sales of the Company's
wines in California (excluding direct sales to consumers) amounted to
approximately 12% of 2006 wine revenues.
The luxury segment of the wine industry is intensely competitive. The
Company's wines compete with small and large producers in the U.S., as well as
with imported wines. Demand for wine in the luxury market segment can rise and
fall with general economic conditions, and is also significantly affected by
available supply. The demand for the Company's wines is also affected by the
ratings given the Company's wines in industry and consumer publications. Wines
are rated on a 1 to 100 numerical scale for each vintage and each type of wine.
Future ratings are impossible to predict; however, the Company expects ratings
for newly released wines will continue to reflect the specific wine quality of
the Company's wineries and the overall perceived quality of the vintage in the
Napa and Willamette valleys.
At the beginning of 2005, inventory levels of the Company's wines held by
the Company and its distributors were too high, resulting in the need to hold
prices for certain varietals and increase spending on promotional, sales and
marketing programs to sell more wine. In particular, Pine Ridge had been
producing too much Merlot for its historical sales volume, and it has reduced
future production through re-budding and re-planting activities. The Company's
wineries have also been focused on improving wine quality. Wine quality
improvements are principally being made by reducing the amount of grape clusters
grown on each grapevine (resulting in yield reduction) to further concentrate
flavor, and investing in new winemaking equipment. Luxury wines available for
sale in any given year are also dependent upon harvest yields of earlier
periods, which can fluctuate from harvest to harvest depending on weather
patterns, insects and other non-controllable circumstances. For Pine Ridge and
Archery Summit, low yields in the 2004 harvest will result in lower cases
available for sale in 2007 as compared with 2006.
14
The wineries' production, sales and distribution activities are subject
to regulation by agencies of both federal and state governments. Many states
have historically prohibited or restricted sales of wine direct to consumers by
producers that are located in another state, even though the same states may
permit in-state producers to ship direct to in-state consumers. In 2005, the
U.S. Supreme Court decided that such discriminatory state direct shipment laws
violated the Commerce Clause of the U.S. Constitution. As a result, many states
have revised their laws to allow both in-state and out-of-state wineries to ship
directly to consumers. Other states have prohibited direct-to-consumer sales by
in-state and out-of-state wineries. Overall, these changes have improved the
Company's ability to sell wine directly to consumers, but have also increased
the complexity of compliance reporting and taxation required for each state.
The Company continues to review additional investments in the wine
business to achieve synergies with the existing properties and broaden the wine
portfolio. Potential investments could include new wine businesses, vineyards in
other locations or new wine brands. The Company has purchased approximately 611
acres of farmland in Washington State ($3,300,000), some of which is under
short-term leases to third parties. The Company plans to plant 90 acres with
grape vineyards, and may build a winery in the future.
Energy Projects
During the past few years, the Company has been incurring costs (all of
which have been expensed) to investigate and evaluate the development of a
number of domestic energy projects. The projects the Company has investigated
all employ gasification technology to convert different types of fossil fuels
into clean energy products. Gasification technology generally involves the
combination of coal, petroleum coke or petroleum pitch ("feedstocks") with
water, which is then fed into a gasifier and converted into a low BTU gas
("syngas"). Potential pollutants like sulfur and mercury are chemically stripped
from the syngas through another process, resulting in syngas that can be applied
to many commercial uses including the generation of electrical power, the
manufacture of methanol and hydrogen, the production of ammonia for fertilizer,
conversion to liquid fuels and, through a methanation process, upgrading the
liquid fuels to a pipeline quality natural gas. The gasification process can
also generate large quantities of commercial quality steam that can be sold to
industrial customers. The Company has incurred expenses investigating and
evaluating these projects of $8,300,000, $1,600,000 and $4,400,000 during the
years ended December 31, 2006, 2005 and 2004, respectively.
Although there are a number of projects the Company is currently
investigating, the Company is not obligated to develop any of the projects. Any
project that the Company might develop would likely require a significant equity
investment by the Company, the acquisition of substantial non-recourse
borrowings to build the projects (total development costs for these types of
projects range from $1 billion to $3 billion), the procurement of and purchase
commitment for long-term supplies of feedstock, long-term commitments from
purchasers of the output, and significant technological and engineering
expertise to implement. The investigation, evaluation and financing of these
projects takes years to complete; the Company does not expect that any of the
projects it is currently working on would reach the financing stage in the next
18 to 24 months, if ever. This diligence process can be costly, and no assurance
can be given that the Company will be successful in fully developing any of
these projects.
Antilles Crossing Group
The Company owns approximately 75% of entities comprising the Antilles
Crossing Group ("ACG"), a startup venture that constructed a sub-sea fiber optic
cable system in the Caribbean. The remaining interest is principally owned by
Light & Power Holdings Ltd., in which the Company holds a 38% interest.
ACG has completed the construction of a sub-sea fiber system from St.
Croix to Barbados with a link to St. Lucia. In St. Croix, capacity agreements
have been purchased to access sub-sea fiber systems to carry ACG customer
traffic to and from the United States, Canada, the United Kingdom, and the rest
of the world. The system is only the second to be built to Barbados and St.
Lucia and is expected to alleviate much of the bandwidth supply restrictions to
those islands. Since ACG completed construction activities during 2006,
operating revenues were not material reflecting the start-up nature of the
enterprise.
15
The system has allowed ACG to begin providing telecommunications and data
services to carriers serving the islands of Barbados and St. Lucia. In addition,
TeleBarbados Inc, one of the ACG entities, is building an on-island fiber and
wireless communications network on Barbados and is providing residential and
commercial data and voice services there. A launch of similar services in St.
Lucia is expected in 2007. International telecommunications and data services
are highly competitive, based on price, reliability of service and breadth of
coverage, and are impacted by regulatory requirements and technological
advances.
Banking and Lending
Historically, banking and lending operations made collateralized consumer
loans consisting principally of personal automobile instalment loans to
individuals who had difficulty obtaining credit. Over the past few years, the
Company has been shrinking its banking and lending operations. Operating
activities have been concentrated on maximizing returns on its investment
portfolio, collecting and servicing its remaining loan portfolios and
discharging deposit liabilities as they come due. During 2005, the Company's
banking and lending subsidiary filed a formal plan with the Office of the
Comptroller of the Currency to liquidate its operations, sold its remaining
customer deposits and surrendered its national bank charter. Net outstanding
loans were $2,200,000 and $3,000,000 as of December 31, 2006 and 2005,
respectively. Pre-tax income for the banking and lending operations was
$1,800,000, $1,400,000 and $22,000,000 for the years ended December 31, 2006,
2005 and 2004, respectively.
Other Investments
Fortescue
The Company invested $408,000,000 in Fortescue's Pilbara iron ore and
infrastructure project in Western Australia, including expenses. In exchange for
its cash investment, the Company received 26,400,000 common shares of Fortescue,
representing approximately 9.99% of the outstanding Fortescue common stock, and
a 13 year, $100,000,000 note of FMG. Interest on the note is calculated as 4% of
the revenue, net of government royalties, invoiced from the iron ore produced
from the project's Cloud Break and Christmas Creek areas only. The note is
unsecured and subordinate to the project's senior secured debt referred to
below. Fortescue is a publicly traded company on the Australian Stock Exchange,
and the shares acquired by the Company may be sold without restriction. At the
date of acquisition, the Company's investment in Fortescue's common shares was
recorded at its aggregate fair value, based on the closing price of Fortescue's
common shares on that date. Subsequent to acquisition, the Company's investment
in the Fortescue common shares is classified as a non-current available for sale
investment and carried at market value as of each balance sheet date. At
December 31, 2006, the market value of the Fortescue common shares was
$276,300,000.
For accounting purposes, the Company bifurcated its remaining Fortescue
investment into a 13 year zero-coupon note and a prepaid mining interest. The
zero-coupon note was recorded at an estimated initial fair value of $21,600,000,
representing the present value of the principal amount discounted at 12.5%. The
prepaid mining interest of $184,300,000 has been classified with other
non-current assets, and will be amortized to expense as the 4% of revenue is
earned.
The project information disclosed below was obtained from Fortescue's
website, (http://www.fmgl.com.au/), which contains substantial additional
information about Fortescue and the project. In April 2006, Fortescue announced
a proved reserve estimate of 121 million metric tons of iron ore and a probable
reserve estimate of 932 million metric tons of iron ore, in accordance with the
Australasian Joint Ore Reserves Committee code. Fortescue and its independent
mining consultant, Snowden Mining Industry Consultants ("Snowden"), have
completed a Mining Definitive Feasibility Study for this reserve. Snowden's
study focused exclusively on the Cloud Break and Christmas Creek mining
tenements, which cover an area of approximately 770 square kilometers. Fortescue
also announced that it has received all major approvals required under the
various governmental, environmental, and native title processes for the Cloud
Break and Christmas Creek tenements. Fortescue has substantial additional
tenements in the Pilbara region of Western Australia which have not yet been
approved for mining activities (mining revenues from other areas do not increase
the interest paid on the FMG note).
16
Fortescue's feasibility study was commissioned to identify a quantity
and quality of iron ore that would support an initial mine plan that produces 45
million metric tons per annum ("mtpa") for a 20 year period. Fortescue has
announced agreements with third parties that intend to purchase 41.5 mtpa of the
initial 45 mtpa plan; these agreements include relationships with 8 of the
largest steel mills in China. These agreements reference the benchmark price for
premium Pilbara iron ore which is set annually based on the first negotiated
price between any of the world's largest steel mills and one of the world's
three largest iron ore producers. The benchmark price for the year beginning in
April 2007 has been set at a price that represents a 9.5% increase over the
current price for iron ore.
In addition to the Company's investment, Fortescue raised
$2,051,000,000 of senior secured debt to fund the construction of the project.
Fortescue is building a 260 kilometer railroad, a port and related port
infrastructure at Port Hedland, Australia, as well as a crushing and screening
plant, access roads and other infrastructure at the mine site. Construction on
the rail, port, and mine site has begun and Fortescue has announced that it
expects to begin shipping ore in 2008. The control budget for the infrastructure
associated with the mine, rail and port, first published by Fortescue in April
2006, aggregates A$2,246,000,000 ($1,762,000,000 at exchange rates in effect on
February 15, 2007).
Goober
In April 2006, the Company acquired a 30% limited liability company
interest in Goober for aggregate consideration of $60,000,000, excluding
expenses, and agreed to lend to Goober, on a secured basis, up to $80,000,000 to
finance new rig equipment purchases and construction costs and to repay existing
debt. In June 2006, the Company agreed to increase the secured credit facility
amount to an aggregate of $126,000,000 to finance additional new rig equipment
purchases and construction costs. As of December 31, 2006, the outstanding
balance of the existing credit facility was $126,000,000. The Company's
investment in Goober is classified as an investment in an associated company.
From acquisition to December 31, 2006, Goober's revenues were $91,800,000 and
its pre-tax income (excluding interest expense payable to the Company), was
$27,300,000. After deducting depreciation and amortization related to purchase
accounting adjustments, the Company's share of Goober's pre-tax earnings before
intercompany interest was $2,000,000.
In January 2007, the credit facility was further amended to increase the
interest rate on the facility from LIBOR plus 2% to LIBOR plus 5%, and to
provide Goober with an additional secured credit facility for up to $45,000,000
at an interest rate of LIBOR plus 10%. In addition, the Company increased its
equity interest in Goober to 42% for an additional equity investment of
$25,000,000. The additional funding was required primarily due to increased raw
material and labor costs to construct the new rigs and working capital needs due
to delays in rig construction.
Goober is a land based contract oil and gas drilling company based in
Stillwater, Oklahoma that provides drilling services to exploration and
production companies in the Mid-Continent Region of the U.S., primarily in
Oklahoma and Texas. Goober typically generates revenues through drilling
contracts based on daily rates, footage (charged by depth of the well) or based
on a turnkey contract (fixed price to drill a well). Goober supplies the
drilling rig and all ancillary equipment and drilling personnel. Upon
completion, a well is connected to the customer's rig pump, storage facility and
eventually a pipeline. Goober's business is regionally concentrated with major
independent and local oil and gas producers awarding business to Goober based on
its quality of service, proximity to the well site and experience with the
specific geological formation. Goober has been in business since 1991.
As of December 31, 2006, Goober has 21 operating drilling rigs, 6 of
which were built after April 2006. For these operating rigs, 16 are under
contract for 1 to 3 year terms and 3 are "floaters" or rigs that are made
available on the spot market and which generally command higher daily rates. In
addition, the company has 13 rigs under construction and has committed to
purchase an additional two rigs. For these 15 rigs that are not yet in
operation, 10 are under contract for 1 to 3 year terms that will commence once
the rigs are operational. Goober expects that the rigs currently under
construction and the new rigs which have yet to be delivered will be operational
by the middle of 2007.
17
CLC
CLC is a Spanish company that holds the exploration and mineral rights to
the Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet, a Canadian-based
global mining company traded on the Toronto stock exchange (Symbol: IMN). Inmet
acquired the interest in CLC in exchange for 5,600,000 newly issued Inmet common
shares, representing approximately 11.6% of Inmet's current outstanding common
shares. Although the Inmet shares have registration rights, they may not be sold
until the earlier of August 2009 or the date on which the Company is no longer
obligated under the guarantee discussed below. The Inmet shares are reflected on
the Company's consolidated balance sheet at their fair value on the date they
were received of approximately $78,000,000; at December 31, 2006, the market
value of the Inmet shares was $299,800,000. The Company retains a 30% interest
in CLC.
CLC entered into an agreement with third party lenders for project
financing consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000 to finance subsidies and value-added tax. The Company and Inmet
have guaranteed 30% and 70%, respectively, of the obligations outstanding under
both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2006, approximately $74,200,000 was
outstanding under the senior secured credit facility and (euro)21,000,000 was
outstanding under the senior secured bridge credit facility. The Company and
Inmet have also committed to provide financing to CLC which is currently
estimated to be (euro)156,000,000 ($205,000,000 at exchange rates in effect on
February 15, 2007), of which the Company's share will be 30% ($26,100,000 of
which has been loaned as of December 31, 2006).
A May 2005 technical report prepared by Pincock, Allen & Holt, an
independent engineering company, indicated proven and probable reserves at the
Las Cruces deposit of approximately 16 million metric tons of copper ore at an
average grade of 6.6% copper. The capital costs to build the project have been
estimated at (euro)380,000,000 ($499,300,000 at exchange rates in effect on
February 15, 2007), including working capital, land purchases, and
contingencies, but excluding reclamation bonding requirements, inflation,
interest during construction, cost overruns and other financing costs. CLC
expects to begin commercial production in early 2008 and reach full mine
production in early 2009. Cash operating costs per pound of copper produced are
expected to average (euro)0.39 per pound ($0.51 per pound) of copper produced.
The project's capital and operating costs will be paid for in euros, while
copper revenues during the life of the mine are currently based on the U.S.
dollar. In order to minimize its exposure to currency fluctuations, CLC has
entered into an agreement to swap (euro)171,000,000 of euro denominated debt
into $215,000,000 of U.S. dollar denominated debt once construction of the mine
is complete.
Other
At December 31, 2006, the book value of the Company's equity investment
in JPOF II, a registered broker-dealer, was $126,200,000. JPOF II is managed by
Jefferies & Company, Inc., a full service investment bank to middle market
companies. JPOF II invests in high yield securities, special situation
investments and distressed securities and provides trading services to its
customers and clients. For the years ended December 31, 2006, 2005 and 2004, the
Company recorded $26,200,000, $23,600,000 and $16,200,000, respectively, of
pre-tax income from this investment under the equity method of accounting, all
of which was distributed to the Company shortly after the end of each year. Over
the seven years the Company has had the investment in JPOF II, the weighted
average return on investment has been approximately 20%.
In December 2001, the Company invested $50,000,000 in EagleRock, a
limited partnership that invests and trades in securities and other investment
vehicles. At December 31, 2006, the book value of the Company's equity
investment in EagleRock was $60,400,000, which is net of aggregate distributions
of $48,200,000 that were received during 2006 and $3,700,000 in 2004. The
Company is currently in discussions with EagleRock as to the timing and manner
in which the Company's remaining investment will be remitted by EagleRock to the
Company. Pre-tax income (losses) of $16,400,000, $(28,900,000) and $29,400,000
for the years ended December 31, 2006, 2005 and 2004, respectively, were
recorded from this investment under the equity method of accounting.
The Company has invested an aggregate of $50,000,000 in Wintergreen, a
limited partnership that invests in domestic and foreign debt and equity
securities. For the years ended December 31, 2006 and 2005, the Company recorded
$11,000,000 and $500,000, respectively, of pre-tax income from this investment
under the equity method of accounting. At December 31, 2006, the book value of
the Company's investment in Wintergreen was $61,500,000.
18
In January 2006, the Company invested $50,000,000 in Safe Harbor, a
limited partnership which principally invests in the securities of Japanese
public companies. Pre-tax losses of $7,600,000 were recorded during 2006 from
this investment under the equity method of accounting. At December 31, 2006, the
book value of the Company's investment in Safe Harbor was $42,400,000.
In 2004, the Company invested $75,000,000 in INTL Consilium Emerging
Market Absolute Return Fund, LLC ("INTL"), a limited liability company that is
invested in a master fund which primarily invests in emerging markets debt and
equity securities. INTL and the master fund are managed and controlled by an
investment manager who has full discretion over investment and operating
decisions. Under generally accepted accounting principles ("GAAP"), INTL is
considered a variable interest entity and the Company is the primary
beneficiary; as a result, the Company accounts for its investment in INTL as a
consolidated subsidiary. The Company has included INTL in its Corporate segment.
In December 2006, the Company redeemed $10,000,000 of its investment and has
requested an additional redemption of $40,000,000 during the first quarter of
2007. The redemption in 2007 may result in the Company deconsolidating INTL and
classifying its remaining investment as an investment in an associated company.
For the years ended December 31, 2006, 2005 and 2004, the Company recorded
pre-tax income relating to INTL of $5,100,000, $9,900,000 and $2,200,000,
respectively. At December 31, 2006, the book value of the Company's investment
in INTL was $92,200,000.
The Company owns approximately 38% of the common stock of Light & Power
Holdings Ltd., the parent company of The Barbados Light and Power Company
Limited, the primary generator and distributor of electricity in Barbados. At
December 31, 2006, the Company's investment of $18,800,000 was accounted for on
the cost method of accounting, due to currency exchange restrictions and stock
transfer restrictions.
The Company beneficially owns equity interests representing more than 5%
of the outstanding capital stock of each of the following domestic public
companies at February 15, 2007 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): The FINOVA Group Inc. ("FINOVA") (25%),
HomeFed (29.9%), International Assets Holding Corporation (17.4%) and Jordan
Industries, Inc. ("JII") (10.1%). In addition to the Company's equity interests
in Fortescue and Inmet discussed above, the Company also owns a 7.0% equity
interest in JZ Equity Partners PLC, a British company traded on the London Stock
Exchange.
For further information about the Company's business, including the
Company's investments, reference is made to Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations of this Report and
Notes to Consolidated Financial Statements.
Item 1A. Risk Factors.
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Our business is subject to a number of risks. You should carefully
consider the following risk factors, together with all of the other information
included or incorporated by reference in this Report, before you decide whether
to purchase our common stock. The risks set out below are not the only risks we
face. If any of the following risks occur, our business, financial condition and
results of operations could be materially adversely affected. In such case, the
trading price of our common stock could decline, and you may lose all or part of
your investment.
Future acquisitions and dispositions of our operations and investments
are possible, and if unsuccessful could reduce the value of our common shares.
We continuously evaluate the retention and disposition of our existing
operations and investigate possible acquisitions of new businesses. Any future
acquisitions or dispositions may result in significant changes in the
composition of our assets and liabilities. Consequently, our financial
condition, results of operations and the trading price of our common shares may
be affected by factors different from those affecting our financial condition,
results of operations and trading price at the present time.
Future acquisitions and investments may expose us to risks to which we
are not currently subject. Future acquisitions and investments may expose us to
risks such as:
o the possibility that future acquisitions and investments may not
immediately, if ever, add value to our Company;
19
o diversion of management's attention from our existing businesses; and
o the possibility that the acquired businesses or investments will
generate insufficient profits to offset the increased expenses
associated with the acquisitions.
Our ability to make future acquisitions and investments successfully
depends on a range of factors, including our ability to identify and compete
with others for potential acquisition targets, the acquisition price, terms and
conditions of any completed acquisitions, and the future profitability of any
new acquisitions and investments.
We are dependent on certain key personnel. We are dependent on the
services of Ian M. Cumming and Joseph S. Steinberg, our Chairman of the Board
and President, respectively. Messrs. Cumming's and Steinberg's employment
agreements with us expire June 30, 2015. These individuals are also significant
shareholders of our Company. As of February 15, 2007, Messrs. Cumming and
Steinberg and their respective families (excluding certain private charitable
foundations) beneficially owned approximately 11.6% and 12.8% of our outstanding
common shares, respectively. Accordingly, Messrs. Cumming and Steinberg exert
significant influence over all matters requiring approval by our shareholders,
including the election or removal of directors and the approval of mergers or
other business combination transactions.
We operate in a variety of industries and market sectors, certain of
which may be more susceptible to economic downturns than others. The industries
in which we operate may be subject to the effects of national or local economic
cycles, increased competition and changes in demographic conditions, any of
which may adversely affect our businesses and are beyond our control. Changes in
economic conditions in the U.S. or internationally can cause fluctuation in
prices and sales volumes which could adversely affect the Company's operating
results. A worsening of general economic or market conditions may result in
lower valuations for our businesses or investments or have a negative impact on
the credit quality of our assets.
Declines in the U.S. housing market could reduce revenues and
profitability of the manufacturing businesses. Revenues at our manufacturing
segments benefit from strong new housing starts and the strong home improvement
market in the U.S. Declines in the U.S. housing market, resulting from local,
regional, national or international economic changes, or from other factors,
including increases in mortgage interest rate levels, have negatively impacted
the revenues and profits of our manufacturing businesses, which could continue.
We are subject to risks associated with increased volatility in raw
material prices and availability of key raw materials. Idaho Timber and Conwed
Plastics purchase significant amounts of raw materials from third parties for
use in their operations. The price for polypropylene, the principal raw material
used by Conwed Plastics, tends to fluctuate with the price of oil and as a
result has risen significantly over the past couple of years. To the extent this
trend continues and we are unable to pass these price increases to our
customers, our results of operations will be negatively impacted. A significant
portion of Idaho Timber's raw material purchases are from foreign suppliers, and
the availability of that supply can be adversely impacted by trade disputes, or
by the imposition of export tariffs on Canadian imports resulting from the
Softwood Lumber Agreement between Canada and the U.S. In addition, raw material
prices at Idaho Timber will not always rise and fall in proportion to selling
prices of Idaho Timber's products, which can have a negative impact on operating
results.
From time to time we are subject to litigation, for which we may be
unable to accurately assess our level of exposure and which if adversely
determined, may have a material adverse effect on our consolidated financial
condition or results of operations. The Company and its subsidiaries are parties
to legal proceedings that are considered to be either ordinary, routine
litigation incidental to their business or not material to the Company's
consolidated financial position or liquidity. However, adverse determinations in
specific legal matters could have a material impact on the Company's financial
statements. See "Item 3, Legal Proceedings" for additional information.
20
Premier is located in a geographic area subject to catastrophic storms,
and it may not be able to purchase sufficient insurance coverage at an
acceptable price. Subsequent to Hurricane Katrina, the availability of
catastrophic insurance coverage was reduced and premiums increased
significantly. If Premier is unable to purchase insurance coverage for
catastrophic losses, the Company could suffer a material loss from a hurricane.
Premier, as a debtor-in-possession, must obtain bankruptcy court
approval for the conduct of its business and may not be successful in obtaining
approval for its plan of reorganization or in obtaining the necessary funds to
rebuild the Hard Rock Biloxi. If the bankruptcy court does not approve Premier's
plan of reorganization, or otherwise provide Premier with access to insurance
proceeds currently under the control of Premier's pre-petition bondholders in a
timely manner, Premier will not be able to repair and rebuild the Hard Rock
Biloxi or carry out its business plan in a timely manner, which would result in
losses for the Company.
Premier could encounter problems during reconstruction that could
substantially increase the construction costs or delay the opening of the Hard
Rock Biloxi. Reconstruction projects like the Hard Rock Biloxi are subject to
significant development and construction risks, which can cause unanticipated
cost increases and delays. These include, among others, shortages of materials
and skilled labor; adverse weather which damages the project or causes delays;
delays in obtaining or inability to obtain necessary permits, licenses and
approvals, including alcoholic beverage licensing and gaming commission
approval; changes in statutes, regulations, policies and agency interpretations
of laws applicable to gaming projects; changes to the plans or specifications
for Premier's rebuilding efforts; engineering problems; labor disputes and work
stoppages; environmental issues; fire, flooding and other natural disasters; and
geological, construction, excavation, regulatory and equipment problems.
Premier has no operating history or history of earnings and does not have
any experience developing or operating a gaming facility. Following
reconstruction, the Hard Rock Biloxi will be a new business and, accordingly,
will be subject to all of the risks inherent in the establishment of a new
business enterprise. If Premier is unable to manage these risks successfully, or
fail to attract a sufficient number of guests, gaming customers and other
visitors to the Hard Rock Biloxi, it would negatively impact its operations.
The right to operate the Hard Rock Biloxi is contingent upon governmental
approval. A revocation, suspension, limit or condition of Premier's gaming
licenses or registrations would result in a material adverse effect on its
business. If Premier's gaming licenses and/or registrations are revoked for any
reason, the Mississippi Gaming Commission could require us to close the Hard
Rock Biloxi. Failure to maintain such approvals could prevent or delay the
completion of reconstruction or opening of the Hard Rock Biloxi, or otherwise
affect the design and features of the operation of the Hard Rock Biloxi, all of
which could materially and adversely affect financial position and results of
operations.
Delays in obtaining governmental authorizations could adversely affect
the profitability of our real estate development projects. Our real estate
development business requires numerous governmental approvals, licenses and
permits, which we must obtain before we can begin development and construction.
This approval process can be delayed by withdrawals or modifications of
preliminary approvals, by litigation and appeals challenging development rights
and by changes in prevailing local circumstances or applicable laws that may
require additional approvals. Adverse regulatory changes or failure to obtain
approvals could delay real estate development projects or make them more costly
to complete.
Changes in mortgage interest rate levels or changes in consumer lending
practices could reduce consumer affordability and demand for some of our real
estate development projects. Certain of our real estate development projects are
dependent upon the availability and cost of mortgage financing for potential
homebuyers. Any significant increase in the prevailing low mortgage interest
rate environment or decrease in available credit could reduce consumer demand
for housing, which in turn could lead to fewer home sales or lower selling
prices.
The Company's current and future investment in Sangart is subject to
certain regulatory risks and costs, as well as risks associated with the
operation of a new business without a proven track record. Sangart's clinical
trials are expensive and time consuming, and Sangart cannot be certain that the
results of its trials will be acceptable to the regulatory authorities or that
they won't be required to conduct new or expanded trials. Sangart's activities
are subject to extensive government regulation and Sangart cannot generate any
revenue without regulatory approval of its products. Even if regulatory
approvals are received, Sangart would be a new business and will be subject to
all of the risks inherent in establishing a new business, in addition to the
risks associated with establishing the appropriate infrastructure necessary to
operate and manage the commercial exploitation of Sangart's products.
Sangart's Hemospan product is subject to competition from other products
under development. There are other companies developing products for the same
market that Sangart is targeting, and if they are successful in bringing their
product to market before Sangart it may significantly impair Sangart's ability
to compete in the same market segment.
21
Sangart's success depends on its ability to obtain, maintain and defend
patent protection for its products and technologies, preserve trade secrets and
operate without infringing the intellectual property rights of others. The
patent positions of biopharmaceutical companies, such as Sangart, are generally
uncertain and involve complex legal and factual questions. If Sangart's
intellectual property positions are challenged, invalidated, circumvented or
expire, or if Sangart fails to maintain its third-party intellectual property
licenses in good standing, its ability to successfully bring Hemospan to market
would be adversely affected. There can be no guarantee that any of Sangart's
pending patent applications will result in issued patents, or that any patents
issued to Sangart or its licensors will not be challenged, circumvented or
invalidated by third parties. If Sangart loses challenges to its intellectual
property it could incur monetary liabilities, be required to enter into
third-party licenses for the infringed product or technology (if available) or
be required to cease using the technology or product in dispute.
A decrease in consumer spending or general increases in the cost of
living could adversely impact sales at our wineries. Our wineries primarily
produce and sell wines in the luxury segment of the premium table wine market,
and are significantly dependent on the level of consumer spending. Consumer
spending habits are influenced by a number of factors beyond our control,
including the general state of the economy, increases in the cost of living,
federal and state income tax rates, deductibility of business entertainment
expenses under federal and state law and consumer confidence in future economic
conditions.
We could experience significant increases in operating costs due to
competition for qualified personnel in our operating businesses. Our inability
to attract and retain skilled personnel would make it difficult to compete and
operate efficiently. Many of our operating businesses require skilled management
and staff employees; we compete for their services with other companies.
Our various businesses are dependent on the proper functioning of our
information systems. Additionally, we rely on our information systems in
managing our accounting and financial reporting. Hardware and software is
protected by various forms and levels of security, and certain of our
information technology functions have backup processing capabilities. However,
these systems are still vulnerable to fire, storm, flood, power loss,
telecommunications failures, physical or software break-ins and similar events.
In the event that critical information systems are unavailable, it could
temporarily impair our operations or our ability to maintain our accounting and
financial reporting effectively.
We face intense competition in the operation of our businesses. The
industries in which we operate are highly competitive. There are numerous
competitors who operate in our markets, many of which have advantages over us,
such as more favorable locations, greater financial and other resources and may
be more established in their respective communities than we are. Competitors may
offer newer or different products or services that our customers may find more
attractive.
We may not be able to generate sufficient taxable income to fully
realize our deferred tax asset. We and certain of our subsidiaries have
significant net operating loss carryforwards ("NOLs") and other tax attributes.
At December 31, 2006, we have recognized a deferred tax asset of $991,900,000 in
respect of these tax attributes. If we are unable to generate sufficient taxable
income, we will not be able to fully realize the recorded amount of the deferred
tax asset.
Weather related conditions and significant natural disasters, including
hurricanes, tornadoes, windstorms, earthquakes and hailstorms could adversely
affect our business. The occurrence of natural disasters may impact our
wineries, real estate holdings, manufacturing and gaming operations, interfere
with our ability to obtain raw materials, sell our products and provide service
or realize income from our operations. Any shortage of reliable water and energy
resources or a drop in consumer confidence in the dependability of such
resources in areas where we operate or own land may adversely affect our
business operations, the values of our properties and/or result in government
restrictions that curtail operations.
22
We may not be able to insure certain risks economically. We may
experience economic harm if any damage to our properties is not covered by
insurance. We cannot be certain that we will be able to insure all risks that we
desire to insure economically or that all of our insurers or reinsurers will be
financially viable if we make a claim. We may suffer losses that are not covered
under our insurance or reinsurance policies. If an uninsured loss or a loss in
excess of insured limits should occur, results of operations could be adversely
affected.
We may reduce or cease to pay dividends on our common shares. On a split
adjusted basis, we paid cash dividends of $0.25 per common share in 2006 and
$.125 per common share in 2005 and 2004. However, we cannot assure you that we
will pay dividends on our common shares in the future or, if we do, the amount
of such dividends. The payment of dividends on our common shares in the future
is subject to the discretion of our Board of Directors and will depend upon
general business conditions, the availability of our NOLs, legal and contractual
restrictions on the payment of dividends and other factors that our Board of
Directors may deem to be relevant. In connection with the declaration of
dividends or the making of distributions on, or the purchase, redemption or
other acquisition of our common shares, we are required to comply with certain
restrictions contained in certain of our debt instruments.
Our common shares are subject to transfer restrictions. We and certain of
our subsidiaries have significant NOLs and other tax attributes, the amount and
availability of which are subject to certain qualifications, limitations and
uncertainties. In order to reduce the possibility that certain changes in
ownership could result in limitations on the use of the tax attributes, our
certificate of incorporation contains provisions that generally restrict the
ability of a person or entity from acquiring ownership (including through
attribution under the tax law) of 5% or more of our common shares and the
ability of persons or entities now owning 5% or more of our common shares from
acquiring additional common shares. The restriction will remain until the
earliest of (a) December 31, 2024, (b) the repeal of Section 382 of the Internal
Revenue Code (or any comparable successor provision) and (c) the beginning of
our taxable year to which these tax attributes may no longer be carried forward.
The restriction may be waived by our Board of Directors. Shareholders are
advised to carefully monitor their ownership of our common shares and consult
their own legal advisors and/or us to determine whether their ownership of our
common shares approaches the proscribed level.
Item 1B. Unresolved Staff Comments.
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Not applicable.
Item 2. Properties.
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Idaho Timber's plants and sawmills, which are the principal properties
used in its business are described in Item 1 of this Report.
Through its various subsidiaries, the Company owns and utilizes office
space in Salt Lake City, Utah for corporate and other activities (totaling
approximately 31,800 square feet). Subsidiaries of the Company own facilities
primarily used for plastics manufacturing located in Georgia, Virginia and Genk,
Belgium (totaling approximately 457,300 square feet) and facilities and land in
California and Oregon used for winery operations (totaling approximately 110,800
square feet and 396 acres, respectively).
The Company and its subsidiaries lease numerous manufacturing,
warehousing, office and headquarters facilities. The facilities vary in size and
have leases expiring at various times, subject, in certain instances, to renewal
options. A subsidiary of the Company also leases space in New York, New York for
corporate and other activities (approximately 29,800 square feet). See Notes to
Consolidated Financial Statements.
Item 3. Legal Proceedings.
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The Company and its subsidiaries are parties to legal proceedings that
are considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position or
liquidity.
23
The Company is a defendant in Special Situations Fund III, L.P., et al
v. Leucadia National Corporation, et al, a consolidated action involving a
petition for appraisal and a class action pending in the Delaware Chancery Court
related to our 2005 acquisition of the minority interest in MK Resources Company
("MK Resources"). The pending appraisal petition seeks a judicial determination
of the fair value of approximately 3,979,400 shares of MK Resources' common
stock as of August 19, 2005, the date of the merger of one of our subsidiaries
into MK Resources. The class action complaint seeks compensatory damages in an
unspecified amount, costs, disbursements and any further relief that the court
may deem just and proper, and in the alternative, seeks rescissory damages, in
each case taking into account the $1.27 per share consideration paid to the
minority stockholders of MK Resources in the merger. Based on discovery to date,
we understand that the plaintiffs believe that the fair value of each share of
MK Resources common stock at the date of the merger ranged from $4.75 to $10.16
per share (with respect to a total of approximately 10,500,000 shares), while we
believe that the fair value of each MK Resources share at that date was $0.57
per share.
The trial in this case is currently scheduled for March 12-16, 2007.
While there can be no assurance that the Company will prevail, the Company
believes that the material allegations of the complaints are without merit and
intends to defend these actions vigorously. While the Company does not believe
it is probable that a loss will be incurred, if the Company is unsuccessful in
this matter, an adverse determination could be material.
From time to time in the future the Company may also be named as a
defendant in other legal proceedings in the ordinary course of business which,
if determined adversely, could result in material liabilities that would have a
material adverse effect on our consolidated financial condition or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders.
------ ---------------------------------------------------
Not applicable.
Item 10. Executive Officers of the Registrant.
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All executive officers of the Company are elected at the organizational
meeting of the Board of Directors of the Company held annually and serve at the
pleasure of the Board of Directors. As of February 15, 2007, the executive
officers of the Company, their ages, the positions held by them and the periods
during which they have served in such positions were as follows:
Name Age Position with Leucadia Office Held Since
---- --- ---------------------- -----------------
Ian M. Cumming 66 Chairman of the Board June 1978
Joseph S. Steinberg 63 President January 1979
Thomas E. Mara 61 Executive Vice President May 1980;
and Treasurer January 1993
Joseph A. Orlando 51 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 52 Vice President and April 1996
Comptroller
Justin R. Wheeler 34 Vice President October 2006
Mr. Cumming has served as a director and Chairman of the Board of the
Company since June 1978 and as Chairman of the Board of FINOVA since August
2001. Mr. Cumming has also been a director of Skywest, Inc., a Utah-based
regional air carrier, since June 1986 and a director of HomeFed since May 1999.
He is also a member of Premier's Board of Managers since April 2006. Mr. Cumming
is also an alternate director of Fortescue should Mr. Steinberg be unavailable
to vote on Fortescue board matters.
Mr. Steinberg has served as a director of the Company since December 1978
and as President of the Company since January 1979. In addition, he has served
as a director of JII since June 1988, HomeFed since August 1998 (Chairman since
December 1999) and FINOVA since August 2001. He is also a member of Premier's
Board of Managers since April 2006. He has served as a director of Fortescue
since August 2006.
Mr. Mara joined the Company in April 1977 and was elected Vice President
of the Company in May 1977. He has served as Executive Vice President of the
Company since May 1980 and as Treasurer of the Company since January 1993. In
addition, he has served as a director and Chief Executive Officer of FINOVA
since September 2002, and as a director of Inmet since August 2005.
24
Mr. Orlando, a certified public accountant, has served as Chief Financial
Officer of the Company since April 1996 and as Vice President of the Company
since January 1994.
Ms. Lowenthal, a certified public accountant, has served as Vice
President and Comptroller of the Company since April 1996.
Mr. Wheeler joined the Company in March 2000, and has served in a variety
of capacities in the Company's subsidiaries and as Vice President of the Company
since October 2006.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
------- ----------------------------------------------------------------------
Issuer Purchases of Equity Securities.
--------------------------------------
The common shares of the Company are traded on the NYSE under the symbol
LUK. The following table sets forth, for the calendar periods indicated, the
high and low sales price per common share on the consolidated transaction
reporting system, as reported by the Bloomberg Professional Service provided by
Bloomberg L.P.
Common Share
------------
High Low
---- ---
2005
----
First Quarter $23.33 $16.20
Second Quarter 20.61 16.46
Third Quarter 22.46 18.90
Fourth Quarter 24.64 20.05
2006
----
First Quarter $29.93 $23.26
Second Quarter 32.62 27.67
Third Quarter 29.31 25.07
Fourth Quarter 29.35 25.52
2007
----
First Quarter (through February 15, 2007) $28.75 $26.52
As of February 15, 2007, there were approximately 2,684 record holders of
the common shares.
On a split adjusted basis, the Company paid cash dividends of $0.25 per
common share in 2006 and $.125 per common share in 2005 and 2004. The payment of
dividends in the future is subject to the discretion of the Board of Directors
and will depend upon general business conditions, legal and contractual
restrictions on the payment of dividends and other factors that the Board of
Directors may deem to be relevant.
In connection with the declaration of dividends or the making of
distributions on, or the purchase, redemption or other acquisition of common
shares, the Company is required to comply with certain restrictions contained in
certain of its debt instruments. For further information, see Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in this Report.
Certain subsidiaries of the Company have significant NOLs and other tax
attributes, the amount and availability of which are subject to certain
qualifications, limitations and uncertainties. In order to reduce the
possibility that certain changes in ownership could result in limitations on the
use of the Company's tax attributes, the Company's certificate of incorporation
contains provisions which generally restrict the ability of a person or entity
from acquiring ownership (including through attribution under the tax law) of
five percent or more of the common shares and the ability of persons or entities
now owning five percent or more of the common shares from acquiring additional
common shares. The restrictions will remain in effect until the earliest of (a)
December 31, 2024, (b) the repeal of Section 382 of the Internal Revenue Code
(or any comparable successor provision) or (c) the beginning of a taxable year
of the Company to which certain tax benefits may no longer be carried forward.
25
The Company's purchases of its common shares during the fourth quarter of 2006
were as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of
Shares Purchased Approximate
as Part of Dollar Value of
Publicly Shares that May
Total Number Average Announced Plans Yet Be Purchased
of Shares Price Paid or under the Plans
Purchased (1) Per Share Programs or Programs
------------- --------- --------- -----------
December 1 to December 31 5,526 $27.81 -- $ --
------------- ---------
Total 5,526 --
============= =========
(1) Consists of common shares received from an employee to exercise stock
options. Shares were valued at the market price at the date of the option
exercise.
The Board of Directors from time to time has authorized acquisitions of
the Company's common shares. In December 1999, the Company's Board of Directors
increased to 6,000,000 the maximum number of shares that the Company is
authorized to purchase. At December 31, 2006, the Company is authorized to
repurchase 1,452,393 common shares.
Equity Compensation Plan Information
The following table summarizes information regarding the Company's equity
compensation plans as of December 31, 2006. All outstanding awards relate to the
Company's common shares.
Number of securities
remaining available
for future issuance
Number of securities Weighted-average under equity
to be issued upon exercise price of compensation plans
exercise of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
------------- ------------------------------- -------------------- -----------------------
Equity compensation
plans approved by
security holders 6,658,250 $25.87 1,516,150
Equity compensation
plans not approved
by security holders -- -- -
--------- ------ ---------
Total 6,658,250 $25.87 1,516,150
========= ====== =========
26
Stockholder Return Performance Chart
------------------------------------
Set forth below is a chart comparing the cumulative total stockholder
return on our common shares against the cumulative total return of the Standard
& Poor's 500 Stock Index, the Standard & Poor's 500 Telecommunication Services
Sector Index (our previous industry index) and the Standard & Poor's 1500
Industrial Conglomerates Index (our new industry index) for the period
commencing December 31, 2001 to December 31, 2006. Index data was furnished by
Standard & Poor's Compustat Services, Inc. We no longer will use the Standard &
Poor's 500 Telecommunication Services Sector Index because we no longer own any
significant telecommunications assets and instead will use the S&P 1500
Industrial Conglomerates Index as we believe it is more representative of our
current operations. The chart assumes that $100 was invested on December 31,
2001 in each of our common stock, the S&P 500 Index, the S&P Telecommunication
Services Sector Index and the S&P 1500 Industrial Conglomerates Index and that
all dividends were reinvested.
Total Return To Shareholders
(Includes reinvestment of dividends)
ANNUAL RETURN PERCENTAGE
Years Ending
-------------------------------------------------------
Company / Index Dec02 Dec03 Dec04 Dec05 Dec06
----------------------------------- --------- -------- ------ ------ -------
Leucadia National Corp 30.10 24.23 51.53 3.00 19.89
S&P 500 Index -22.10 28.68 10.88 4.91 15.79
S&P 1500 Industrial Conglomerates -40.24 34.88 19.15 -3.70 8.69
S&P 500 Telecommunication Services -34.11 7.08 19.85 -5.63 36.80
INDEXED RETURNS
Years Ending
----------------------------------------------------------------------
Base
Period
Company / Index Dec01 Dec02 Dec03 Dec04 Dec05 Dec06
----------------------------------- ----------- --------- -------- ------ ------ -------
Leucadia National Corp 100 130.10 161.62 244.91 252.26 302.43
S&P 500 Index 100 77.90 100.25 111.15 116.61 135.03
S&P 1500 Industrial Conglomerates 100 59.76 80.60 96.04 92.49 100.52
S&P 500 Telecommunication Services 100 65.89 70.56 84.57 79.81 109.18
Item 6. Selected Financial Data.
------ -----------------------
The following selected financial data have been summarized from the
Company's consolidated financial statements and are qualified in their entirety
by reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations of this Report.
Year Ended December 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues and other income (b) $ 862,672 $ 689,883 $ 379,566 $ 242,614 $ 235,157
Expenses 728,852 555,448 272,742 248,525 274,301
Income (loss) from continuing operations before income
taxes, minority expense of trust preferred securities
and equity in income (losses) of associated companies 133,820 134,435 106,824 (5,911) (39,144)
Income from continuing operations before minority
expense of trust preferred securities and equity in
income (losses) of associated companies (c) 92,049 1,265,473 127,368 28,456 104,931
Minority expense of trust preferred securities, net of
taxes -- -- -- (2,761) (5,521)
Equity in income (losses) of associated companies, net
of taxes 37,720 (45,133) 76,479 76,947 54,712
Income from continuing operations 129,769 1,220,340 203,847 102,642 154,122
Income (loss) from discontinued operations, including
gain on disposal, net of taxes 59,630 415,701 (58,347) (5,588) 7,501
Net income 189,399 1,636,041 145,500 97,054 161,623
27
Year Ended December 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(In thousands, except per share amounts)
Per share:
Basic earnings (loss) per common share:
Income from continuing operations $ .60 $ 5.66 $ .96 $ .56 $ .93
Income (loss) from discontinued operations,
including gain on disposal .28 1.93 (.28) (.03) .04
------ ------ ----- ----- -----
Net income $ .88 $ 7.59 $ .68 $ .53 $ .97
====== ====== ===== ===== =====
Diluted earnings (loss) per common share:
Income from continuing operations $ .60 $ 5.34 $ .93 $ .55 $ .92
Income (loss) from discontinued operations,
including gain on disposal .25 1.80 (.26) (.03) .04
------ ------ ----- ----- -----
Net income $ .85 $ 7.14 $ .67 $ .52 $ .96
====== ====== ===== ===== =====
At Ended December 31,
--------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 2,657,021 $ 2,687,846 $ 2,080,309 $ 1,403,619 $ 1,043,471
Total assets 5,303,824 5,260,884 4,800,403 4,397,164 2,541,778
Debt, including current maturities 1,159,461 1,162,382 1,131,922 682,135 233,073
Customer banking deposits -- -- 24,591 145,532 392,904
Shareholders' equity 3,893,275 3,661,914 2,258,653 2,134,161 1,534,525
Book value per common share $18.00 $16.95 $10.50 $10.05 $ 8.58
Cash dividends per common share $ .25 $ .13 $ .13 $ .08 $ .08
(a) Subsidiaries are reflected above as consolidated entities from the date of
acquisition as follows: Sangart, November 2005; and Idaho Timber, May 2005.
For additional information, see Note 3 of Notes to Consolidated Financial
Statements.
(b) Includes net securities gains (losses) of $117,159,000, $208,816,000,
$136,564,000, $9,928,000, and $(37,066,000) for the years ended December
31, 2006, 2005, 2004, 2003 and 2002, respectively.
(c) During 2005, the Company's revised projections of future taxable income
enabled it to conclude that it is more likely than not that it will have
future taxable income sufficient to realize a portion of the Company's net
deferred tax asset; accordingly, $1,135,100,000 of the deferred tax
valuation allowance was reversed as a credit to income tax expense. As a
result of the favorable resolution of various state and federal income tax
contingencies, the income tax provision reflects a benefit of approximately
$8,000,000 for 2006, $27,300,000 for 2004, $24,400,000 for 2003, and
$120,000,000 for 2002.
Item 7. Management's Discussion and Analysis of Financial Condition and
------ ---------------------------------------------------------------
Results of Operations.
----------------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
Liquidity and Capital Resources
28
Parent Company Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its direct subsidiaries, cash and
cash equivalents and other non-controlling investments in debt and equity
securities. The Parent continuously evaluates the retention and disposition of
its existing operations and investments and investigates possible acquisitions
of new businesses in order to maximize shareholder value. Accordingly, further
acquisitions, divestitures, investments and changes in capital structure are
possible. Its principal sources of funds are its available cash resources,
liquid investments, bank borrowings, public and private capital market
transactions, repayment of subsidiary advances, funds distributed from its
subsidiaries as tax sharing payments, management and other fees, and borrowings
and dividends from its subsidiaries.
In addition to cash and cash equivalents, the Company also considers
investments classified as current assets and investments classified as
non-current assets on the face of its consolidated balance sheet as being
generally available to meet its liquidity needs. Securities classified as
current and non-current investments are not as liquid as cash and cash
equivalents, but they are generally easily convertible into cash within a short
period of time. As of December 31, 2006, the sum of these amounts aggregated
$2,657,000,000. However, since $422,600,000 of this amount is pledged as
collateral pursuant to various agreements, represents investments in non-public
securities or is held by subsidiaries that are party to agreements which
restrict the Company's ability to use the funds for other purposes (including
the Inmet shares), the Company does not consider those amounts to be available
to meet the Parent's liquidity needs. The $2,234,400,000 that is available is
comprised of cash and short-term bonds and notes of the U.S. Government and its
agencies, U.S. Government-Sponsored Enterprises and other publicly traded debt
and equity securities. The investment income realized from the Parent's cash,
cash equivalents and marketable securities is used to meet the Parent company's
short-term recurring cash requirements, which are principally the payment of
interest on its debt and corporate overhead expenses.
The Parent's only long-term cash requirement is to make principal
payments on its long-term debt ($923,200,000 principal outstanding as of
December 31, 2006), of which $475,000,000 is due in 2013, $350,000,000 is due in
2014 and $98,200,000 is due in 2027. Historically, the Parent has used its
available liquidity to make acquisitions of new businesses and other
investments, but, except as disclosed in this Report, the timing of any future
investments and the cost can not be predicted. Should the Company require
additional liquidity for an investment or any other purpose, the Parent also has
an unsecured bank credit facility of $100,000,000 that matures in 2011 and bears
interest based on the Eurocurrency Rate or the prime rate. No amounts are
currently outstanding under the bank credit facility. In addition, based on
discussions with commercial and investment bankers, the Company believes that it
has the ability to raise additional funds under acceptable conditions for use in
its existing businesses or for appropriate investment opportunities. The
Parent's senior debt obligations are rated two levels below investment grade by
Moody's Investors Services and Standard & Poor's, and one level below investment
grade by Fitch Ratings. Ratings issued by bond rating agencies are subject to
change at any time.
The Company and Jefferies & Company, Inc. ("Jefferies") have entered into
an agreement to expand and restructure the Company's equity investment in JPOF
II, one of several entities managed by Jefferies that invests capital in
Jefferies' high yield trading business. Pursuant to an executed agreement, the
Company would increase its investment to $600,000,000 (requiring up to an
additional estimated $500,000,000 in cash), Jefferies would increase its
investment to the same level as the Company, and this new venture would provide
for additional capital investments from passive investors of up to $800,000,000
in the aggregate over time. Jefferies will also receive additional securities in
the new venture entitling it to 20% of the profits. Jefferies and the Company
would each have the right to nominate two of a total of four directors to the
new venture's board, and each would own 50% of the voting securities. The new
venture will be a registered broker-dealer engaged in the secondary sales and
trading of high yield securities and special situation securities formerly
conducted by Jefferies, including bank debt, post-reorganization equity, equity,
equity derivatives, credit default swaps and other financial instruments. It
will commit capital to the market by making markets in high yield and distressed
securities and will invest in and provide research coverage on these types of
securities. Commencement of the investment is subject to the receipt of
regulatory approvals and certain other matters.
29
The Company is currently considering raising approximately $500,000,000 in
debt financing through a private placement of its senior notes. The senior notes
are expected to have substantially similar terms to its existing series of 7%
Senior Notes due 2013 other than the interest rate, call features and maturity
date, which is currently expected to be ten years from issuance. The net
proceeds from the senior notes financing, if completed, would be used in part to
fund a portion of the additional investment described above, with the balance to
be used for general corporate purposes, which may include working capital,
acquisitions, or other investment opportunities. The decision to proceed with
the private placement of new senior notes will be subject to market and other
conditions and available pricing. The senior notes, if issued, have not and will
not be registered under the Securities Act and may not be offered or sold in the
United States absent registration or an applicable exemption from the
registration requirements.
In February 2006, Square 711, a 90% owned subsidiary of the Company,
completed the sale of 8 acres of unimproved land in Washington, D.C. The Company
received net cash proceeds of approximately $75,700,000, and recorded a pre-tax
gain of $48,900,000.
In July 2006, the Company sold Symphony to RehabCare Group, Inc., for
approximately $107,000,000. After satisfaction of Symphony's outstanding credit
agreement by the buyer ($31,700,000 at date of sale) and certain sale related
obligations, the Company realized net cash proceeds of $62,300,000 and recorded
a pre-tax gain on sale of discontinued operations of $53,300,000.
In September 2006, the Company sold ATX to Broadview Networks Holdings,
Inc. for aggregate cash consideration of approximately $85,700,000, and recorded
a pre-tax gain on sale of discontinued operations of $41,600,000.
In the second quarter of 2006, the Company acquired a 30% limited
liability company interest in Goober for aggregate consideration of $60,000,000,
excluding expenses, and agreed to lend to Goober, on a secured basis, up to
$126,000,000 (all of which was loaned at December 31, 2006) to finance new rig
equipment purchases and construction costs and to repay existing debt. In
January 2007, the loan facility was further amended to increase the interest
rate on the facility to LIBOR plus 5%, and to provide Goober with an additional
secured credit facility for up to $45,000,000 at an interest rate of LIBOR plus
10%. In addition, the Company increased its equity interest in Goober to 42% for
an additional equity investment of $25,000,000. The additional funding was
required primarily due to increased raw material and labor costs to construct
the new rigs and working capital needs due to delays in rig construction. The
Company's investment in Goober is classified as an investment in an associated
company.
During 2006, the Company indirectly acquired a controlling voting
interest in Premier for an aggregate purchase price of $90,800,000, excluding
expenses. The Company owns approximately 46% of the common units of Premier and
all of Premier's preferred units, which accrue an annual preferred return of
17%. The Company also acquired Premier's junior subordinated note due August
2012, with an outstanding balance at acquisition of $13,400,000, and has made an
$8,100,000 12% loan to Premier that matures in May 2007. All of Premier's equity
interests are pledged to secure repayment of the Premier Notes with an
outstanding principal amount of $160,000,000. In addition, the Company agreed to
provide up to $40,000,000 of construction financing to Premier's general
contractor by purchasing the contractor's receivables from Premier if the
receivables are more than ten days past due ($11,300,000 is outstanding at
December 31, 2006). At acquisition, the Company consolidated Premier as a result
of its controlling voting interest.
Premier owns the Hard Rock Hotel & Casino Biloxi, located in Biloxi,
Mississippi, which was severely damaged by Hurricane Katrina and which is
currently being rebuilt. Prior to Hurricane Katrina, Premier purchased a
comprehensive blanket insurance policy providing up to $181,100,000 in coverage
for damage to real and personal property, including business interruption
coverage. Premier has received payments from various insurance carriers
aggregating $160,900,000 with respect to $168,200,000 face amount of coverage;
the remaining $12,900,000 face amount of coverage has not been settled and is
currently in litigation. All insurance settlements have been placed on deposit
into restricted accounts under the control of the indenture trustee of the
Premier Notes. Premier believes that the funds in the restricted accounts
together with permitted equipment financing will be sufficient to rebuild the
Hard Rock Biloxi similar to its condition immediately preceding Hurricane
Katrina.
30
On September 19, 2006, Premier and its subsidiary filed voluntary
petitions for reorganization under chapter 11 of title 11 of the Bankruptcy
Code. Premier filed its petitions in order to seek the Court's assistance in
gaining access to Hurricane Katrina-related insurance proceeds which had been
denied to Premier by its pre-petition secured bondholders. Premier continues to
operate its business as "debtors in possession" under the jurisdiction of the
Court and in accordance with the applicable provisions of the Bankruptcy Code
and orders of the Court. The Company deconsolidated Premier effective with the
filing of the voluntary petitions, and has classified its net investment in
Premier as an investment in an associated company ($125,600,000 as of December
31, 2006, including all loans and equity interests). The Company has also
committed to provide up to $180,000,000 to finance Premier's plan of
reorganization, which would principally be used to pay-off the Premier Notes.
Upon its emergence from bankruptcy proceedings, the Company expects that Premier
will be accounted for as a consolidated subsidiary.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino,
which was a facility built on floating barges, and caused significant damage to
the hotel and related structures. The threat of hurricanes remains a risk to the
existing facilities and to the new casino, which will be constructed over water
on concrete pilings that will greatly improve the structural integrity of the
facility. In July 2006, Premier purchased a new insurance policy providing up to
$149,300,000 in coverage for damage to real and personal property and up to the
lesser of six months or $30,000,000 of business interruption and delayed opening
coverage. The coverage is syndicated through several insurance carriers, each
with an A.M. Best rating of A- (Excellent) or better. The policy provides
coverage for the existing structures, as well as for the repair and rebuild of
the hotel, low rise building and parking garage and the construction of the new
casino.
Although the insurance policy is an "all risk" policy, weather
catastrophe occurrence ("WCO"), which is defined to include damage caused by a
named storm, is limited to $50,000,000 with a deductible equal to the greater of
$7,000,000 or 5% of total insured values at risk. WCO coverage is subject to
mandatory reinstatement of coverage for an additional pre-determined premium.
Premier's current insurance policy expires in July 2007; Premier expects
it will purchase new insurance coverage that will be in effect for the balance
of the 2007 hurricane season. Premiums for WCO policies have increased
dramatically as a result of Hurricane Katrina, and the amount of coverage that
can be purchased has also been reduced as insurance companies seek to reduce
their exposure to such events. Premier cannot currently estimate how much
insurance will be available to it at an acceptable premium.
The Company invested $408,000,000 in Fortescue's Pilbara iron ore and
infrastructure project in Western Australia, including expenses. In exchange for
its cash investment, the Company received 26,400,000 common shares of Fortescue,
representing approximately 9.99% of the outstanding Fortescue common stock, and
a 13 year, $100,000,000 note of FMG. Interest on the note is calculated as 4% of
the revenue, net of government royalties, invoiced from the iron ore produced
from the project's Cloud Break and Christmas Creek areas only. The note is
unsecured and subordinate to the project's senior secured debt. Fortescue is a
publicly traded company on the Australian Stock Exchange, and the shares
acquired by the Company may be sold without restriction. At the date of
acquisition, the Company's investment in Fortescue's common shares was recorded
at its aggregate fair value, based on the closing price of Fortescue's common
shares on that date. Subsequent to acquisition, the Company's investment in the
Fortescue common shares are classified as a non-current available for sale
investment and carried at market value as of each balance sheet date. At
December 31, 2006, the market value of the Fortescue common shares was
$276,300,000.
For accounting purposes, the Company bifurcated its remaining Fortescue
investment into a 13 year zero-coupon note and a prepaid mining interest. The
zero-coupon note was recorded at an estimated initial fair value of $21,600,000,
representing the present value of the principal amount discounted at 12.5%. The
prepaid mining interest of $184,300,000 has been classified with other
non-current assets, and will be amortized to expense as the 4% of revenue is
earned.
Over the past few years, the Company has invested in various limited
partnerships or limited liability companies that are engaged in investing and/or
securities transactions activities. These investments include Safe Harbor
($50,000,000 invested in 2006) and Wintergreen (a total of $50,000,000 invested
during 2005 and 2006), each of which is classified as an investment in
associated companies.
31
In January 2007, the Company entered into an agreement to acquire a 75%
interest in the telecommunications business of Telco Group, Inc. ("Telco") for
$120,000,000 in cash, subject to working capital adjustments. Consummation of
the transaction, which is subject to customary closing conditions including
receipt of regulatory approvals, is expected to occur during the first half of
2007. Telco, which operates under the brand name STi Prepaid and variations
thereof, is a provider of international prepaid phone cards, prepaid wireless
and other telecommunications services in the U.S.
The Company and certain of its subsidiaries have substantial NOLs and
other tax attributes. The amount and availability of the NOLs and other tax
attributes are subject to certain qualifications, limitations and uncertainties.
In order to reduce the possibility that certain changes in ownership could
impose limitations on the use of the NOLs, the Company's certificate of
incorporation contains provisions which generally restrict the ability of a
person or entity from acquiring ownership (including through attribution under
the tax law) of five percent or more of the common shares and the ability of
persons or entities now owning five percent or more of the common shares from
acquiring additional common shares. The restrictions will remain in effect until
the earliest of (a) December 31, 2024, (b) the repeal of Section 382 of the
Internal Revenue Code (or any comparable successor provision) or (c) the
beginning of a taxable year of the Company to which certain tax benefits may no
longer be carried forward. For more information about the NOLs and other tax
attributes, see Note 16 of Notes to Consolidated Financial Statements.
As of February 15, 2007, the Company is authorized to repurchase
1,452,393 common shares. Such purchases may be made from time to time in the
open market, through block trades or otherwise. Depending on market conditions
and other factors, such purchases may be commenced or suspended at any time
without prior notice. Except in connection with employees using common shares to
pay the exercise price of employee stock options, the Company has not
repurchased any common shares during the three year period ended December 31,
2006.
Consolidated Statements of Cash Flows
As discussed above, the Company relies on the Parent's available
liquidity to meet its short-term and long-term needs, and to make acquisitions
of new businesses and investments. Except as otherwise disclosed herein, the
Company's operating businesses do not generally require material funds from the
Parent to support their operating activities, and the Parent does not depend on
positive cash flow from its operating segments to meet its liquidity needs. The
components of the Company's operating businesses and investments change
frequently as a result of acquisitions or divestitures, the timing of which is
impossible to predict but which often have a material impact on the Company's
consolidated statements of cash flows in any one period. Further, the timing and
amounts of distributions from certain of the Company's investments in
partnerships accounted for under the equity method are generally outside the
control of the Company. As a result, reported cash flows from operating,
investing and financing activities do not generally follow any particular
pattern or trend, and reported results in the most recent period should not be
expected to recur in any subsequent period.
Net cash provided by operating activities decreased by $229,600,000 in
2006 as compared to the prior year, due principally to no 2006 cash flows from
WilTel, which was sold in December 2005, reduced distributions of earnings from
associated companies, reduced funds generated from activity in the trading
portfolio, payment of incentive compensation and increased defined benefit
pension plan contributions. In addition, funds provided by operating activities
during 2006 reflect a $19,400,000 use of funds by Sangart, a development stage
company which became a subsidiary in November 2005. During 2006, cash provided
by operating activities reflect the collection of the balance of certain
receivables from AT&T Inc. ($198,500,000). The AT&T receivables resulted from a
termination agreement entered into between WilTel and its largest customer
during 2005; however, these receivables were not included with the assets
purchased by Level 3. WilTel's cash flow from operating activities for the 2005
period prior to its sale was $278,500,000. In 2006, distributions from
associated companies principally include earnings distributed by EagleRock
($48,200,000) and JPOF II ($23,600,000). In 2005, distributions from associated
companies principally resulted from JPOF II ($16,200,000) and the sale of Union
Square, two entities in which the Company had non-controlling equity interests.
In May 2005, these entities sold their respective interests in an office complex
located on Capitol Hill in Washington, D.C.; the Company's share of the net
proceeds was $73,200,000. Contributions to the defined benefit pension plans
were $50,100,000 in 2006 as compared to $21,800,000 in 2005. The current status
of the Company's frozen defined benefit pension plans is more fully discussed
below.
32
Net cash provided by operating activities increased by $252,700,000 in
2005 as compared to 2004, due principally to increased distributions of earnings
from associated companies, a decrease in the size of the Company's investment in
its trading portfolio and increased cash flow from the Company's operating
units, principally WilTel and the manufacturing businesses. The increased cash
flow from the Company's manufacturing units reflects the 2005 acquisition of
Idaho Timber, and increased revenues at Conwed Plastics resulting from an
acquisition and growth in most of its markets. The increased distributions from
associated companies principally resulted from the proceeds received from Union
Square, which is discussed above. WilTel's cash flow from operating activities
(which increased by $67,100,000 in 2005 as compared to 2004) did not increase
the liquidity available to the Parent (as defined above), since WilTel's debt
agreements prohibited the payment of dividends.
Net cash flows used for investing activities were $186,200,000 in 2006
and $16,700,000 in 2004; net cash flows provided by investing activities were
$22,600,000 in 2005. As a result of the sale of WilTel, the Company's use of
funds for property, equipment and leasehold improvements declined significantly
in 2006; funds used for WilTel's acquisition of property, equipment and
leasehold improvements totaled $96,100,000 in 2005 and $73,200,000 in 2004.
During 2006, funds provided by the disposal of real estate and other assets
include the sales of Square 711 discussed above, and two associated companies.
The Company received aggregate cash proceeds of $56,400,000 from the sale of its
equity interest in and loan repayment by two associated companies and recorded a
pre-tax gain totaling $27,500,000, which is reflected in investment and other
income. During 2004, funds provided by the disposal of real estate and other
assets include the sales of corporate aircraft ($38,800,000) and two Florida
residential lot development projects ($56,700,000) that have been substantially
completed. Pursuant to the indenture governing the Premier Notes, Premier was
required to put insurance proceeds it collected into restricted accounts, which
is the principal reason for the net change in restricted cash during 2006.
Premier cash flow activity is reflected in the Company's 2006 consolidated
statement of cash flows only during the period it was a consolidated subsidiary
(April through September 2006).
During the 2006 period, proceeds from the disposal of discontinued
operations net of expenses and cash sold principally reflect the sales of
Symphony ($62,900,000) and ATX ($74,300,000), net of a payment that resolved
WilTel's working capital adjustment ($27,000,000). During 2005, proceeds from
the disposal of discontinued operations net of expenses and cash sold
principally reflect the sales of WilTel ($357,100,000) and the Waikiki Beach
hotel ($95,200,000). During 2006, acquisitions, net of cash acquired principally
include Premier ($105,700,000); during 2005, acquisitions, net of cash acquired
principally include ATX ($12,500,000), Idaho Timber ($133,500,000) and NSW, LLC
U.S. ("NSW"), an acquisition by Conwed Plastics ($26,600,000). During 2004, net
cash provided from principal collections on loan receivables and from the sale
of substantially all of the Company's remaining consumer loan portfolio
aggregated $199,000,000; as discussed below, banking and lending operations have
been in run-off for the past few years. Investments in associated companies
include Goober ($188,000,000), Safe Harbor ($50,000,000), Wintergreen
($30,000,000), CLC ($12,100,000) and Premier ($9,000,000) in 2006, Wintergreen
($20,000,000) in 2005 and Pershing Square, L.P. ("Pershing") ($50,000,000) in
2004.
Net cash used for financing activities was $5,200,000 in 2006 and
$442,700,000 in 2005. During 2005, funds were used to retire customer banking
deposits of the banking and lending operations as they became due and the
remaining deposits were sold. Issuance of long-term debt during 2006 and 2005
principally relates to repurchase agreements, which are discussed below. The
reduction of long-term debt during 2006 includes the repayment of debt of Square
711 ($32,000,000), which was sold, and the maturity of the Company's 7 7/8%
Senior Subordinated Notes ($21,700,000). The reduction of long-term debt during
2005 includes the repayment of $442,500,000 of debt of operations sold (WilTel
and Waikiki Beach hotel) and the maturity of the Company's 8 1/4% Senior
Subordinated Notes ($19,100,000).
During 2004, net cash provided by financing activities was $220,500,000.
Funds were used to retire customer banking deposits of the banking and lending
operations as they became due. In 2004, the Company sold $100,000,000 principal
amount of its 7% Senior Notes and $350,000,000 principal amount of its 3 3/4%
Convertible Senior Subordinated Notes. Proceeds received from the sale of all
the Notes can be used by the Company for investing or general corporate
purposes. Issuance of common shares for all periods presented principally
reflects the exercise of employee stock options and, in 2004, the exercise of
warrants to purchase common shares.
33
Debt due within one year includes $181,800,000 and $92,100,000 as of
December 31, 2006 and December 31, 2005, respectively, relating to repurchase
agreements of one of the Company's subsidiaries. These fixed rate repurchase
agreements have a weighted average interest rate of approximately 5.3%, mature
at various dates through June 2007 and are secured by non-current investments
with a carrying value of $182,900,000 at December 31, 2006.
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by
certain of its corporate aircraft, of which $41,300,000 is currently
outstanding. Capital leases of another subsidiary aggregating $9,400,000 consist
of a sale-leaseback transaction related to other corporate aircraft. The Parent
company has guaranteed these financings.
The Company's debt instruments require maintenance of minimum Tangible
Net Worth, limit distributions to shareholders and limit Indebtedness and Funded
Debt (as such terms are defined in the agreements). In addition, the debt
instruments contain limitations on investments, liens, contingent obligations
and certain other matters. The Company is in compliance with all of these
restrictions, and the Company has the ability to incur additional indebtedness
or make distributions to its shareholders and still remain in compliance with
these restrictions. Certain of the debt instruments of subsidiaries of the
Company require that collateral be provided to the lender; principally as a
result of such requirements, the assets of subsidiaries which are subject to
limitations on transfer of funds to the Company were approximately $247,500,000
at December 31, 2006. For more information, see Note 12 of Notes to Consolidated
Financial Statements.
As shown below, at December 31, 2006, the Company's contractual cash
obligations totaled $1,756,719,000.
Payments Due by Period (in thousands)
---------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
---------------------------- ----- ---- --------- --------- -------------
Long-term debt $1,159,461 $184,815 $ 8,630 $ 37,025 $ 928,991
Estimated interest expense on long-term
debt 513,945 61,750 120,262 117,525 214,408
Estimated payments related to derivative
financial instruments 19,257 5,646 10,421 3,190 --
Planned funding of pension and
postretirement obligations 44,074 405 38,562 795 4,312
Operating leases, net of sublease
income 19,482 3,658 5,673 3,662 6,489
Asset purchase obligations 500 282 218 -- --
---------- -------- --------- --------- ----------
Total Contractual Cash Obligations $1,756,719 $256,556 $ 183,766 $ 162,197 $1,154,200
========== ======== ========= ========= ==========
The estimated interest expense on long-term debt includes estimated
interest related to variable rate debt which the Company determined using rates
in effect at December 31, 2006. Estimated payments related to a currency swap
agreement are based on the currency rate in effect at December 31, 2006. Amounts
related to the Company's consolidated pension liability ($40,400,000) are
included in the table primarily during the 1-3 year period; however, the exact
timing of the cash payments is uncertain.
34
At December 31, 2006, the Company had recorded a liability of
$40,400,000 on its consolidated balance sheet for its unfunded defined benefit
pension plan obligations. This amount represents the difference between the
present value of amounts owed to current and former employees (referred to as
the projected benefit obligation) and the market value of plan assets set aside
in segregated trust accounts. Since the benefits in these plans have been
frozen, future changes to the benefit obligation are expected to principally
result from benefit payments, differences between actuarial assumptions and
actual experience and interest rates.
During 2006, the Company contributed $50,100,000 to these plans, and
expects to make substantial additional contributions to the segregated trust
accounts in the future to reduce its plan liabilities and reduce administrative
and insurance costs associated with the plans. The tax deductibility of these
contributions is not a primary consideration, principally due to the
availability of the Company's NOLs to otherwise reduce taxable income. The
timing and amount of additional contributions are uncertain; however, the
Company believes it will make substantial additional contributions over the next
few years to reduce, but not to entirely eliminate, its defined pension benefit
plan liability.
The Company maintained defined benefit pension plans covering certain
operating units prior to 1999, and WilTel also maintained defined pension
benefit plans that were not transferred in connection with the sale of WilTel.
As of December 31, 2006, certain amounts for these plans are reflected
separately in the table below (dollars in thousands):
The Company's WilTel's
Plans Plans
----- -----
Projected benefit obligation $54,876 $ 176,724
Funded status - balance sheet liability at December 31, 2006 7,223 33,134
Deferred losses included in other comprehensive income 19,053 24,294
Discount rate used to determine the projected benefit obligation 4.90% 5.70%
Calculations of pension expense and projected benefit obligations are
prepared by actuaries based on assumptions provided by management. These
assumptions are reviewed on an annual basis, including assumptions about
discount rates, interest credit rates and expected long-term rates of return on
plan assets. For the Company's plans, a discount rate was selected to result in
an estimated projected benefit obligation on a plan termination basis, using
current rates for annuity settlements and lump sum payments weighted for the
assumed elections of participants. For the WilTel plans, the timing of expected
future benefit payments was used in conjunction with the Citigroup Pension
Discount Curve to develop a discount rate that is representative of the high
quality corporate bond market, adjusted for current rates which might be
available for annuity settlements.
These discount rates will be used to determine pension expense in 2007.
Holding all other assumptions constant, a 0.25% change in these discount rates
would affect pension expense by $600,000 and the benefit obligation by
$9,300,000.
The deferred losses in other comprehensive income primarily result from
changes in actuarial assumptions, including changes in discount rates, changes
in interest credit rates and differences between the actual and assumed return
on plan assets. Deferred losses are amortized to expense if they exceed 10% of
the greater of the projected benefit obligation or the market value of plan
assets as of the beginning of the year; such amount aggregated $20,200,000 at
December 31, 2006 for all plans. A portion of these excess deferred losses will
be amortized to expense during 2007, based on an amortization period of twelve
years.
The assumed long-term rates of return on plan assets are based on the
investment objectives of the specific plan, which are more fully discussed in
Note 17 of Notes to Consolidated Financial Statements. Differences between the
actual and expected rates of return on plan assets have not been material.
35
Off-Balance Sheet Arrangements
At December 31, 2006, the Company's off-balance sheet arrangements
consist of guarantees and letters of credit aggregating $61,600,000. Pursuant to
an agreement that was entered into before the Company sold CDS Holding
Corporation ("CDS") to HomeFed in 2002, the Company agreed to provide project
improvement bonds for the San Elijo Hills project. These bonds, which are for
the benefit of the City of San Marcos, California and other government agencies,
are required prior to the commencement of any development at the project. CDS is
responsible for paying all third party fees related to obtaining the bonds.
Should the City or others draw on the bonds for any reason, CDS and one of its
subsidiaries would be obligated to reimburse the Company for the amount drawn.
At December 31, 2006, the amount of outstanding bonds was $18,300,000,
$16,100,000 of which expires in 2007, $800,000 in 2008, $100,000 in 2009 and the
remainder in 2010. Subsidiaries of the Company have outstanding letters of
credit aggregating $12,700,000 at December 31, 2006, principally to secure
various obligations. Substantially all of these letters of credit expire before
2009.
As discussed above, the Company has also guaranteed 30% of the amounts
outstanding under CLC's $240,000,000 senior secured credit facility and CLC's
(euro)69,000,000 senior secured bridge credit facility. At December 31, 2006,
$74,200,000 was outstanding under the senior secured credit facility and
(euro)21,000,000 was outstanding under the senior secured bridge credit
facility; as a result, the Company's outstanding guaranty at that date was
$22,300,000 and (euro)6,300,000 ($8,300,000 at exchange rates in effect on
February 15, 2007), respectively.
Critical Accounting Estimates
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with GAAP. The preparation of these
financial statements requires the Company to make estimates and assumptions that
affect the reported amounts in the financial statements and disclosures of
contingent assets and liabilities. On an on-going basis, the Company evaluates
all of these estimates and assumptions. The following areas have been identified
as critical accounting estimates because they have the potential to have a
material impact on the Company's financial statements, and because they are
based on assumptions which are used in the accounting records to reflect, at a
specific point in time, events whose ultimate outcome won't be known until a
later date. Actual results could differ from these estimates.
Income Taxes - The Company records a valuation allowance to reduce its
deferred tax asset to the amount that is more likely than not to be realized. If
in the future the Company were to determine that it would be able to realize its
deferred tax asset in excess of its net recorded amount, an adjustment would
increase income in such period. Similarly, if in the future the Company were to
determine that it would not be able to realize all or part of its deferred tax
asset, an adjustment would be charged to income in such period. The
determination of the amount of the valuation allowance required is based, in
significant part, upon the Company's projection of future taxable income at any
point in time. The Company also records reserves for contingent tax liabilities
based on the Company's assessment of the probability of successfully sustaining
its tax filing positions.
During 2005, the Company's projections of future taxable income enabled
it to conclude that it is more likely than not that it will have future taxable
income sufficient to realize a portion of the Company's net deferred tax asset;
accordingly, $1,135,100,000 of the deferred tax valuation allowance was reversed
as a credit to income tax expense. The Company's conclusion that a portion of
the deferred tax asset is more likely than not to be realized is strongly
influenced by its historical ability to generate significant amounts of taxable
income. The Company's estimate of future taxable income considers all available
evidence, both positive and negative, about its current operations and
investments, includes an aggregation of individual projections for each material
operation and investment, and includes all future years that the Company
estimated it would have available net operating losses. The Company believes
that its estimate of future taxable income is reasonable but inherently
uncertain, and if its current or future operations and investments generate
taxable income greater than the projected amounts, further adjustments to reduce
the valuation allowance are possible. Conversely, if the Company realizes
unforeseen material losses in the future, or its ability to generate future
taxable income necessary to realize a portion of the deferred tax asset is
materially reduced, additions to the valuation allowance could be recorded. At
December 31, 2006, the balance of the deferred valuation allowance was
approximately $911,800,000.
36
Impairment of Long-Lived Assets - In accordance with Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), the Company evaluates its long-lived assets for impairment
whenever events or changes in circumstances indicate, in management's judgment,
that the carrying value of such assets may not be recoverable. When testing for
impairment, the Company groups its long-lived assets with other assets and
liabilities at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset group).
The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value.
The Company did not recognize any impairment losses on long-lived assets
during 2006; however, during 2005 an impairment loss of $42,400,000 was recorded
to reduce the carrying amount of WilTel's former headquarters facility to its
estimated fair value in connection with the sale of WilTel to Level 3
(classified with gain on disposal of discontinued operations). WilTel's former
headquarters building, including the adjacent parking garage, was not included
in the sale to Level 3 and has been retained by the Company. The Company
concluded that the change in the manner in which the asset was being used, from
a headquarters facility of an operating subsidiary to a property held for
investment, was a change in circumstances which indicated that the carrying
amount of the facility might not be recoverable.
Impairment of Securities - Investments with an impairment in value
considered to be other than temporary are written down to estimated fair value.
The write-downs are included in net securities gains in the consolidated
statements of operations. The Company evaluates its investments for impairment
on a quarterly basis.
The Company's determination of whether a security is other than
temporarily impaired incorporates both quantitative and qualitative information;
GAAP requires the exercise of judgment in making this assessment, rather than
the application of fixed mathematical criteria. The Company considers a number
of factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The Company's assessment involves a high degree of
judgment and accordingly, actual results may differ materially from the
Company's estimates and judgments. The Company recorded impairment charges for
securities of $12,900,000, $12,200,000 and $4,600,000 for the years ended
December 31, 2006, 2005 and 2004, respectively.
Business Combinations - At acquisition, the Company allocates the cost of
a business acquisition to the specific tangible and intangible assets acquired
and liabilities assumed based upon their relative fair values. Significant
judgments and estimates are often made to determine these allocated values, and
may include the use of independent appraisals, consider market quotes for
similar transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts
adjustments are recorded. Any excess of the cost of a business acquisition over
the fair values of the net assets and liabilities acquired is recorded as
goodwill which is not amortized to expense. Recorded goodwill of a reporting
unit is required to be tested for impairment on an annual basis, and between
annual testing dates if events or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its net book value.
Subsequent to the finalization of the purchase price allocation, any
adjustments to the recorded values of acquired assets and liabilities would be
reflected in the Company's consolidated statement of operations. Once final, the
Company is not permitted to revise the allocation of the original purchase
price, even if subsequent events or circumstances prove the Company's original
judgments and estimates to be incorrect. In addition, long-lived assets like
property and equipment, amortizable intangibles and goodwill may be deemed to be
impaired in the future resulting in the recognition of an impairment loss;
however, under GAAP the methods, assumptions and results of an impairment review
are not the same for all long-lived assets. The assumptions and judgments made
by the Company when recording business combinations will have an impact on
reported results of operations for many years into the future.
Purchase price allocations for all of the Company's recent acquisitions
have been finalized. Adjustments to the initial purchase price allocations were
not material.
37
Contingencies - The Company accrues for contingent losses when the
contingent loss is probable and the amount of loss can be reasonably estimated.
Estimates of the likelihood that a loss will be incurred and of contingent loss
amounts normally require significant judgment by management, can be highly
subjective and are subject to material change with the passage of time as more
information becomes available. As of December 31, 2006, the Company's accrual
for contingent losses was not material.
Results of Operations
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber for the year ended December
31, 2006 and from the date of acquisition (May 2005) through December 31, 2005
were $345,700,000 and $239,000,000, respectively; gross profits were $30,000,000
and $22,000,000, respectively; salaries and incentive compensation expenses were
$9,400,000 and $6,300,000, respectively; depreciation and amortization expenses
were $4,900,000 and $4,200,000, respectively; and pre-tax income was $12,000,000
and $8,200,000, respectively.
Idaho Timber's revenues weakened during 2006, reflecting lower average
selling prices and reduced shipment volume. This decline was principally due to
weakening demand resulting from reductions in housing starts and the abundant
supply of lumber in the marketplace. In October 2006, the trade dispute between
the U.S. and Canada over Canadian lumber imports was resolved and a new Softwood
Lumber Agreement became effective that restricts and imposes a tax on Canadian
lumber imports. Prior to the effective date of that agreement, imports from
Canada increased, which added to the oversupply in the market.
While raw material costs, the largest component of cost of sales
(approximately 84% of cost of sales), declined during 2006 due to the continued
decline in market conditions and the diminished uncertainty concerning the
impact of the Softwood Lumber Agreement, this reduction lagged behind the
reduction in selling prices. The difference between Idaho Timber's selling price
and raw material cost per thousand board feet (spread) is closely monitored, and
the rate of change in pricing and cost is typically not the same. During 2006,
spreads compressed negatively impacting gross profit and pre-tax results. With
the continued oversupply in the market, Idaho Timber intends to continue to
focus on developing new higher margin products, diversifying its supply chain,
improving cost control and solidifying customer and supplier relationships, in
an effort to maximize gross margins and pre-tax results.
Manufacturing - Conwed Plastics
Pre-tax income for Conwed Plastics was $17,900,000, $14,200,000 and
$7,900,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Its manufacturing revenues were $106,300,000, $93,300,000 and $64,100,000, and
gross profits were $34,400,000, $28,900,000 and $19,000,000 for the years ended
December 31, 2006, 2005 and 2004, respectively. Revenues increased by 14% in
2006, 46% in 2005 and 20% in 2004, each as compared to the prior year.
The increase in revenues in 2006 reflects $5,400,000 of increased
revenues from the acquisitions of NSW in February 2005 and Polynet in May 2006,
which increased the segment's product offerings and customer base. In addition,
2006 revenues reflect increases in the erosion control, carpet cushion and turf
reinforcement markets, partially reduced by a decline in the consumer products
market due to lower demand for certain products. These changes result from a
variety of factors including the impact of price increases implemented in 2005,
increased road construction and using a new distributor for certain products.
While the carpet cushion market continued to benefit from the previously strong
housing market through the first half of 2006, it experienced a reduction in
sales volume during the second half of the year resulting from a slowdown in
housing starts.
The increase in revenues in 2005 as compared to 2004 reflects NSW's
revenues since acquisition of $17,500,000, and increases in most of the
segment's markets. Sales increases resulted from a variety of factors including
the strong housing market, new products developed late in 2004, and the impact
of price increases implemented during the second half of 2004 and in the first
and fourth quarters of 2005.
Raw material costs increased by approximately 4% in 2006 as compared to
2005, and 19% in 2005 as compared to 2004; however, the segment was able to
increase selling prices in most markets, which, along with increased sales and
production volumes, resulted in greater gross margins in each period as compared
to the immediately preceding period. The primary raw material in Conwed
Plastics' products is a polypropylene resin, which is a byproduct of the oil
refining process, whose price tends to fluctuate with the price of oil. There is
relatively little direct labor or other raw material costs in the products. In
addition to managing resin purchases, Conwed Plastics also has initiatives to
reduce and/or reuse scrap, thereby increasing raw material utilization.
38
In addition, gross margin and pre-tax results for 2006 reflect $1,100,000
of greater amortization expense on intangible assets resulting from acquisitions
and depreciation expense. Pre-tax results for 2006 also reflect $1,900,000 of
higher salaries and incentive compensation expense than 2005, due principally to
greater pre-tax profits and increased headcount.
In 2005, gross margins and pre-tax results reflect $1,300,000 of greater
amortization expense on intangible assets resulting from acquisitions as
compared to 2004. In addition, pre-tax results for 2005 include higher salaries,
incentive compensation expense and sales commissions as compared to 2004,
primarily related to NSW.
Domestic Real Estate
Pre-tax income for the domestic real estate segment was $44,000,000,
$4,100,000 and $20,700,000 for the years ended December 31, 2006, 2005 and 2004,
respectively. Pre-tax results for the domestic real estate segment are largely
dependent upon the performance of the segment's operating properties, the
current status of the Company's real estate development projects and
non-recurring gains or losses recognized when real estate assets are sold. As a
result, pre-tax income for this segment for any particular year is not
predictable and does not follow any consistent pattern.
Pre-tax income for 2006 principally reflects the sale by Square 711,
which resulted in a pre-tax gain of $48,900,000, and the sale of other land
parcels in Utah for a pre-tax gain of $11,200,000. In addition, the Company
recognized pre-tax profit related to its 95-lot development project in South
Walton County, Florida of $3,600,000 and $6,600,000 for the years ended December
31, 2006 and 2005, respectively. Such amounts principally result from the
completion of certain required improvements to land previously sold. Pre-tax
results for 2006 reflect $8,100,000 of incentive compensation accruals related
to the Company's real estate development project in Myrtle Beach, South
Carolina.
In 2004, the Company sold 92 lots of its 95-lot development project in
South Walton County, Florida for aggregate sales proceeds of approximately
$50,000,000, recognized pre-tax profits of $15,800,000 and deferred recognition
of pre-tax profits of $10,200,000. In addition, revenues during 2004 reflect the
sale of certain unimproved land for cash proceeds of $8,800,000, which resulted
in a pre-tax gain of $7,600,000. Pre-tax results for 2004 also reflect due
diligence expenses for a real estate development project that the Company
decided not to develop.
Medical Product Development
Pre-tax losses (net of minority interest) for Sangart for the year ended
December 31, 2006 and from the date of acquisition through December 31, 2005
(Sangart was acquired in November 2005) were $21,100,000 and $1,400,000,
respectively. Sangart's losses for 2006 and for the period from acquisition
through December 31, 2005 reflect research and development costs of $16,500,000
and $600,000, respectively, and salaries and incentive compensation expenses of
$6,400,000 and $1,000,000, respectively.
As more fully discussed above, Sangart is a development stage company
that does not have any revenues from product sales. Since 2002, it has been
developing its current product candidate, Hemospan, and is currently conducting
clinical trials in the U.S. (a Phase II trial) and Europe (two Phase III
trials). It does not expect to complete its clinical trials until 2008, and if
they are successful it will then seek approval with the appropriate regulatory
authorities to market its product. Until such time, if ever, that Sangart
obtains regulatory approval for Hemospan, the Company will report losses from
this segment. U.S. or foreign regulatory agencies could also require Sangart to
perform more clinical trials, which could be both expensive and time consuming.
The Company is unable to predict with certainty when, if ever, it will report
operating profits for this segment.
When the Company increases its investment in Sangart, which it expects to
do in March 2007, the additional investment will be accounted for under the
purchase method of accounting. Under the purchase method, the price paid is
allocated to Sangart's individual assets and liabilities based on their relative
fair values; in Sangart's case, substantially all of the fair value of assets
acquired is initially allocated to research and development. However, since GAAP
does not permit the recognition of research and development as an asset under
the purchase method, any amounts initially allocated to research and development
are immediately expensed. These amounts are expected to be material.
39
Banking and Lending
As stated previously, the Company's banking and lending operations have
been in run-off, and during 2005 the Company's banking and lending subsidiary
filed a formal plan with the Office of the Comptroller of the Currency to
liquidate its operations, sold its remaining customer deposits and surrendered
its national bank charter. Pre-tax results for banking and lending operations of
$1,800,000, $1,400,000 and $22,000,000 for the years ended December 31, 2006,
2005 and 2004, respectively, have been classified with other operations. During
2004, the Company sold its subprime automobile and collateralized consumer loan
portfolios representing approximately 97% of its total outstanding loans (net of
unearned finance charges) and certain loan portfolios that had been
substantially written-off for aggregate pre-tax gains of $16,300,000, which is
reflected in investment and other income.
Corporate and Other Operations
Investment and other income increased in 2006 as compared to 2005
primarily due to greater interest income of $61,600,000, reflecting a larger
amount of invested assets and higher interest rates, a $27,500,000 gain from the
sales of two associated companies and $7,400,000 from the recovery of bankruptcy
claims. Investment and other income in 2005 includes a gain of $10,500,000 on
the sale of 70% of the Company's interest in CLC to Inmet.
Investment and other income increased in 2005 as compared to 2004
primarily due to the CLC gain, greater investment income of $24,200,000
reflecting a larger amount of invested assets and higher interest rates, and
increased sales at the wineries of $5,000,000. Investment and other income in
2004 reflects a pre-tax gain of $11,300,000 from the sale of two of the
Company's older corporate aircraft. Available corporate cash is generally
invested on a short-term basis until such time as investment opportunities
require an expenditure of funds.
Net securities gains for Corporate and Other Operations aggregated
$117,200,000, $208,800,000 and $136,100,000 for the years ended December 31,
2006, 2005 and 2004, respectively. The Company's net securities gains largely
reflect realized gains from the sale of publicly traded debt and equity
securities that had been classified as Corporate available for sale securities.
Included in net securities gains for 2006 is a gain of $37,400,000 from the sale
of Level 3 common stock. Included in net securities gains for 2005 is a gain of
$146,000,000 from the sale of 375,000 shares of WMIG common stock. Net
securities gains for 2006, 2005 and 2004 include provisions of $12,900,000,
$12,200,000 and $4,600,000, respectively, to write down the Company's
investments in certain available for sale securities. The write-down of the
securities resulted from a decline in market value determined to be other than
temporary.
The Company's decision to sell securities and realize security gains or
losses is generally based on its evaluation of an individual security's value at
the time and the prospect for changes in its value in the future. The decision
could also be influenced by the status of the Company's tax attributes or
liquidity needs; however, sales in recent years have not been influenced by
these considerations. Therefore, the timing of realized security gains or losses
is not predictable and does not follow any pattern from year to year.
The increase in interest expense during 2006 as compared to 2005
primarily reflects interest expense relating to Premier prior to its
deconsolidation and the fixed rate repurchase agreements. The increase in
interest expense during 2005 as compared to 2004 primarily reflects interest
expense relating to $100,000,000 principal amount of 7% Senior Notes and
$350,000,000 principal amount of 3 3/4% Convertible Senior Subordinated Notes
issued in April 2004.
Salaries and incentive compensation expense did not significantly change
in 2006 as compared to 2005. As a result of the adoption of SFAS 123R in 2006,
the Company recorded $15,200,000 for share-based compensation expense relating
to grants made under the Company's senior executive warrant plan and the fixed
stock option plan. Salaries and incentive compensation expense for 2006 also
reflects decreased bonus expense. Salaries and incentive compensation expense
increased by $31,300,000 in 2005 as compared to 2004, principally due to
increased bonus expense.
40
The increase in selling, general and other expenses of $8,800,000 in
2006 as compared to 2005 primarily reflects increased corporate aircraft
expenses, higher professional fees and other costs, which largely relate to
potential investments and projects and existing investments, and greater
employee benefit costs including pension costs relating to WilTel's retained
pension plan. In addition, 2005 reflects an impairment loss (described below)
for the remaining book value of Olympus Re Holdings, Ltd. ("Olympus") of
$3,700,000.
Selling, general and other expenses increased by $14,600,000 in 2005 as
compared to 2004, primarily due to higher minority interest expense relating to
MK Resources of $4,200,000 (the Company acquired the outstanding minority
interest in August 2005), greater foreign exchange losses of $2,700,000, higher
professional fees of $4,400,000 that principally relate to due diligence
expenses for potential investments and investment management fees, an impairment
loss for the remaining book value of Olympus of $3,700,000 and greater employee
benefit expenses.
The Company's total comprehensive income in 2004 enabled it to realize
certain acquired deferred tax assets which had been fully reserved for at the
acquisition of WilTel. The resulting reduction in the valuation allowance for
deferred tax assets ($22,300,000 in 2004) was applied to reduce the recorded
amount of identifiable intangible assets to zero.
The income tax provision reflects the reversal of tax reserves
aggregating $8,000,000 and $27,300,000 for the years ended December 31, 2006 and
2004, respectively, as a result of the favorable resolution of various state and
federal income tax contingencies. In addition, in 2004 the tax provision
reflects a benefit to record a federal income tax carryback refund of
$3,900,000.
As more fully discussed above, during 2005 the Company's revised
projections of future taxable income enabled it to conclude that it is more
likely than not that it will have future taxable income sufficient to realize a
portion of the Company's net deferred tax asset; accordingly, $1,135,100,000 of
the deferred tax valuation allowance was reversed as a credit to income tax
expense. The Company adjusted the valuation allowance in 2005 since it believes
it is more likely than not that it will have future taxable income sufficient to
realize that portion of the net deferred tax asset.
Associated Companies
Equity in income (losses) of associated companies includes the following
for the years ended December 31, 2006, 2005 and 2004 (in thousands):
2006 2005 2004
---- ---- ----
Olympus $ -- $ (120,100) $ 9,700
EagleRock 16,400 (28,900) 29,400
HomeFed 2,900 5,800 10,000
JPOF II 26,200 23,600 16,200
Union Square -- 72,800 1,300
Pershing -- -- 21,300
Safe Harbor (7,600) -- --
Wintergreen 11,000 500 --
Goober 2,000 -- --
CLC 3,800 (1,600) --
Other 5,400 3,500 3,600
---------- ---------- ----------
Equity in income (losses) before
income taxes 60,100 (44,400) 91,500
Income tax expense (22,400) (700) (15,000)
---------- ---------- ----------
Equity in income (losses),
net of taxes $ 37,700 $ (45,100) $ 76,500
========== ========== ==========
The Company's equity in losses from Olympus for 2005 reflects its share
of Olympus losses from Hurricanes Katrina, Rita and Wilma. Effective January 1,
2006, Olympus received new capital which reduced the Company's equity interest
to less than 4%; as a result, the Company no longer applies the equity method of
accounting. The book value of the Company's investment in Olympus was written
down to zero in 2005.
41
As described above, the Company owns approximately 30% of HomeFed, a
California real estate development company, which it acquired in 2002. The
Company's share of HomeFed's reported earnings fluctuates with the level of real
estate sales activity at HomeFed's development projects.
The Company's share of JPOF II's earnings was distributed to the Company
shortly after the end of each year.
EagleRock distributed $48,200,000 to the Company in 2006 and $3,700,000
in 2004.
Union Square, two entities in which the Company had non-controlling
equity interests, sold their respective interests in an office complex located
on Capitol Hill in Washington, D.C. during 2005. Including repayment of its
mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000, and the Company recognized a pre-tax gain of $72,300,000.
In January 2004, the Company invested $50,000,000 in Pershing, a limited
partnership that is authorized to engage in a variety of investing activities.
The Company redeemed its interest effective December 31, 2004; $71,300,000 was
distributed to the Company in early 2005.
Discontinued Operations
Healthcare Services
As discussed above, in July 2006 the Company sold Symphony and
classified its historical operating results as a discontinued operation. Pre-tax
income of Symphony was $200,000, $3,300,000 and $5,100,000 for the years ended
December 31, 2006, 2005 and 2004, respectively. Gain on disposal of discontinued
operations for 2006 includes a pre-tax gain on the sale of Symphony of
$53,300,000 ($33,500,000 after tax).
Telecommunications - ATX
As discussed above, in September 2006 the Company sold ATX and classified
its historical operating results as a discontinued operation. Pre-tax losses of
ATX were $1,200,000 and $1,900,000 for the years ended December 31, 2006 and
2005, respectively. Gain on disposal of discontinued operations for 2006
includes a pre-tax gain on the sale of ATX of $41,600,000 ($26,100,000 after
tax).
WilTel
The Company sold WilTel to Level 3 in December 2005, recognized a pre-tax
gain on disposal of $243,800,000 ($243,800,000 after tax) and classified its
historical operating results as a discontinued operation. The calculation of the
gain on sale included: (1) the cash proceeds received from Level 3 of
$460,300,000, which was net of estimated working capital adjustments of
$25,500,000; (2) the fair value of the Level 3 common shares of $339,300,000,
based on the $2.95 per share closing price of Level 3 common stock immediately
prior to closing; (3) the amount of the AT&T cash payments that had not been
previously accrued prior to closing ($175,900,000); (4) an impairment charge for
WilTel's headquarters building of $42,400,000; and (5) the net book value of the
net assets sold and estimated expenses and other costs related to the
transaction. WilTel's pre-tax income (loss) from discontinued operations was
$116,000,000 and $(56,600,000) for the years ended December 31, 2005 and 2004,
respectively.
Gain on disposal of discontinued operations during 2006 includes
$2,400,000 of pre-tax gains ($1,500,000 after tax) principally for the
resolution of certain sale-related contingencies and obligations and working
capital adjustments related to WilTel.
Real Estate
In May 2005, the Company sold its 716-room Waikiki Beach hotel and
related assets for an aggregate purchase price of $107,000,000, before closing
costs and other required payments. The Company recorded a pre-tax gain of
$56,600,000 ($56,600,000 after tax), which is reflected in gain on disposal of
discontinued operations.
42
In 2004, the Company sold a commercial real estate property and
classified it as a discontinued operation; a pre-tax loss of $600,000 was
reflected as loss on disposal of discontinued operations. Pre-tax losses for
this property were $6,600,000 in 2004.
Other
In 2006, the Company sold its gas properties and recorded a pre-tax loss
on disposal of discontinued operations of $900,000. Income (loss) from
discontinued operations for 2006 includes $2,900,000 of pre-tax losses related
to these gas properties; amounts for the 2005 and 2004 periods were not
material.
In 2006, the Company received $3,000,000 from a former insurance
subsidiary which, for many years, has been undergoing liquidation proceedings
controlled by state insurance regulators. The Company reflected the amount
received as a gain on disposal of discontinued operations. For income tax
purposes, the payment is treated as a non-taxable distribution paid by a
subsidiary; as a result, no tax expense has been recorded.
In December 2005, the Company sold its interest in an Argentine shoe
manufacturer that had been acquired earlier in the year. Although there was no
material gain or loss on disposal, results of discontinued operations during
2005 include a pre-tax loss of $4,400,000.
In the fourth quarter of 2004, the Company sold its geothermal power
generation business for $14,800,000, net of closing costs, and recognized a
pre-tax gain of $200,000. For the year ended December 31, 2004, the Company
recorded pre-tax losses from discontinued operations relating to this business
of $1,500,000.
During 2004, the Company recorded $2,200,000 as gain on disposal of
discontinued operations (net of minority interest), which represented the
estimated fair value of warrants whose vesting criteria became satisfied. These
warrants had been received during 2003 as part of the sales proceeds from the
discontinued operations of WebLink Wireless, Inc. The gain was not reduced for
any federal income tax expense due to WebLink's large net operating loss
carryforwards.
Recently Issued Accounting Standards
In June 2006, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" ("FIN 48"), which prescribes the
accounting for and disclosure of uncertainty in income tax positions. FIN 48
defines the criteria that must be met before any part of the benefit of a tax
position can be recognized in the financial statements, provides guidance for
the measurement of tax benefits recognized and guidance for classification and
disclosure. FIN 48 is effective for fiscal years beginning after December 15,
2006, with the cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. The Company continues to evaluate
the impact of adopting FIN 48 on its consolidated financial statements but does
not expect it to be material; however, additional footnote disclosures will be
required.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. SFAS 157 is effective for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the impact of
adopting SFAS 157 on its consolidated financial statements.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such statements may relate, but are not limited, to projections of
revenues, income or loss, development expenditures, plans for growth and future
operations, competition and regulation, as well as assumptions relating to the
foregoing. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995.
43
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates," "expects," "anticipates," "believes,"
"plans," "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
Factors that could cause actual results to differ materially from any
results projected, forecasted, estimated or budgeted or may materially and
adversely affect the Company's actual results include, but are not limited to,
those set forth in Item 1A. Risk Factors and elsewhere in this Report and in the
Company's other public filings with the Securities and Exchange Commission.
Undue reliance should not be placed on these forward-looking statements,
which are applicable only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements to reflect
events or circumstances that arise after the date of this Report or to reflect
the occurrence of unanticipated events.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
-------- -----------------------------------------------------------
The following includes "forward-looking statements" that involve risk
and uncertainties. Actual results could differ materially from those projected
in the forward-looking statements.
The Company's market risk arises principally from interest rate risk
related to its investment portfolio and its borrowing activities and equity
price risk.
The Company's investment portfolio is primarily classified as available
for sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's available for sale investment portfolio are fixed income securities,
which comprised approximately 57% of the Company's total investment portfolio at
December 31, 2006. These fixed income securities are primarily rated "investment
grade" or are U.S. governmental agency issued or U.S. Government-Sponsored
Enterprises. The estimated weighted average remaining life of these fixed income
securities was approximately 2.5 years at December 31, 2006. The Company's fixed
income securities, like all fixed income instruments, are subject to interest
rate risk and will fall in value if market interest rates increase. At December
31, 2005, fixed income securities comprised approximately 69% of the Company's
total investment portfolio and had an estimated weighted average remaining life
of 1.2 years.
Also included in the Company's available for sale investment portfolio
are equity securities, which are recorded on the balance sheet at an aggregate
fair value of $736,700,000 (aggregate cost of $584,400,000), and which comprised
approximately 31% of the Company's total investment portfolio at December 31,
2006. The majority of this amount consists of two publicly traded securities,
the largest of which is the investment in Fortescue common shares, which is
carried at fair value of $276,300,000. In addition, the Company's investment
portfolio includes its investment in Inmet, which is carried at cost of
$78,000,000 at December 31, 2006. Although the Company is restricted from
selling the Inmet common shares, the investment is subject to price risk. The
market value of this investment is $299,800,000 at December 31, 2006. As
discussed more fully above in Management's Discussion and Analysis of Financial
Condition and Results of Operations, the Company evaluates its investments for
impairment on a quarterly basis.
At December 31, 2006 and 2005, the Company's portfolio of trading
securities was not material to the total investment portfolio.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt. Generally, the fair market value of debt securities with a
fixed interest rate will increase as interest rates fall, and the fair market
value will decrease as interest rates rise.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are primarily sensitive to
changes in interest rates. For investment securities and debt obligations, the
table presents principal cash flows by expected maturity dates. For the variable
rate borrowings, the weighted average interest rates are based on implied
forward rates in the yield curve at the reporting date. For securities and
liabilities with contractual maturities, the table presents contractual
principal cash flows adjusted for the Company's historical experience and
prepayments of mortgage-backed securities.
44
For additional information, see Notes 6, 12 and 21 of Notes to
Consolidated Financial Statements.
Expected Maturity Date
----------------------
2007 2008 2009 2010 2011 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government and agencies $ 452,593 $ 22,302 $ 7,104 $ 5,107 $ 3,686 $ 9,775 $ 500,567 $ 500,567
Weighted Average
Interest Rate 4.07% 5.27% 5.76% 5.77% 5.77% 5.79%
U.S. Government-
Sponsored Enterprises $ 268,834 $ 77,565 $ 45,136 $ 34,011 $ 25,695 $ 74,661 $ 525,902 $ 525,902
Weighted Average
Interest Rate 4.89% 6.05% 6.37% 6.39% 6.40% 6.39%
Other Fixed Maturities:
Rated Investment Grade $ 84,394 $ 1,593 $ 690 $ -- $ 5,926 $ 24,388 $ 116,991 $ 116,991
Weighted Average
Interest Rate 5.51% 4.90% 4.03% -- 0.66% 2.89%
Rated Less Than Investment
Grade/Not Rated $ 86,148 $ 28,518 $ 29,399 $ 20,223 $ 9,608 $ 39,097 $ 212,993 $ 212,993
Weighted Average Interest
Rate 9.20% 8.16% 9.52% 9.27% 8.79% 3.32%
Rate Sensitive Liabilities:
Fixed Interest Rate Borrowings $ 182,701 $ 3,524 $ 878 $ 978 $ 1,054 $ 928,991 $1,118,126 $1,279,649
Weighted Average
Interest Rate 5.34% 2.66% 11.96% 12.01% 12.15% 6.05%
Variable Interest Rate
Borrowings $ 2,114 $ 2,114 $ 2,114 $ 2,114 $ 32,879 $ -- $ 41,335 $ 41,335
Weighted Average
Interest Rate 8.95% 8.84% 8.94% 9.06% 9.10% --
Rate Sensitive Derivative
Financial Instruments:
Euro currency swap $ 2,085 $ 2,085 $ 2,085 $ 522 $ -- $ -- $ 6,777 $ (2,430)
Average Pay Rate 5.89% 5.89% 5.89% 5.89% -- --
Average Receive Rate 7.60% 7.60% 7.60% 7.60% -- --
Pay Fixed/Receive Variable
Interest Rate Swap $ 2,114 $ 2,114 $ 2,114 $ 2,114 $ 32,879 $ -- $ 41,335 $ (268)
Average Pay Rate 5.01% 5.01% 5.01% 5.01% 5.01% --
Average Receive Rate 4.95% 4.84% 4.94% 5.06% 5.10% --
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $ -- $ -- $ 100,000 $ -- $ 100,000 $ 100,000
Weighted Average
Interest Rate 5.95% 5.84% 5.94% 6.06% 6.10% --
45
Item 8. Financial Statements and Supplementary Data.
------ -------------------------------------------
Financial Statements and supplementary data required by this Item 8 are
set forth at the pages indicated in Item 15(a) below.
Item 9. Changes in and Disagreements with Accountants on Accounting
------ -----------------------------------------------------------
and Financial Disclosure.
-------------------------
None.
Item 9A. Controls and Procedures.
------- -----------------------
Evaluation of disclosure controls and procedures
------------------------------------------------
(a) The Company's management evaluated, with the participation of the
Company's principal executive and principal financial officers, the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2006. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2006.
Changes in internal control over financial reporting
----------------------------------------------------
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2006, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
or 15d-15(f) promulgated under the Securities Exchange Act of 1934. Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and procedures that:
o Pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and disposition of the
assets of the Company;
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management
and directors of the Company; and
46
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006. In making
this assessment, the Company's management used the criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
Based on our assessment and those criteria, management concluded that, as
of December 31, 2006, the Company's internal control over financial reporting
was effective.
Our management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006 has been
audited by PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in their report which appears herein.
Item 9B. Other Information.
------- -----------------
Not applicable.
47
PART III
Item 10. Directors and Executive Officers of the Registrant.
------- --------------------------------------------------
The information to be included under the caption "Election of Directors"
and "Information Concerning the Board and Board Committees" in the Company's
definitive proxy statement to be filed with the Commission pursuant to
Regulation 14A of the Exchange Act in connection with the 2007 annual meeting of
shareholders of the Company (the "Proxy Statement") is incorporated herein by
reference. In addition, reference is made to Item 10 in Part I of this Report.
Item 11. Executive Compensation.
------- ----------------------
The information to be included under the caption "Executive Compensation"
in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
------- --------------------------------------------------------------
The information to be included under the caption "Present Beneficial
Ownership of Common Shares" in the Proxy Statement is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions.
------- ----------------------------------------------
The information to be included under the caption "Executive Compensation
- Certain Relationships and Related Transactions" in the Proxy Statement is
incorporated herein by reference.
Item 14. Independent Accounting Firm Fees.
-------- --------------------------------
The information to be included under the caption "Independent Accounting
Firm Fees" in the Proxy Statement is incorporated herein by reference.
48
PART IV
Item 15. Exhibits and Financial Statement Schedule.
-------- ------------------------------------------
(a)(1)(2) Financial Statements and Schedule.
Report of Independent Registered Public Accounting Firm..................................... F-1
Financial Statements:
Consolidated Balance Sheets at December 31, 2006 and 2005.................................. F-3
Consolidated Statements of Operations for the years ended December 31, 2006,
2005 and 2004........................................................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2006,
2005 and 2004........................................................................... F-5
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2006, 2005 and 2004........................................................ F-7
Notes to Consolidated Financial Statements................................................. F-8
Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts...... ...................................... F-49
(3) Executive Compensation Plans and Arrangements. See Item 15(b)
below for a complete list of Exhibits to this Report.
1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex
C to the Company's Proxy Statement dated April 17, 2006 (the
"2006 Proxy Statement")).
Form of Grant Letter for the 1999 Stock Option Plan (filed as
Exhibit 10.4 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2004 (the "2004 10-K")).
Amended and Restated Shareholders Agreement dated as of June 30,
2003 among the Company, Ian M. Cumming and Joseph S. Steinberg
(filed as Exhibit 10.5 to the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2003 (the "2003
10-K")).
Form of Amendment No. 1 to the Amended and Restated Shareholders
Agreement dated as of June 30, 2003 (filed as Exhibit 10.6 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 30, 2006 (the "2nd Quarter 2006 10-Q")).
Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A
to the 2006 Proxy Statement).
Leucadia National Corporation 2006 Senior Executive Warrant Plan
(filed as Annex B to the 2006 Proxy Statement).
Employment Agreement made as of June 30, 2005 by and between the
Company and Ian M. Cumming (filed as Exhibit 99.1 to the
Company's Current Report on Form 8-K dated July 13, 2005 (the
"July 13, 2005 8-K")).
Employment Agreement made as of June 30, 2005 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the
July 13, 2005 8-K).
49
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate
Secretary, 315 Park Avenue South, New York, NY 10010. We charge
$.50 per page to cover expenses of copying and mailing.
3.1 Restated Certificate of Incorporation (filed as Exhibit 5.1 to the
Company's Current Report on Form 8-K dated July 14, 1993).*
3.2 Certificate of Amendment of the Certificate of Incorporation dated
as of May 14, 2002 (filed as Exhibit 3.2 to the 2003 10-K).*
3.3 Certificate of Amendment of the Certificate of Incorporation dated
as of December 23, 2002 (filed as Exhibit 3.2 to the Company's
Annual Report on Form 10-K for the fiscal year ended December 31,
2002 (the "2002 10-K")).*
3.4 Amended and Restated By-laws as amended through March 9, 2004
(filed as Exhibit 3.4 to the 2003 10-K).*
3.5 Certificate of Amendment of the Certificate of Incorporation dated
as of May 13, 2004 (filed as Exhibit 3.5 to the Company's 2004
10-K).*
3.6 Certificate of Amendment of the Certificate of Incorporation dated
as of May 17, 2005 (filed as Exhibit 3.5 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2005
(the "2005 10-K")).*
4.1 The Company undertakes to furnish the Securities and Exchange
Commission, upon written request, a copy of all instruments with
respect to long-term debt not filed herewith.
10.1 1999 Stock Option Plan, as amended April 5, 2006 (filed as Annex A
to the 2006 Proxy Statement).*
10.2 Form of Grant Letter for the 1999 Stock Option Plan (filed as
Exhibit 10.4 to the Company's 2004 10-K).*
10.3 Amended and Restated Shareholders Agreement dated as of June 30,
2003 among the Company, Ian M. Cumming and Joseph S. Steinberg
(filed as Exhibit 10.5 to the 2003 10-K).*
10.4 Debtors' Modified Second Amended Joint Plan of Reorganization
under chapter 11 of the Bankruptcy Code, dated as of April 13,
2005, of ATX Communications, Inc. (filed as Exhibit 99.1 to ATX
Communication's Current Report on Form 8-K dated April 20, 2005).*
10.5 Services Agreement, dated as of January 1, 2004, between the
Company and Ian M. Cumming (filed as Exhibit 10.37 to the 2005
10-K).*
10.6 Services Agreement, dated as of January 1, 2004, between the
Company and Joseph S. Steinberg (filed as Exhibit 10.38 to the
2005 10-K).*
10.7 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex A to
the 2006 Proxy Statement).*
10.8 Employment Agreement made as of June 30, 2005 by and between the
Company and Ian M. Cumming (filed as Exhibit 99.1 to the July 13,
2005 8-K).*
10.9 Employment Agreement made as of June 30, 2005 by and between the
Company and Joseph S. Steinberg (filed as Exhibit 99.2 to the July
13, 2005 8-K).*
50
10.10 Management Services Agreement dated as of February 26, 2001 among
The FINOVA Group Inc., the Company and Leucadia International
Corporation (filed as Exhibit 10.20 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 2000).*
10.11 Voting Agreement, dated August 21, 2001, by and among Berkadia
LLC, Berkshire Hathaway Inc., the Company and The FINOVA Group
Inc. (filed as Exhibit 10.J to the Company's Current Report on
Form 8-K dated August 27, 2001).*
10.12 Second Amended and Restated Berkadia LLC Operating Agreement,
dated December 2, 2002, by and among BH Finance LLC and WMAC
Investment Corporation (filed as Exhibit 10.40 to the 2002 10-K).*
10.13 First Amended Joint Chapter 11 Plan of Reorganization of Williams
Communications Group, Inc. ("WCG") and CG Austria, Inc. filed with
the Bankruptcy Court as Exhibit 1 to the Settlement Agreement
(filed as Exhibit 99.3 to the Current Report on Form 8-K of WCG
dated July 31, 2002 (the "WCG July 31, 2002 8-K")).*
10.14 Tax Cooperation Agreement between WCG and The Williams Companies
Inc. dated July 26, 2002, filed with the Bankruptcy Court as
Exhibit 7 to the Settlement Agreement (filed as Exhibit 99.9 to
the WCG July 31, 2002 8-K).*
10.15 Third Amended and Restated Credit And Guaranty Agreement, dated as
of September 8, 1999, as amended and restated as of April 25,
2001, as further amended and restated as of October 15, 2002, and
as further amended and restated as of September 24, 2004, among
WilTel, WilTel Communications, LLC, certain of its domestic
subsidiaries, as loan parties, the several banks and other
financial institutions or entities from time to time parties
thereto as lenders, Credit Suisse First Boston, acting through its
Cayman Islands branch, as administrative agent, as first lien
administrative agent and as second lien administrative agent, and
Wells Fargo Foothill, LLC, as syndication agent (filed as Exhibit
99.1 to the Company's Current Report on Form 8-K dated September
24, 2002 (the "Company's September 24, 2002 8-K")).*
10.16 First Amendment to Third Amended and Restated Credit And Guaranty
Agreement, dated September 2, 2005, by and among WilTel
Communications, LLC, WilTel Communications Group LLC, the
Subsidiary Guarantors (as defined), and the First Lien
Administrative Agent, the Second Lien Administrative Agent and the
Administrative Agent for the Lenders (filed as Exhibit 99.1 to the
Company's Current Report on Form 8-K dated September 2, 2005).*
10.17 Second Amended and Restated Security Agreement, dated as of April
23, 2001, as amended and restated as of October 15, 2002, and as
further amended and restated as of September 24, 2004, among
WilTel, WilTel Communications, LLC, and the additional grantors
party thereto in favor of Credit Suisse First Boston, acting
through its Cayman Islands branch, as administrative agent, as
first lien administrative agent and as second lien administrative
agent (filed as Exhibit 99.2 to the Company's September 24, 2002
8-K).*
10.18 Exhibit 1 to the Agreement and Plan of Reorganization between the
Company and TLC Associates, dated February 23, 1989 (filed as
Exhibit 3 to Amendment No. 12 to the Schedule 13D dated December
29, 2004 of Ian M. Cumming and Joseph S. Steinberg with respect to
the Company).*
10.19 Termination, Mutual Release and Settlement Agreement dated June
15, 2005 among the Company, WCGLLC, WCLLC, SBC, SBC Operations,
Inc. and SBC Long Distance, LLC (filed as Exhibit 99.2 to the
Company's June 15, 2005 8-K/A).*
10.20 Information Concerning Executive Compensation (filed as Exhibit
10.1 to the Company's Current Report on Form 8-K dated January 11,
2007).*
51
10.21 Hotel Purchase Agreement, dated as of April 6, 2005, by and
between HWB 2507 Kalakaua, LLC and Gaylord Entertainment Co.
(filed as Exhibit 10.2. to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2005 (the "1st
Quarter 2005 10-Q")).*
10.22 Stock Purchase Agreement, dated as of May 2, 2005, by and among
the Company and the individuals named therein (filed as Exhibit
10.4 to the 1st Quarter 2005 10-Q).*
10.23 Purchase Agreement, dated as of October 30, 2005, among the
Company, Baldwin Enterprises, Inc., Level 3 Communications, LLC
and Level 3 Communications, Inc. ("Level 3") (filed as Exhibit
10.1 to the Company's Current Report on Form 8-K dated October 30,
2005).*
10.24 Registration Rights and Transfer Restriction Agreement, dated as
of December 23, 2005, by and among Level 3, the Company and
Baldwin Enterprises, Inc. (filed as Exhibit 10.2 to Level 3's
Current Report on Form 8-K dated December 23, 2005).*
10.25 Purchase and Sale Agreement ("Square 711 Purchase and Sale
Agreement"), dated as of November 14, 2005, between Square 711
Developer, LLC and Walton Acquisition Holdings V, L.L.C., a
Delaware limited liability company (filed as Exhibit 10.26 to the
2005 10-K).*
10.26 First Amendment to Square 711 Purchase and Sale Agreement, dated
as of December 14, 2005 (filed as Exhibit 10.27 to the 2005
10-K).*
10.27 Share Purchase Agreement, dated May 2, 2005, between Inmet Mining
Corporation, the Company and MK Resources Company (filed as
Exhibit 2 to Amendment No. 10 to the Schedule 13D dated May 2,
2005 of the Company with respect to MK Resources Company (the "MK
13D")).*
10.28 Agreement and Plan of Merger, dated as of May 2, 2005, among the
Company, Marigold Acquisition Corp. and MK Resources Company
(filed as Exhibit 3 to the MK 13D).*
10.29 Voting Agreement, dated as of May 2, 2005, between the Company and
Inmet Mining Corporation (filed as Exhibit 4 to the MK 13D).*
10.30 Letter Agreement, dated March 30, 2005 between SBC Services, Inc.
("SBC Services") and WilTel Communications, LLC ("WCLLC") (filed
as Exhibit 10.1 to the 1st Quarter 2005 10-Q).*
10.31 Letter Agreement, dated April 27, 2005 between SBC Services and
WCLLC (filed as Exhibit 10.3 to the 1st Quarter 2005 10-Q).*
10.32 Letter Agreement, dated May 25, 2005 between SBC Services and
WCLLC (filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 2005).*
10.33 Master Services Agreement dated June 15, 2005 among WilTel
Communications Group ("WCGLLC"), WilTel Local Network, LLC, SBC
Services. and SBC Communications Inc. ("SBC") (filed as Exhibit
99.1 to the Company's Current Report on Form 8-K/A dated June 15,
2005 (the "June 15, 2005 8-K/A")).*
10.34 Form of Unit Purchase Agreement, dated as of April 6, 2006, by and
among GAR, LLC, the Company, AA Capital Equity Fund, L.P., AA
Capital Biloxi Co-Investment Fund, L.P. and HRHC Holdings, LLC
(filed as Exhibit 10.1 to the 2nd Quarter 2006 10-Q).*
10.35 Form of Loan Agreement, dated as of April 6, 2006, by and among
Goober Drilling, LLC, the Subsidiaries of Goober Drilling, LLC
from time to time signatory thereto and the Company (filed as
Exhibit 10.2 to the 2nd Quarter 2006 10-Q).*
10.36 Form of First Amendment to Loan Agreement, dated as of June 15,
2006, between Goober Drilling, LLC, the Subsidiaries of Goober
Drilling, LLC from time to time signatory thereto and the Company
(filed as Exhibit 10.3 to the 2nd Quarter 2006 10-Q).*
52
10.37 Form of First Amended and Restated Limited Liability Company
Agreement of Goober Drilling, LLC, dated as of June 15, 2006, by
and among Goober Holdings, LLC, Baldwin Enterprises, Inc., the
Persons that become Members from time to time, John Special, Chris
McCutchen, Jim Eden, Mike Brown and Goober Drilling Corporation
(filed as Exhibit 10.4 to the 2nd Quarter 2006 10-Q).*
10.38 Form of Purchase and Sale Agreement, dated as of May 3, 2006, by
and among LUK-Symphony Management, LLC, Symphony Health Services,
LLC and RehabCare Group, Inc. (filed as Exhibit 10.5 to the 2nd
Quarter 2006 10-Q).*
10.39 Form of Amendment No. 1, dated as of May 16, 2006, to the Amended
and Restated Shareholders Agreement dated as of June 30, 2003, by
and among Ian M. Cumming, Joseph S. Steinberg and the Company
(filed as Exhibit 10.6 to the 2nd Quarter 2006 10-Q).*
10.40 Form of Credit Agreement, dated as of June 28, 2006, by and among
the Company, the various financial institutions and other Persons
from time to time party thereto and JPMorgan Chase Bank, National
Association (filed as Exhibit 10.7 to the 2nd Quarter 2006 10-Q).*
10.41 Form of Subscription Agreement, dated as of July 15, 2006, by and
among FMG Chichester Pty Ltd, the Company, and Fortescue Metals
Group Ltd (filed as Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended September 30, 2006
(the "3rd Quarter 2006 10-Q")).*
10.42 Form of Amending Agreement, dated as of August 18, 2006, by and
among FMG Chichester Pty Ltd, the Company and Fortescue Metals
Group Ltd (filed as Exhibit 10.2 to the 3rd Quarter 2006 10-Q).*
10.43 Compensation Information Concerning Non-Employee Directors (filed
under item 1.01 of the Company's Current Report on Form 8-K dated
May 22, 2006).*
10.44 Leucadia National Corporation 2006 Senior Executive Warrant Plan
(filed as Annex B to the 2006 Proxy Statement).*
21 Subsidiaries of the registrant.
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statement on Form S-8 (No. 333-51494).
23.2 Consent of PricewaterhouseCoopers, with respect to the inclusion
in this Annual Report on Form 10-K the financial statements of
Olympus Re Holdings, Ltd. and with respect to the incorporation by
reference in the Company's Registration Statements on Form S-8
(No. 333-51494).**
23.3 Consent of independent auditors from BDO Seidman, LLP with respect
to the inclusion in this Annual Report on Form 10-K of the
financial statements of EagleRock Capital Partners (QP), LP and
EagleRock Master Fund, LP and with respect to the incorporation by
reference in the Company's Registration Statements on Form S-8
(No. 333-51494).**
23.4 Independent Auditors' Consent from KPMG LLP, with respect to the
inclusion in this Annual Report on Form 10-K of the financial
statements of Jefferies Partners Opportunity Fund II, LLC and with
respect to the incorporation by reference into the Company's
Registration Statements on Form S-8 (No. 333-51494).**
31.1 Certification of Chairman of the Board and Chief Executive Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.3 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
53
32.1 Certification of Chairman of the Board and Chief Executive Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.***
32.3 Certification of Principal Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.***
(c) Financial statement schedules.
(1) Olympus Re Holdings, Ltd. consolidated financial statements
as of December 31, 2005 and for the years ended December
31, 2005 and 2004.**
(2) EagleRock Capital Partners (QP), LP financial statements as
of December 31, 2006 and 2005 and for the years ended
December 31, 2006, 2005 and 2004 and EagleRock Master Fund,
LP financial statements as of December 31, 2006 and 2005
and for the years ended December 31, 2006, 2005 and 2004.**
(3) Jefferies Partners Opportunity Fund II, LLC financial
statements as of December 31, 2006 and 2005, and for the
years ended December 31, 2006, 2005 and 2004.**
-----------------------------
* Incorporated by reference.
** To be filed by amendment pursuant to Item 3-09(b) of Regulation S-X.
*** Furnished herewith pursuant to item 601(b)(32) of Regulation S-K.
54
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.
LEUCADIA NATIONAL CORPORATION
February 28, 2007 By: /s/ Barbara L. Lowenthal
-----------------------------------
Barbara L. Lowenthal
Vice President and Comptroller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on the date set forth above.
Signature Title
--------- -----
/s/ Ian M. Cumming Chairman of the Board
--------------------------------------- (Principal Executive Officer)
Ian M. Cumming
/s/ Joseph S. Steinberg President and Director
--------------------------------------- (Principal Executive officer)
Joseph S. Steinberg
/s/ Joseph A. Orlando Vice President and Chief
--------------------------------------- Financial Officer
Joseph A. Orlando (Principal Financial Officer)
/s/ Barbara L. Lowenthal Vice President and Comptroller
--------------------------------------- (Principal Accounting Officer)
Barbara L. Lowenthal
/s/ Paul M. Dougan Director
---------------------------------------
Paul M. Dougan
/s/ Lawrence D. Glaubinger Director
---------------------------------------
Lawrence D. Glaubinger
/s/ Alan J. Hirschfield Director
---------------------------------------
Alan J. Hirschfield
/s/ James E. Jordan Director
---------------------------------------
James E. Jordan
/s/ Jeffrey C. Keil Director
---------------------------------------
Jeffrey C. Keil
/s/ Jesse Clyde Nichols, III Director
---------------------------------------
Jesse Clyde Nichols, III
55
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of Leucadia National Corporation:
We have completed integrated audits of Leucadia National Corporation's
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2006, in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Our opinions, based
on our audits, are presented below.
Consolidated financial statements and financial statement schedule
------------------------------------------------------------------
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1)(2) present fairly, in all material respects, the
financial position of Leucadia National Corporation and its subsidiaries at
December 31, 2006 and 2005, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2006 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(1)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. These financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 2 and Note 13 to the consolidated financial statements, the
Company changed the manner in which it accounts for share-based compensation in
2006.
Internal control over financial reporting
-----------------------------------------
Also, in our opinion, management's assessment, included in "Management's Report
on Internal Control Over Financial Reporting" appearing under Item 9A, that the
Company maintained effective internal control over financial reporting as of
December 31, 2006 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2006, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
February 27, 2007
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
(Dollars in thousands, except par value)
2006 2005
---- ----
ASSETS
------
Current assets:
Cash and cash equivalents $ 287,199 $ 386,957
Investments 903,973 1,323,562
Trade, notes and other receivables, net 69,822 377,216
Prepaids and other current assets 105,215 140,880
----------- -----------
Total current assets 1,366,209 2,228,615
Non-current investments 1,465,849 977,327
Notes and other receivables, net 24,999 22,747
Intangible assets, net and goodwill 59,437 85,083
Deferred tax asset, net 978,415 1,094,017
Other assets 401,689 240,601
Property, equipment and leasehold improvements, net 234,216 237,021
Investments in associated companies 773,010 375,473
----------- -----------
Total $ 5,303,824 $ 5,260,884
=========== ===========
LIABILITIES
-----------
Current liabilities:
Trade payables and expense accruals $ 127,739 $ 230,636
Other current liabilities 5,688 52,925
Debt due within one year 184,815 175,664
Income taxes payable 8,411 15,171
----------- -----------
Total current liabilities 326,653 474,396
Other non-current liabilities 90,268 121,893
Long-term debt 974,646 986,718
----------- -----------
Total liabilities 1,391,567 1,583,007
----------- -----------
Commitments and contingencies
Minority interest 18,982 15,963
----------- -----------
SHAREHOLDERS' EQUITY
--------------------
Common shares, par value $1 per share, authorized 300,000,000 shares;
216,351,466 and 216,058,016 shares issued and outstanding, after deducting
56,881,489 and 56,874,929 shares
held in treasury 216,351 216,058
Additional paid-in capital 520,892 501,914
Accumulated other comprehensive loss (4,726) (81,502)
Retained earnings 3,160,758 3,025,444
----------- -----------
Total shareholders' equity 3,893,275 3,661,914
----------- -----------
Total $ 5,303,824 $ 5,260,884
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2006, 2005 and 2004
(In thousands, except per share amounts)
2006 2005 2004
---- ---- ----
REVENUES AND OTHER INCOME:
-------------------------
Manufacturing $ 450,835 $ 332,253 $ 64,055
Investment and other income 294,678 148,814 178,947
Net securities gains 117,159 208,816 136,564
----------- ----------- ----------
862,672 689,883 379,566
----------- ----------- ----------
EXPENSES:
--------
Manufacturing cost of sales 386,466 281,451 45,055
Interest 79,392 65,523 60,557
Salaries and incentive compensation 89,501 71,884 34,811
Depreciation and amortization 22,105 18,070 18,959
Selling, general and other expenses 151,388 118,520 113,360
----------- ----------- ----------
728,852 555,448 272,742
----------- ----------- ----------
Income from continuing operations before income taxes and equity in
income (losses) of associated companies 133,820 134,435 106,824
----------- ----------- ----------
Income tax (benefit) provision:
Current (4,902) 4,062 (27,786)
Deferred 46,673 (1,135,100) 7,242
----------- ----------- -----------
41,771 (1,131,038) (20,544)
----------- ----------- ----------
Income from continuing operations before equity in income (losses)
of associated companies 92,049 1,265,473 127,368
Equity in income (losses) of associated companies, net of taxes 37,720 (45,133) 76,479
----------- ----------- ----------
Income from continuing operations 129,769 1,220,340 203,847
Income (loss) from discontinued operations, net of taxes (3,960) 115,329 (60,160)
Gain on disposal of discontinued operations, net of taxes 63,590 300,372 1,813
----------- ----------- ----------
Net income $ 189,399 $ 1,636,041 $ 145,500
=========== =========== ==========
Basic earnings (loss) per common share:
Income from continuing operations $ .60 $ 5.66 $ .96
Income (loss) from discontinued operations (.02) .54 (.29)
Gain on disposal of discontinued operations .30 1.39 .01
----- ------ -----
Net income $ .88 $ 7.59 $ .68
===== ====== =====
Diluted earnings (loss) per common share:
Income from continuing operations $ .60 $ 5.34 $ .93
Income (loss) from discontinued operations (.02) .50 (.27)
Gain on disposal of discontinued operations .27 1.30 .01
----- ------ -----
Net income $ .85 $ 7.14 $ .67
===== ====== =====
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2006, 2005 and 2004
(In thousands)
2006 2005 2004
---- ---- ----
Net cash flows from operating activities:
-----------------------------------------
Net income $ 189,399 $ 1,636,041 $ 145,500
Adjustments to reconcile net income to net cash provided by operations:
Deferred income tax provision (benefit) 99,990 (1,135,100) 7,242
Depreciation and amortization of property, equipment and leasehold improvements 35,884 186,428 232,600
Other amortization (11,884) 3,068 3,316
Share-based compensation 15,164 -- --
Excess tax benefit from exercise of stock options (456) -- --
Provision for doubtful accounts 1,089 6,181 (5,366)
Net securities gains (117,159) (212,299) (142,936)
Equity in (income) losses of associated companies (60,056) 44,403 (91,546)
Distributions from associated companies 75,725 90,280 23,878
Net gains related to real estate, property and equipment, loan receivables and
other assets (109,107) (29,386) (60,866)
Gain on disposal of discontinued operations (99,456) (300,372) (1,813)
Investments classified as trading, net 4,469 18,022 (68,612)
Net change in:
Trade, notes and other receivables 183,263 20,850 19,578
Prepaids and other assets 5,776 (29,978) 11,491
Trade payables and expense accruals (73,342) 54,344 19,654
Other liabilities (47,230) (36,427) (52,250)
Deferred revenue -- 10,553 9,945
Income taxes payable (6,628) (2,537) 16,890
Other 6,081 (2,961) 1,732
----------- ----------- ----------
Net cash provided by operating activities 91,522 321,110 68,437
---------- ----------- ---------
Net cash flows from investing activities:
-----------------------------------------
Acquisition of property, equipment and leasehold improvements (39,021) (136,260) (97,412)
Acquisition of and capital expenditures for real estate investments (71,505) (26,053) (23,022)
Proceeds from disposals of real estate, property and equipment, and other assets 188,836 33,722 123,302
Proceeds from disposal of discontinued operations, net of expenses and
cash of operations sold 120,228 459,094 22,311
Acquisitions, net of cash acquired (105,282) (170,516) --
Collection of Premier Entertainment Biloxi, LLC's insurance proceeds 109,383 -- --
Net change in restricted cash (90,959) -- --
Principal collections on loan receivables -- 1,591 41,862
Proceeds from sale of loan receivables -- -- 157,134
Advances on notes and other receivables (31,518) (100) (400)
Collections on notes and other receivables 29,823 1,721 27,789
Investments in associated companies (313,152) (34,466) (69,398)
Capital distributions from associated companies 4,845 2,644 5,632
Investment in Fortescue Metals Group Ltd (408,030) -- --
Purchases of investments (other than short-term) (3,661,421) (3,350,651) (2,534,404)
Proceeds from maturities of investments 1,149,123 1,262,577 869,707
Proceeds from sales of investments 2,933,601 1,979,288 1,460,181
Other (1,127) -- --
----------- ----------- -----------
Net cash provided by (used for) investing activities (186,176) 22,591 (16,718)
----------- ----------- -----------
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2006, 2005 and 2004
(In thousands)
2006 2005 2004
---- ---- ----
Net cash flows from financing activities:
-----------------------------------------
Net change in customer banking deposits $ -- $ (24,565) $ (120,516)
Issuance of long-term debt, net of issuance costs 96,676 82,753 438,393
Reduction of long-term debt (66,223) (477,360) (92,454)
Issuance of common shares 3,838 3,689 22,006
Purchase of common shares for treasury (187) (167) --
Excess tax benefit from exercise of stock options 456 -- --
Dividends paid (54,085) (27,008) (26,901)
Other 14,313 -- --
----------- ----------- -----------
Net cash provided by (used for) financing activities (5,212) (442,658) 220,528
----------- ----------- -----------
Effect of foreign exchange rate changes on cash 108 (1,034) 311
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (99,758) (99,991) 272,558
Cash and cash equivalents at January 1, 386,957 486,948 214,390
----------- ----------- -----------
Cash and cash equivalents at December 31, $ 287,199 $ 386,957 $ 486,948
=========== =========== ===========
Supplemental disclosures of cash flow information:
--------------------------------------------------
Cash paid during the year for:
Interest $ 82,072 $ 96,958 $ 89,707
Income tax payments (refunds), net $ 6,707 $ 3,486 $ (26,024)
Non-cash investing activities:
-----------------------------
Common stock issued for acquisition of MK Resources Company $ -- $ 8,346 $ --
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31, 2006, 2005 and 2004
(In thousands, except par value and per share amounts)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
----- ------- ------------- -------- -----
Balance, January 1, 2004 $ 212,471 $471,627 $152,251 $1,297,812 $2,134,161
----------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $0 (8,592) (8,592)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 6,807 6,807
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 (355) (355)
Net change in minimum pension liability, net
of taxes of $0 (13,973) (13,973)
Net income 145,500 145,500
----------
Comprehensive income 129,387
----------
Exercise of warrants to purchase common shares 2,400 16,760 19,160
Exercise of options to purchase common shares 330 2,516 2,846
Dividends ($.13 per common share) (26,901) (26,901)
--------- -------- -------- ---------- ----------
Balance, December 31, 2004 215,201 490,903 136,138 1,416,411 2,258,653
----------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $0 (175,577) (175,577)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 (17,199) (17,199)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 2,747 2,747
Net change in minimum pension liability, net
of taxes of $0 (27,611) (27,611)
Net income 1,636,041 1,636,041
----------
Comprehensive income 1,418,401
----------
Issuance of common shares on acquisition of
minority interest in MK Resources Company 432 7,914 8,346
Exercise of options to purchase common shares 432 3,257 3,689
Purchase of common shares for treasury (7) (160) (167)
Dividends ($.13 per common share) (27,008) (27,008)
--------- -------- -------- ---------- ----------
Balance, December 31, 2005 216,058 501,914 (81,502) 3,025,444 3,661,914
----------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $34,149 60,187 60,187
Net change in unrealized foreign exchange
gain (loss), net of taxes of $2,137 3,768 3,768
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $128 (224) (224)
Net change in minimum pension liability,
net of taxes of $6,958 12,263 12,263
Net income 189,399 189,399
----------
Comprehensive income 265,393
----------
Share-based compensation expense 15,164 15,164
Adjustment to initially apply SFAS 158, net of
taxes of $444 782 782
Exercise of options to purchase common shares,
including excess tax benefit 300 3,994 4,294
Purchase of common shares for treasury (7) (180) (187)
Dividends ($.25 per common share) (54,085) (54,085)
--------- -------- -------- ---------- ----------
Balance, December 31, 2006 $ 216,351 $520,892 $ (4,726) $3,160,758 $3,893,275
========= ======== ======== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Nature of Operations:
-----------------------
The Company is a diversified holding company engaged in a variety of businesses,
including manufacturing, real estate activities, medical product development,
winery operations and residual banking and lending activities that are in
run-off. The Company also owns equity interests in operating businesses and
investment partnerships which are accounted for under the equity method of
accounting, including gaming entertainment, land based contract oil and gas
drilling, real estate activities and development of a copper mine in Spain. The
Company continuously evaluates the retention and disposition of its existing
operations and investments and frequently investigates the acquisition of new
businesses. Changes in the mix of the Company's owned businesses and investments
should be expected.
The manufacturing operations are conducted through Idaho Timber, LLC ("Idaho
Timber") and Conwed Plastics, LLC ("Conwed Plastics"). Idaho Timber's principal
product lines include remanufacturing dimension lumber; remanufacturing,
bundling and bar coding of home center boards for large retailers; and
production of 5/4" radius-edge, pine decking. Idaho Timber also manufactures
and/or distributes a number of other specialty wood products. Idaho Timber
operates eleven facilities located throughout the United States.
Conwed Plastics manufactures and markets lightweight plastic netting used for a
variety of purposes including, among other things, building and construction,
erosion control, packaging, agricultural, carpet padding, filtration and
consumer products. Conwed Plastics manufacturing segment has three domestic
manufacturing facilities, and it owns and operates a manufacturing and sales
facility in Belgium.
The domestic real estate operations include a mixture of commercial properties,
residential land development projects and other unimproved land, all in various
stages of development and all available for sale.
The Company's medical product development operations are conducted through
Sangart, Inc. ("Sangart"), which became a majority-owned subsidiary of the
Company in 2005. Sangart is developing a product called Hemospan(R), which is a
form of cell-free hemoglobin that is designed for intravenous administration to
treat a wide variety of medical conditions, including use as an alternative to
red blood cell transfusions.
The winery operations consist of two wineries, Pine Ridge Winery in Napa Valley,
California and Archery Summit in the Willamette Valley of Oregon, which
primarily produce and sell wines in the luxury segment of the premium table wine
market.
During 2005, the banking and lending operations sold its remaining customer
deposits and surrendered its national bank charter. The remaining operating
activities are concentrated on collecting and servicing its remaining loan
portfolio.
On June 14, 2006, a two-for-one stock split was effected in the form of a 100%
stock dividend that was paid to shareholders of record on May 30, 2006. The
financial statements (and notes thereto) give retroactive effect to the stock
split for all periods presented.
Certain amounts for prior periods have also been reclassified to be consistent
with the 2006 presentation, and to reflect as discontinued operations Symphony
Health Services, LLC ("Symphony"), which was sold in July 2006, and ATX
Communications, Inc. ("ATX"), which was sold in September 2006. For more
information concerning the sales and the Company's other discontinued
operations, see Note 5.
F-8
2. Significant Accounting Policies:
-------------------------------
(a) Critical Accounting Estimates: The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
("GAAP") requires the Company to make estimates and assumptions that affect the
reported amounts in the financial statements and disclosures of contingent
assets and liabilities. On an on-going basis, the Company evaluates all of these
estimates and assumptions. The following areas have been identified as critical
accounting estimates because they have the potential to have a material impact
on the Company's financial statements, and because they are based on assumptions
which are used in the accounting records to reflect, at a specific point in
time, events whose ultimate outcome won't be known until a later date. Actual
results could differ from these estimates.
Income Taxes - The Company records a valuation allowance to reduce its deferred
tax asset to the amount that is more likely than not to be realized. If in the
future the Company were to determine that it would be able to realize its
deferred tax asset in excess of its net recorded amount, an adjustment would
increase income in such period. Similarly, if in the future the Company were to
determine that it would not be able to realize all or part of its deferred tax
asset, an adjustment would be charged to income in such period. The
determination of the amount of the valuation allowance required is based, in
significant part, upon the Company's projection of future taxable income at any
point in time. The Company also records reserves for contingent tax liabilities
based on the Company's assessment of the probability of successfully sustaining
its tax filing positions.
During 2005, the Company's projections of future taxable income enabled it to
conclude that it is more likely than not that it will have future taxable income
sufficient to realize a portion of the Company's net deferred tax asset;
accordingly, $1,135,100,000 of the deferred tax valuation allowance was reversed
as a credit to income tax expense. The Company's conclusion that a portion of
the deferred tax asset is more likely than not to be realized is strongly
influenced by its historical ability to generate significant amounts of taxable
income. The Company's estimate of future taxable income considers all available
evidence, both positive and negative, about its current operations and
investments, includes an aggregation of individual projections for each material
operation and investment, and includes all future years that the Company
estimated it would have available net operating losses. The Company believes
that its estimate of future taxable income is reasonable but inherently
uncertain, and if its current or future operations and investments generate
taxable income greater than the projected amounts, further adjustments to reduce
the valuation allowance are possible. Conversely, if the Company realizes
unforeseen material losses in the future, or its ability to generate future
taxable income necessary to realize a portion of the deferred tax asset is
materially reduced, additions to the valuation allowance could be recorded. At
December 31, 2006, the balance of the deferred valuation allowance was
approximately $911,800,000.
Impairment of Long-Lived Assets - In accordance with Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), the Company evaluates its long-lived assets for impairment
whenever events or changes in circumstances indicate, in management's judgment,
that the carrying value of such assets may not be recoverable. When testing for
impairment, the Company groups its long-lived assets with other assets and
liabilities at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset group).
The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value.
As more fully discussed in Note 5, during 2005 an impairment loss of $42,400,000
was recorded to reduce the carrying amount of WilTel Communications Group, LLC's
("WilTel"), former headquarters facility to its estimated fair value.
F-9
2. Significant Accounting Policies, continued:
-------------------------------
Impairment of Securities - Investments with an impairment in value considered to
be other than temporary are written down to estimated fair value. The
write-downs are included in net securities gains in the consolidated statements
of operations. The Company evaluates its investments for impairment on a
quarterly basis. The Company's determination of whether a security is other than
temporarily impaired incorporates both quantitative and qualitative information;
GAAP requires the exercise of judgment in making this assessment, rather than
the application of fixed mathematical criteria. The Company considers a number
of factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The Company's assessment involves a high degree of
judgment and accordingly, actual results may differ materially from the
Company's estimates and judgments. The Company recorded impairment charges for
securities of $12,900,000, $12,200,000 and $4,600,000 for the years ended
December 31, 2006, 2005 and 2004, respectively.
Business Combinations - At acquisition, the Company allocates the cost of a
business acquisition to the specific tangible and intangible assets acquired and
liabilities assumed based upon their relative fair values. Significant judgments
and estimates are often made to determine these allocated values, and may
include the use of independent appraisals, consider market quotes for similar
transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts
adjustments are recorded. Any excess of the cost of a business acquisition over
the fair values of the net assets and liabilities acquired is recorded as
goodwill which is not amortized to expense. Recorded goodwill of a reporting
unit is required to be tested for impairment on an annual basis, and between
annual testing dates if events or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its net book value.
Subsequent to the finalization of the purchase price allocation, any adjustments
to the recorded values of acquired assets and liabilities would be reflected in
the Company's consolidated statement of operations. Once final, the Company is
not permitted to revise the allocation of the original purchase price, even if
subsequent events or circumstances prove the Company's original judgments and
estimates to be incorrect. In addition, long-lived assets like property and
equipment, amortizable intangibles and goodwill may be deemed to be impaired in
the future resulting in the recognition of an impairment loss; however, under
GAAP the methods, assumptions and results of an impairment review are not the
same for all long-lived assets. The assumptions and judgments made by the
Company when recording business combinations will have an impact on reported
results of operations for many years into the future.
Purchase price allocations for all of the Company's recent acquisitions have
been finalized. Adjustments to the initial purchase price allocations were not
material.
Contingencies - The Company accrues for contingent losses when the contingent
loss is probable and the amount of loss can be reasonably estimated. Estimates
of the likelihood that a loss will be incurred and of contingent loss amounts
normally require significant judgment by management, can be highly subjective
and are subject to material change with the passage of time as more information
becomes available. As of December 31, 2006, the Company's accrual for contingent
losses was not material.
(b) Consolidation Policy: The consolidated financial statements include the
accounts of the Company, all variable interest entities of which the Company or
a subsidiary is the primary beneficiary, and all majority-controlled entities
that are not variable interest entities. All intercompany transactions and
balances are eliminated in consolidation.
F-10
2. Significant Accounting Policies, continued:
-------------------------------
Associated companies are investments in equity interests that are accounted for
on the equity method of accounting. These include investments in corporations
that the Company does not control but has the ability to exercise significant
influence, investments in limited partnerships in which the Company's interest
is more than minor and its investment in Premier Entertainment Biloxi, LLC
("Premier"), as discussed more fully below.
(c) Cash Equivalents: The Company considers short-term investments, which have
maturities of less than three months at the time of acquisition, to be cash
equivalents. Cash and cash equivalents include short-term investments of
$158,100,000 and $295,600,000 at December 31, 2006 and 2005, respectively.
(d) Investments: At acquisition, marketable debt and equity securities are
designated as either i) held to maturity, which are carried at amortized cost,
ii) trading, which are carried at estimated fair value with unrealized gains and
losses reflected in results of operations, or iii) available for sale, which are
carried at estimated fair value with unrealized gains and losses reflected as a
separate component of shareholders' equity, net of taxes. Equity securities that
do not have readily determinable fair values are carried at cost. The cost of
securities sold is based on average cost.
Held to maturity investments are made with the intention of holding such
securities to maturity, which the Company has the ability to do. Estimated fair
values are principally based on quoted market prices.
(e) Property, Equipment and Leasehold Improvements: Property, equipment and
leasehold improvements are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are provided principally on the
straight-line method over the estimated useful lives of the assets or, if less,
the term of the underlying lease.
(f) Revenue Recognition: Revenues are recognized when the following conditions
are met: (1) collectibility is reasonably assured; (2) title to the product has
passed or the service has been rendered and earned; (3) persuasive evidence of
an arrangement exists; and (4) there is a fixed or determinable price.
Manufacturing revenues are recognized when title passes, which for Idaho Timber
is generally upon the customer's receipt of the goods and for Conwed Plastics
upon shipment of goods. Revenue from the sale of real estate is generally
recognized when title passes; however, if the Company is obligated to make
improvements to the real estate subsequent to closing, a portion of revenues are
deferred and recognized under the percentage of completion method of accounting.
(g) Cost of Sales: Manufacturing inventories are stated at the lower of cost or
market, with cost determined under the first-in-first-out method. Manufacturing
cost of sales principally includes product and manufacturing costs, inbound and
outbound shipping costs and handling costs.
(h) Research and Development Costs: Research and development costs are expensed
as incurred.
(i) Income Taxes: The Company provides for income taxes using the liability
method. The future benefit of certain tax loss carryforwards and future
deductions is recorded as an asset. A valuation allowance is provided if
deferred tax assets are not considered to be more likely than not to be
realized.
(j) Derivative Financial Instruments: The Company reflects its derivative
financial instruments in its balance sheet at fair value. The Company has
utilized derivative financial instruments to manage the impact of changes in
interest rates on certain debt obligations, hedge net investments in foreign
subsidiaries and manage foreign currency risk on certain available for sale
securities. Although the Company believes that these derivative financial
instruments are practical economic hedges of the Company's risks, except for the
hedge of the net investment in foreign subsidiaries, they do not meet the
effectiveness criteria under GAAP, and therefore are not accounted for as
hedges.
F-11
2. Significant Accounting Policies, continued:
-------------------------------
Amounts recorded as income in investment and other income as a result of
accounting for its derivative financial instruments were $1,200,000 and
$1,700,000 for the years ended December 31, 2006 and 2005, respectively, and not
material for 2004. Net unrealized losses on derivative instruments were
$1,200,000 and $1,000,000 at December 31, 2006 and 2005, respectively.
(k) Translation of Foreign Currency: Foreign currency denominated investments
and financial statements are translated into U.S. dollars at current exchange
rates, except that revenues and expenses are translated at average exchange
rates during each reporting period; resulting translation adjustments are
reported as a component of shareholders' equity. Net foreign exchange
transaction losses were $2,700,000 for each of 2006 and 2005, and not material
for 2004. Net unrealized foreign exchange translation gains (losses) were
$900,000, $(2,900,000) and $14,300,000 at December 31, 2006, 2005 and 2004,
respectively.
(l) Share-Based Compensation: Effective January 1, 2006, the Company adopted
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment"
("SFAS 123R"), using the modified prospective method. SFAS 123R requires that
the cost of all share-based payments to employees, including grants of employee
stock options and warrants, be recognized in the financial statements based on
their fair values. The cost is recognized as an expense over the vesting period
of the award. Prior to adoption of SFAS 123R, no compensation cost was
recognized in the statements of operations for the Company's share-based
compensation plans; the Company disclosed certain pro forma amounts as required.
The fair value of each award is estimated at the date of grant using the
Black-Scholes option pricing model.
(m) Recently Issued Accounting Standards: In June 2006, the Financial Accounting
Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN
48"), which prescribes the accounting for and disclosure of uncertainty in
income tax positions. FIN 48 defines the criteria that must be met before any
part of the benefit of a tax position can be recognized in the financial
statements, provides guidance for the measurement of tax benefits recognized and
guidance for classification and disclosure. FIN 48 is effective for fiscal years
beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings. The
Company continues to evaluate the impact of adopting FIN 48 on its consolidated
financial statements but does not expect it to be material; however, additional
footnote disclosures will be required.
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007. The Company is currently evaluating the impact of adopting
SFAS 157 on its consolidated financial statements.
3. Acquisitions:
-------------
Premier
During 2006, the Company indirectly acquired a controlling voting interest in
Premier for an aggregate purchase price of $90,800,000, excluding expenses. The
Company owns approximately 46% of the common units of Premier and all of
Premier's preferred units, which accrue an annual preferred return of 17%. The
Company also acquired Premier's junior subordinated note due August 2012, with
an outstanding balance at acquisition of $13,400,000, and has made an $8,100,000
12% loan to Premier that matures in May 2007. All of Premier's equity interests
are pledged to secure repayment of Premier's outstanding $160,000,000 principal
amount of 10 3/4% First Mortgage Notes due February 1, 2012 (the "Premier
Notes"). In addition, the Company agreed to provide up to $40,000,000 of
construction financing to Premier's general contractor by purchasing the
contractor's receivables from Premier if the receivables are more than ten days
past due ($11,300,000 is outstanding at December 31, 2006). At acquisition, the
Company consolidated Premier as a result of its controlling voting interest.
F-12
3. Acquisitions, continued:
------------
Premier owns the Hard Rock Hotel & Casino Biloxi ("Hard Rock Biloxi"), located
in Biloxi, Mississippi, which was severely damaged by Hurricane Katrina and
which is currently being rebuilt. Prior to Hurricane Katrina, Premier purchased
a comprehensive blanket insurance policy providing up to $181,100,000 in
coverage for damage to real and personal property, including business
interruption coverage. Premier has received payments from various insurance
carriers aggregating $160,900,000 with respect to $168,200,000 face amount of
coverage; the remaining $12,900,000 face amount of coverage has not been settled
and is currently in litigation. All insurance settlements have been placed on
deposit into restricted accounts under the control of the indenture trustee of
the Premier Notes.
On September 19, 2006, Premier and its subsidiary filed voluntary petitions for
reorganization under chapter 11 of title 11 of the United States Bankruptcy Code
(the "Bankruptcy Code"). Premier filed its petitions in order to seek the
Court's assistance in gaining access to Hurricane Katrina-related insurance
proceeds which had been denied to Premier by its pre-petition secured
bondholders. Premier continues to operate its business as "debtors in
possession" under the jurisdiction of the Court and in accordance with the
applicable provisions of the Bankruptcy Code and orders of the Court. The
Company deconsolidated Premier effective with the filing of the voluntary
petitions, and has classified its net investment in Premier as an investment in
an associated company ($125,600,000 as of December 31, 2006, including all loans
and equity interests). The bankruptcy filings were made to give Premier access
to the insurance proceeds, the proceedings are not expected to last for an
extended period and creditors are expected to receive the amounts owed to them.
For these reasons, the Company believes that the application of the equity
method of accounting during the pendency of the bankruptcy proceedings is
appropriate. The Company has also committed to provide up to $180,000,000 to
finance Premier's plan of reorganization, which would principally be used to
pay-off the Premier Notes. Upon its emergence from bankruptcy proceedings, the
Company expects that Premier will be accounted for as a consolidated subsidiary.
Summarized financial information for Premier as of December 31, 2006 is as
follows (in thousands):
Assets:
Current assets $ 8,693
Non-current assets (a) 323,898
-----------
Total assets $ 332,591
===========
Liabilities:
Current liabilities (b) $ 206,963
Non-current liabilities 8
-----------
Total liabilities 206,971
-----------
Shareholders' equity 125,620
-----------
Total liabilities and shareholders' equity $ 332,591
===========
(a) Includes $11,900,000 of intangible assets, $175,400,000 of net property
and equipment and $134,200,000 of restricted cash, substantially all of
which is held by the indenture trustee of the Premier Notes.
(b) Includes bonds and notes payable of $174,700,000.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino, which was
a facility built on floating barges, and caused significant damage to the hotel
and related structures. The threat of hurricanes remains a risk to the existing
facilities and to the new casino, which will be constructed over water on
concrete pilings that will greatly improve the structural integrity of the
facility. In July 2006, Premier purchased a new insurance policy providing up to
$149,300,000 in coverage for damage to real and personal property and up to the
lesser of six months or $30,000,000 of business interruption and delayed opening
coverage. The coverage is syndicated through several insurance carriers, each
with an A.M. Best rating of A- (Excellent) or better. The policy provides
coverage for the existing structures, as well as for the repair and rebuild of
the hotel, low rise building and parking garage and the construction of the new
casino.
F-13
3. Acquisitions, continued:
------------
Although the insurance policy is an "all risk" policy, weather catastrophe
occurrence ("WCO"), which is defined to include damage caused by a named storm,
is limited to $50,000,000 with a deductible equal to the greater of $7,000,000
or 5% of total insured values at risk. WCO coverage is subject to mandatory
reinstatement of coverage for an additional pre-determined premium.
Premier's current insurance policy expires in July 2007; Premier expects it will
purchase new insurance coverage that will be in effect for the balance of the
2007 hurricane season. Premiums for WCO policies have increased dramatically as
a result of Hurricane Katrina, and the amount of coverage that can be purchased
has also been reduced as insurance companies seek to reduce their exposure to
such events. Premier cannot currently estimate how much insurance will be
available to it at an acceptable premium.
NSW, LLC U.S. ("NSW")
In February 2005, Conwed Plastics acquired the assets of NSW for a purchase
price of approximately $26,600,000; based upon its allocation of the purchase
price the Company recorded an aggregate of $10,200,000 of intangible assets and
$8,200,000 of goodwill. NSW has a manufacturing and distribution facility in
Roanoke, Virginia, which manufactures a variety of products including produce
and packaging nets, header label bags, case liners and heavy weight nets for
drainage and erosion control purposes. For more information concerning
intangible assets and goodwill, see Note 8.
Idaho Timber
In May 2005, the Company acquired Idaho Timber for total cash consideration of
$133,600,000, including working capital adjustments and expenses, and has
consolidated Idaho Timber from the date of acquisition. Based upon its
allocation of the purchase price, the Company recorded Idaho Timber intangible
assets of $45,100,000.
INTL
In July 2004, the Company invested $50,000,000 in INTL Consilium Emerging Market
Absolute Return Fund, LLC ("INTL"), a limited liability company that is invested
in a master fund which primarily invests in emerging markets debt and equity
securities. INTL and the master fund are managed and controlled by an investment
manager who has full discretion over investment and operating decisions. In
accordance with FASB Interpretation No. 46R, "Consolidation of Variable Interest
Entities", INTL is a variable interest entity and the Company is currently the
primary beneficiary; as a result, the Company accounts for its investment in
INTL as a consolidated subsidiary. In October 2004, the Company invested an
additional $25,000,000 in INTL. In December 2006, the Company redeemed
$10,000,000 of its investment and has requested an additional redemption of
$40,000,000 during the first quarter of 2007. The redemption in 2007 may result
in the Company deconsolidating INTL and classifying its remaining investment as
an investment in an associated company. At December 31, 2006, INTL had total
assets of $95,300,000 which are primarily reflected as investments in the
Company's consolidated balance sheet, and its liabilities were not material.
The creditors of INTL have recourse only to the assets of INTL and do not have
recourse to any other assets of the Company. The Company can generally withdraw
its capital account interest upon 90 days notice, subject to the manager's
ability to liquidate security positions in an orderly manner. The Company
recorded $5,100,000, $9,900,000 and $2,200,000 of pre-tax income relating to
INTL for the years ended December 31, 2006, 2005 and 2004, respectively.
F-14
4. Investments in Associated Companies:
----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as equity in income (losses) of associated companies in the
consolidated statements of operations are net of income tax provisions of
$22,400,000, $700,000 and $15,000,000 for the years ended December 31, 2006,
2005 and 2004, respectively. Included in consolidated retained earnings at
December 31, 2006 is approximately $65,600,000 of undistributed earnings of the
associated companies.
Goober Drilling, LLC ("Goober")
In the second quarter of 2006, the Company acquired a 30% limited liability
company interest in Goober for aggregate consideration of $60,000,000, excluding
expenses, and agreed to lend to Goober, on a secured basis, up to $126,000,000
(all of which was loaned at December 31, 2006) to finance new rig equipment
purchases and construction costs and to repay existing debt. Goober is a land
based contract oil and gas drilling company based in Stillwater, Oklahoma that
provides land based drilling services to exploration and production companies in
the Mid-Continent Region of the U.S., primarily in Oklahoma and Texas. In
January 2007, the loan facility was further amended to increase the interest
rate on the facility to LIBOR plus 5%, and to provide Goober with an additional
secured credit facility for up to $45,000,000 at an interest rate of LIBOR plus
10%. In addition, the Company increased its equity interest in Goober to 42% for
an additional equity investment of $25,000,000. The additional funding was
required primarily due to increased raw material and labor costs to construct
the new rigs and working capital needs due to delays in rig construction. For
the year ended December 31, 2006, the Company recorded $2,000,000 of pre-tax
income from this investment under the equity method of accounting.
The Company's investment in Goober exceeds the Company's share of its underlying
net assets by approximately $36,000,000 at December 31, 2006. Substantially all
of this excess is being amortized over a three to fifteen year period.
Cobre Las Cruces, S.A. ("CLC")
CLC is a Spanish company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet Mining Corporation
("Inmet"), a Canadian-based global mining company traded on the Toronto stock
exchange (Symbol: IMN). Inmet acquired the interest in CLC in exchange for
5,600,000 newly issued Inmet common shares, representing approximately 11.6% of
Inmet's current outstanding common shares. The Inmet shares were recorded at
their fair value of approximately $78,000,000, and the Company recorded a
pre-tax gain on the sale of $10,500,000, which is reflected in the caption
investment and other income. For more information on the Inmet shares, see Note
6. The Company retains a 30% interest in CLC.
CLC entered into an agreement with third party lenders for project financing
consisting of a ten year senior secured credit facility of up to $240,000,000
and a senior secured bridge credit facility of up to (euro)69,000,000 to finance
subsidies and value-added tax. The Company and Inmet have guaranteed 30% and
70%, respectively, of the obligations outstanding under both facilities until
completion of the project as defined in the project financing agreement. At
December 31, 2006 approximately $74,200,000 was outstanding under the senior
secured credit facility and (euro)21,000,000 was outstanding under the senior
secured bridge credit facility. The Company and Inmet have also committed to
provide financing to CLC which is currently estimated to be (euro)156,000,000
($205,000,000 at exchange rates in effect on February 15, 2007), of which the
Company's share will be 30% ($26,100,000 of which has been loaned as of December
31, 2006). For the years ended December 31, 2006 and 2005, the Company recorded
pre-tax income (losses) of $3,800,000 and $(1,600,000), respectively, from this
investment under the equity method of accounting.
F-15
4. Investments in Associated Companies, continued:
-----------------------------------
HomeFed Corporation ("HomeFed")
During 2002, the Company sold one of its real estate subsidiaries, CDS Holding
Corporation ("CDS"), to HomeFed for a purchase price of $25,000,000, consisting
of $1,000,000 in cash and 2,474,226 shares of HomeFed's common stock, which
represented approximately 30% of HomeFed's outstanding common stock. For the
years ended December 31, 2006, 2005 and 2004, the Company recorded $2,900,000,
$5,800,000 and $10,000,000, respectively, of pre-tax income from this investment
under the equity method of accounting. HomeFed is engaged, directly and through
subsidiaries, in the investment in and development of residential real estate
projects in the State of California. HomeFed is a public company traded on the
NASD OTC Bulletin Board (Symbol: HOFD).
As a result of a 1998 distribution to all of the Company's shareholders,
approximately 7.3% and 8.2% of HomeFed is owned by the Company's Chairman and
President, respectively. Both are also directors of HomeFed and the Company's
President serves as HomeFed's Chairman.
Jefferies Partners Opportunity Fund II, LLC ("JPOF II")
During 2000, the Company invested $100,000,000 in the equity of JPOF II, a
limited liability company, which is a registered broker-dealer. JPOF II is
managed by Jefferies & Company, Inc. ("Jefferies"), a full service investment
bank to middle market companies. JPOF II invests in high yield securities,
special situation investments and distressed securities and provides trading
services to its customers and clients. For the years ended December 31, 2006,
2005 and 2004, the Company recorded $26,200,000, $23,600,000 and $16,200,000,
respectively, of pre-tax income from this investment under the equity method of
accounting. These earnings were distributed by JPOF II as dividends shortly
after the end of each year.
Wintergreen Partners Fund, L.P. ("Wintergreen")
The Company has invested an aggregate of $50,000,000 in Wintergreen, a limited
partnership that invests in domestic and foreign debt and equity securities. For
the years ended December 31, 2006 and 2005, the Company recorded $11,000,000 and
$500,000, respectively, of pre-tax income from this investment under the equity
method of accounting. At December 31, 2006, the book value of the Company's
investment in Wintergreen was $61,500,000.
EagleRock Capital Partners (QP), LP ("EagleRock")
During 2001, the Company invested $50,000,000 in EagleRock, a limited
partnership that invests and trades in securities and other investment vehicles.
At December 31, 2006, the book value of the Company's equity investment in
EagleRock was $60,400,000, which is net of aggregate distributions of
$48,200,000 that were received during 2006 and $3,700,000 in 2004. The Company
is currently in discussions with EagleRock as to the timing and manner in which
the Company's remaining investment will be remitted by EagleRock to the Company.
Pre-tax income (losses) of $16,400,000, $(28,900,000) and $29,400,000 for the
years ended December 31, 2006, 2005 and 2004, respectively, were recorded from
this investment under the equity method of accounting.
Safe Harbor Domestic Partners L.P. ("Safe Harbor")
In January 2006, the Company invested $50,000,000 in Safe Harbor, a limited
partnership which will principally invest in the securities of Japanese public
companies. For the year ended December 31, 2006, the Company recorded $7,600,000
of pre-tax losses from this investment under the equity method of accounting.
F-16
4. Investments in Associated Companies, continued:
-----------------------------------
Union Square
Union Square, two entities in which the Company had non-controlling equity
interests, sold their respective interests in an office complex located on
Capitol Hill in Washington, D.C. during 2005. Including repayment of its
mortgage loans at closing, the Company's share of the net proceeds was
$73,200,000, and the Company recognized a pre-tax gain of $72,300,000 for the
year ended December 31, 2005.
Olympus Re Holdings, Ltd. ("Olympus")
During 2001, the Company invested $127,500,000 for a 25% common stock interest
in Olympus, a newly formed Bermuda reinsurance company primarily engaged in the
property excess, marine and aviation reinsurance business. In 2003, the Company
sold a portion of its common shares of Olympus back to Olympus for total
proceeds of $79,500,000 as part of an issuer tender offer available to all of
its shareholders.
During 2005, Olympus recorded significant losses as a result of estimated
insurance claims from Hurricanes Katrina, Rita and Wilma. In early 2006, Olympus
raised a significant amount of new equity to replace some, but not all of the
capital that was lost as a result of the 2005 hurricanes. Since the Company did
not invest additional capital in Olympus, its equity interest was diluted (to
less than 4%) such that it no longer applied the equity method of accounting for
this investment subsequent to December 31, 2005. For the years ended December
31, 2005 and 2004, the Company recorded $(120,100,000) and $9,700,000,
respectively, of pre-tax income (losses) from this investment under the equity
method of accounting. In addition, during 2005, the Company recorded an
impairment loss of $3,700,000 to reduce the book value of its investment to
zero.
Pershing Square, L.P. ("Pershing")
In January 2004, the Company invested $50,000,000 in Pershing, a limited
partnership that is authorized to engage in a variety of investing activities.
The Company redeemed its interest as of December 31, 2004, and the total amount
due from Pershing of $71,300,000 was paid during the first quarter of 2005.
The following table provides summarized data with respect to the Associated
Companies accounted for on the equity method of accounting included in results
of operations for the three years ended December 31, 2006. (Amounts are in
thousands.)
2006 2005
---- ----
Assets $ 3,553,900 $ 2,750,800
Liabilities 1,980,500 1,873,300
----------- -----------
Net assets $ 1,573,400 $ 877,500
=========== ===========
The Company's portion of the reported net assets $ 770,800 $ 379,100
=========== ===========
2006 2005 2004
---- ---- ----
Total revenues $ 640,400 $ 984,400 $ 916,900
Income (loss) from continuing operations before
extraordinary items $ 214,600 $ (484,200) $ 223,200
Net income (loss) $ 214,600 $ (484,200) $ 223,200
The Company's equity in net income (loss) $ 60,100 $ (44,400) $ 91,500
Except for its investment in CLC, the Company has not provided any guarantees,
nor is it contingently liable for any of the liabilities reflected in the above
table. All such liabilities are non-recourse to the Company. The Company's
exposure to adverse events at the investee companies is limited to the book
value of its investment.
F-17
5. Discontinued Operations:
-----------------------
Symphony
In July 2006, the Company sold Symphony to RehabCare Group, Inc. for
approximately $107,000,000. After satisfaction of Symphony's outstanding credit
agreement by the buyer ($31,700,000 at date of sale) and certain sale related
obligations, the Company realized net cash proceeds of $62,300,000 and recorded
a pre-tax gain on sale of discontinued operations of $53,300,000 ($33,500,000
after tax).
The Company has not classified Symphony's assets and liabilities as discontinued
operations because the balances are not material. Summarized information for
Symphony's assets and liabilities at December 31, 2005 is as follows (in
thousands):
Current assets $ 52,470
Non-current assets 3,165
---------
Total assets $ 55,635
=========
Current liabilities $ 45,262
Non-current liabilities 280
---------
Total liabilities $ 45,542
=========
At December 31, 2005, current assets principally consisted of trade receivables
and current liabilities principally consisted of trade payables and amounts due
under Symphony's credit agreement.
ATX
In September 2006, the Company sold ATX to Broadview Networks Holdings, Inc. for
aggregate cash consideration of approximately $85,700,000 and recorded a pre-tax
gain on sale of discontinued operations of $41,600,000 ($26,100,000 after tax).
The Company has not classified ATX's assets and liabilities as discontinued
operations because the balances are not material. Summarized information for
ATX's assets and liabilities at December 31, 2005 is as follows (in thousands):
Current assets $ 40,308
Non-current assets 48,550
---------
Total assets $ 88,858
=========
Current liabilities $ 32,479
Non-current liabilities 2,001
---------
Total liabilities $ 34,480
=========
At December 31, 2005, current assets principally consisted of cash and trade
receivables, non-current assets principally consisted of property and equipment
and intangible assets and goodwill, and current liabilities principally
consisted of trade payables.
F-18
5. Discontinued Operations, continued:
-----------------------
WilTel Communications Group, LLC ("WilTel")
In December 2005, the Company sold WilTel to Level 3 Communications, Inc.
("Level 3") for aggregate cash consideration of $460,300,000 (net of estimated
working capital adjustments of approximately $25,500,000), and 115,000,000 newly
issued shares of Level 3 common stock. In connection with the sale, the Company
retained certain assets and liabilities of WilTel that were not purchased by
Level 3. The retained assets include (i) WilTel's headquarters building
(including the adjacent parking garage) located in Tulsa, Oklahoma, (ii) cash
and cash equivalents in excess of $100,000,000, (iii) corporate aircraft and
related capital lease obligations, and (iv) marketable securities. In addition,
the Company retained all of WilTel's right to receive certain cash payments from
AT&T Inc. (formerly SBC Communications Inc.) totaling $236,000,000, of which
$37,500,000 was received prior to closing and the balance was received during
2006. Prior to the closing, WilTel repaid its long-term debt obligations using
its funds, together with $220,000,000 of funds advanced by the Company. The
retained liabilities also include WilTel's defined benefit pension plan and
supplemental retirement plan obligation and certain other employee related
liabilities. The agreement with Level 3 requires that all parties make the
appropriate filings to treat the purchase of WilTel as a purchase of assets for
federal, state and local income and franchise tax purposes. As a result,
WilTel's net operating loss carryforwards ("NOLs"), as well as any tax losses
generated by the sale, remained with the Company. For more information on the
Company's NOLs, see Note 16.
The Company recorded a pre-tax gain on disposal of WilTel of $243,800,000
($243,800,000 after tax). The calculation of the gain on sale included: (1) the
cash proceeds received from Level 3, net of estimated working capital
adjustments; (2) the fair value of the Level 3 common shares of $339,300,000,
based on the $2.95 per share closing price of Level 3 common stock immediately
prior to closing; (3) the amount of the AT&T cash payments that had not been
previously accrued prior to closing ($175,900,000); (4) an impairment charge for
WilTel's headquarters building described below; and (5) the net book value of
the net assets sold and estimated expenses and other costs related to the
transaction.
The Company concluded that the change in the use of WilTel's former headquarters
facility to a property held for investment was a change in circumstances which
indicated that the carrying amount of the facility might not be recoverable. On
the closing date of the sale to Level 3, the carrying amount of the facility was
$96,500,000; based on the assumptions discussed below the Company concluded that
the carrying amount was not recoverable, and an impairment loss of $42,400,000
was recorded reducing the gain on disposal of discontinued operations.
The facility is a fifteen story, 740,000 square foot office building located in
downtown Tulsa, Oklahoma for which construction was substantially completed in
2001, with a total of approximately 640,000 rentable square feet. Approximately
236,000 square feet of the rentable space is leased to various tenants under
primarily short-term leases that expire at the end of 2008, subject to renewal
options. The building is considered to be Class A office space, and the Company
believes that the best value for the building would be obtained by selling the
building to an owner/occupant. The facility is being marketed for sale at a
gross selling price of $80,000,000, including furniture, fixtures and equipment.
The Company utilized a discounted cash flow technique to determine the fair
value of the facility. In order to estimate the amount which could ultimately be
realized upon the sale of the facility, the Company had a market analysis
prepared of sales and leasing activity for the downtown Tulsa market. The
analysis identified the range of historical selling prices for properties of
comparable quality, including the age, size and occupancy rates of the
properties sold, properties currently available for sale or lease, current
market occupancy rates and recent leasing rates. Since the facility is being
marketed to an owner/occupant, the cash flow estimates reflect that it may take
from two to five years before a buyer is identified and the facility can be
sold. The cash flow estimates assume that tenants will only fulfill their
minimum rental commitment; the Company did not assume that space which is
currently vacant will be leased, which results in negative operating cash flow
prior to sale. The Company's cash flow estimates reflect a range of possible
outcomes since the timing of the sale and the ultimate price that the Company
will realize for the facility is uncertain.
F-19
5. Discontinued Operations, continued:
-----------------------
For the year ended December 31, 2006, gain on disposal of discontinued
operations includes $2,400,000 of pre-tax gains ($1,500,000 after tax)
principally for the resolution of certain sale-related contingencies and
obligations and working capital adjustments related to WilTel.
Real Estate
In May 2005, the Company sold its 716-room Waikiki Beach hotel and related
assets for an aggregate purchase price of $107,000,000, before closing costs and
other required payments. After satisfaction of mortgage indebtedness on the
hotel of $22,100,000 at closing, the Company received net cash proceeds of
approximately $73,000,000, and recorded a pre-tax gain of $56,600,000
($56,600,000 after tax) reflected in discontinued operations for the year ended
December 31, 2005. Historical operating results for the hotel were not material.
In October 2004, the Company sold a commercial real estate property and
classified it as a discontinued operation. During the second quarter of 2004,
the Company recorded a non-cash charge of approximately $7,100,000 to reduce the
carrying amount of this property to its estimated fair value. The Company
recorded an additional pre-tax loss of $600,000 when the sale closed, resulting
principally from mortgage prepayment penalties incurred upon satisfaction of the
property's mortgage.
Other
Gain on disposal of discontinued operations for 2006 includes a pre-tax loss of
$900,000 from the sale of the Company's gas properties during the third quarter.
Income (loss) from discontinued operations for 2006 includes $2,900,000 of
pre-tax losses related to these gas properties; amounts for the 2005 and 2004
periods were not material.
In 2006, the Company received $3,000,000 from a former insurance subsidiary
which, for many years, has been undergoing liquidation proceedings controlled by
state insurance regulators. The Company reflected the amount received as a gain
on disposal of discontinued operations. For income tax purposes, the payment is
treated as a non-taxable distribution paid by a subsidiary; as a result, no tax
expense has been recorded.
In December 2005, the Company sold its interest in an Argentine shoe
manufacturer that had been acquired earlier in the year. Although there was no
material gain or loss on disposal, results of discontinued operations during
2005 include a pre-tax loss of $4,400,000 ($4,400,000 after tax).
In the fourth quarter of 2004, the Company sold its geothermal power business
and classified it as a discontinued operation. The Company received proceeds of
$14,800,000, net of closing costs, and recognized a pre-tax gain of $200,000.
During 2004, the Company recorded $2,200,000 as gain on disposal of discontinued
operations (net of minority interest), which represented the estimated fair
value of warrants whose vesting criteria became satisfied. These warrants had
been received during 2003 as part of the sales proceeds from the discontinued
operations of WebLink Wireless, Inc. The gain was not reduced for any federal
income tax expense due to WebLink's large net operating loss carryforwards.
A summary of the results of discontinued operations is as follows for the three
year period ended December 31, 2006 (in thousands):
F-20
5. Discontinued Operations, continued:
-----------------------
2006 2005 2004
---- ---- ----
Revenues and other income:
Telecommunications revenues $ 118,987 $ 1,855,130 $ 1,582,948
Healthcare revenues 110,370 239,046 257,262
Investment and other income 2,790 116,006 42,404
Net securities gains -- 3,483 6,372
-------------- -------------- -------------
232,147 2,213,665 1,888,986
-------------- -------------- -------------
Expenses:
Telecommunications cost of sales 72,231 1,290,409 1,129,248
Healthcare cost of sales 95,628 203,149 216,333
Interest 1,321 30,389 36,612
Salaries 26,889 180,348 153,069
Depreciation and amortization 10,018 171,395 208,495
Selling, general and other expenses 29,888 222,679 205,037
-------------- -------------- -------------
235,975 2,098,369 1,948,794
-------------- -------------- -------------
Income (loss) from discontinued operations before income taxes (3,828) 115,296 (59,808)
Income tax provision (benefit) 132 (33) 352
-------------- -------------- -------------
Income (loss) from discontinued operations, net of taxes $ (3,960) $ 115,329 $ (60,160)
============== ============== =============
6. Investments:
-----------
A summary of investments classified as current assets at December 31, 2006 and
2005 is as follows (in thousands):
2006 2005
------------------------------ -------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- ------------ -------- ----------
Investments available for sale $ 803,034 $ 809,927 $ 1,206,973 $ 1,206,195
Trading securities 79,526 80,321 103,978 105,541
Other investments, including accrued interest income 13,725 13,725 11,826 11,826
--------- ---------- ----------- -----------
Total current investments $ 896,285 $ 903,973 $ 1,322,777 $ 1,323,562
========= ========== =========== ===========
F-21
6. Investments, continued:
-----------
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2006 and 2005 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
2006
----
Bonds and notes:
United States Government and agencies $ 440,375 $ 99 $ 155 $ 440,319
U.S. Government-Sponsored Enterprises 192,357 2 100 192,259
All other corporates 165,396 5,202 56 170,542
----------- ------- ------- -----------
Total fixed maturities 798,128 5,303 311 803,120
----------- ------- ------- -----------
Equity securities:
Industrial, miscellaneous and all other 4,906 1,901 -- 6,807
----------- ------- ------- -----------
Total equity securities 4,906 1,901 -- 6,807
----------- ------- ------- -----------
Total $ 803,034 $ 7,204 $ 311 $ 809,927
=========== ======= ======= ===========
2005
----
Bonds and notes:
United States Government and agencies $ 818,967 $ 107 $ 597 $ 818,477
U.S. Government-Sponsored Enterprises 199,030 17 377 198,670
Foreign governments 1,503 17 -- 1,520
All other corporates 187,473 476 421 187,528
----------- ------- ------- -----------
Total $ 1,206,973 $ 617 $ 1,395 $ 1,206,195
=========== ======= ======= ===========
Trading securities at December 31, 2006 and 2005 is comprised of other
investments, principally INTL's investment in a master fund.
A summary of non-current investments at December 31, 2006 and 2005 is as follows
(in thousands):
2006 2005
--------------------------- ----------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Investments available for sale $ 1,131,198 $ 1,283,261 $ 762,178 $ 825,716
Other investments 182,588 182,588 151,611 151,611
----------- ----------- ---------- ----------
Total non-current investments $ 1,313,786 $ 1,465,849 $ 913,789 $ 977,327
=========== =========== ========== ==========
Other non-current investments include 5,600,000 common shares of Inmet, which
have a cost and carrying value of $78,000,000 at December 31, 2006 and 2005.
Although the Inmet shares have registration rights, they may not be sold until
the earlier of August 2009 or the date on which the Company is no longer
obligated under the guarantee of CLC's credit facilities. At acquisition, the
fair value of the Inmet common stock was determined to be approximately 90% of
the then current trading price as a result of these transferability
restrictions. The Inmet shares will be carried at the initially recorded value
(unless there is an other than temporary impairment) until one year prior to the
termination of the transfer restrictions. At December 31, 2006, the market value
of the Inmet shares is approximately $299,800,000.
In August 2006, pursuant to a subscription agreement with Fortescue Metals Group
Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd ("FMG"), the
Company invested an aggregate of $408,000,000, including expenses, in
Fortescue's Pilbara iron ore and infrastructure project in Western Australia.
Fortescue is a publicly traded company on the Australian Stock Exchange, and the
shares acquired by the Company may be sold without restriction (Symbol: FMG).
F-22
6. Investments, continued:
-----------
In exchange for its cash investment, the Company received 26,400,000 common
shares of Fortescue, representing approximately 9.99% of the outstanding
Fortescue common stock, and a 13 year, $100,000,000 note of FMG. Interest on the
note is calculated as 4% of the revenue, net of government royalties, invoiced
from the iron ore produced from the project's Cloud Break and Christmas Creek
areas only. The note is unsecured and subordinate to the project's senior
secured debt. At the date of acquisition, the Company's investment in
Fortescue's common shares was recorded at its aggregate fair value, based on the
closing price of Fortescue's common shares on that date. Subsequent to
acquisition, the Company's investment in the Fortescue common shares are
classified as a non-current available for sale investment and carried at market
value as of each balance sheet date. At December 31, 2006, the market value of
the Fortescue common shares was $276,300,000.
For accounting purposes, the Company bifurcated its remaining investment into a
13 year zero-coupon note and a prepaid mining interest. The zero-coupon note was
recorded at an estimated initial fair value of $21,600,000, representing the
present value of the principal amount discounted at 12.5%. The prepaid mining
interest of $184,300,000 has been classified with other non-current assets, and
will be amortized to expense as the 4% of revenue is earned.
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2006
and 2005 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
2006
----
Bonds and notes:
United States Government and agencies $ 61,098 $ -- $ 850 $ 60,248
U.S. Government-Sponsored Enterprises 337,397 612 4,366 333,643
States, municipalities and political subdivisions 50 -- -- 50
All other corporates 153,175 6,508 291 159,392
----------- ---------- ------- -----------
Total fixed maturities 551,720 7,120 5,507 553,333
----------- ---------- ------- -----------
Equity securities:
Preferred stocks 8,331 35 -- 8,366
Common stocks:
Banks, trusts and insurance companies 12,340 9,744 -- 22,084
Industrial, miscellaneous and all other 558,807 142,876 2,205 699,478
----------- ---------- ------- -----------
Total equity securities 579,478 152,655 2,205 729,928
----------- ---------- ------- -----------
$ 1,131,198 $ 159,775 $ 7,712 $ 1,283,261
=========== ========== ======= ===========
2005
----
Bonds and notes:
United States Government and agencies $ 39,037 $ 25 $ 584 $ 38,478
U.S. Government-Sponsored Enterprises 141,265 106 1,428 139,943
All other corporates 160,190 37,677 1,675 196,192
----------- ---------- ------- -----------
Total fixed maturities 340,492 37,808 3,687 374,613
----------- ---------- ------- -----------
Equity securities:
Preferred stocks 5,569 -- 118 5,451
Common stocks:
Banks, trusts and insurance companies 12,340 10,010 -- 22,350
Industrial, miscellaneous and all other 403,777 28,817 9,292 423,302
----------- ---------- ------- -----------
Total equity securities 421,686 38,827 9,410 451,103
----------- ---------- ------- -----------
$ 762,178 $ 76,635 $13,097 $ 825,716
=========== ========== ======= ===========
F-23
6. Investments, continued:
-----------
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2006, by contractual maturity,
are shown below. Expected maturities are likely to differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Estimated
Amortized Fair
Cost Value
---- -----
(In thousands)
Due after one year through five years $ 121,077 $ 125,584
Due after five years through ten years 6,181 6,219
Due after ten years 55,608 57,266
---------- ----------
182,866 189,069
Mortgage-backed securities 368,854 364,264
---------- ----------
$ 551,720 $ 553,333
========== ==========
Non-current available for sale equity securities at December 31, 2005 included
115,000,000 shares of Level 3 common stock received in connection with the sale
of WilTel (see Note 5), with a cost of $339,300,000 and an estimated fair value
of $330,100,000. During 2006, the Company sold all of its shares of Level 3
common stock for total proceeds of $376,600,000 and recorded a pre-tax gain of
$37,400,000.
During 2005, the Company sold all 375,000 common shares of White Mountains
Insurance Group, Ltd. ("WMIG") that it owned, and recorded a security gain of
$146,000,000. The Company purchased the shares in 2001 for $75,000,000.
Net unrealized gains (losses) on investments were $37,800,000, $(22,400,000) and
$153,200,000 at December 31, 2006, 2005 and 2004, respectively. Reclassification
adjustments included in comprehensive income for the three year period ended
December 31, 2006 are as follows (in thousands):
2006 2005 2004
---- ---- ----
Unrealized holding gains (losses) arising during the period, net of
taxes of $48,799, $0 and $0 $ 86,004 $ 12,707 $ (26,623)
Less: reclassification adjustment for (gains) losses included in net
income, net of taxes of $14,650, $0 and $0 (25,817) (188,284) 18,031
----------- --------- ----------
Net change in unrealized gains (losses) on investments, net of taxes
of $34,149, $0 and $0 $ 60,187 $(175,577) $ (8,592)
=========== ========= ==========
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category, all of which have been in a
continuous unrealized loss position for less than 12 months, at December 31,
2006 (in thousands):
Unrealized
Description of Securities Fair Value Losses
------------------------- ---------- ------
United States Government and agencies $ 230,299 $ 157
U.S. Government-Sponsored Enterprises 177,579 112
Mortgage-backed securities 171,614 2,709
Corporate bonds 137,600 226
Marketable equity securities 20,259 2,205
------------- ---------
Total temporarily impaired securities $ 737,351 $ 5,409
============= =========
F-24
6. Investments, continued:
-----------
The unrealized losses on the securities issued by the United States Government
and agencies, the U.S. Government-Sponsored Enterprises and the mortgage-backed
securities were caused by interest rate increases and were considered to be
minor (approximately .1%, .1% and 1.6%, respectively). The unrealized losses on
the securities issued by the United States Government and agencies relate to 8
securities which were purchased in 2006 and substantially all of which mature in
2007. The unrealized losses on the U.S. Government-Sponsored Enterprises relate
to 10 securities which were purchased in 2006 and substantially all of which
mature in 2007. The unrealized losses on the mortgage-backed securities (all of
which are issued by U.S. Government agencies and U.S. Government-Sponsored
Enterprises) relate to 52 securities substantially all of which were purchased
in 2006. The unrealized losses related to the corporate bonds and marketable
equity securities are not considered to be an other than temporary impairment.
This determination is based on a number of factors including, but not limited
to, the length of time and extent to which the fair value has been less than
cost, the financial condition and near term prospects of the issuer, the reason
for the decline in the fair value, changes in fair value subsequent to the
balance sheet date, and other factors specific to the individual investment.
At December 31, 2006, the Company's investments which have been in a continuous
unrealized loss position for 12 months or longer are comprised of 47 securities
which had aggregate gross unrealized losses of approximately $2,600,000 and an
aggregate fair value of approximately $134,100,000. These securities are
primarily mortgage-backed securities (all of which are issued by U.S. Government
agencies and U.S. Government-Sponsored Enterprises).
At December 31, 2006 and 2005, the aggregate carrying amount of the Company's
investment in securities that are accounted for under the cost method totaled
$182,600,000 and $151,600,000, respectively. Of this amount, $78,000,000 relates
to the Company's investment in the Inmet common shares, which had a market value
in excess of the carrying amount. The fair value of the remaining cost method
securities was not estimated as there were no identified events or changes in
circumstances that may have a significant adverse effect on the fair value and
it was not practicable to estimate the fair value of these investments.
Securities with book values of $12,400,000 and $12,300,000 at December 31, 2006
and 2005, respectively, collateralized certain swap agreements, and securities
with a book value of $11,100,000 at December 31, 2005 collateralized certain
debt obligations and a related letter of credit.
7. Trade, Notes and Other Receivables, Net:
----------------------------------------
A summary of current trade, notes and other receivables, net at December 31,
2006 and 2005 is as follows (in thousands):
2006 2005
---- ----
Trade receivables $ 25,745 $ 115,538
Receivable from AT&T (a) -- 198,500
Receivable from EagleRock -- 16,636
Instalment loan receivables 903 1,257
Receivables related to securities 24,962 39,387
Receivables relating to real estate activities 6,591 5,602
Other 13,242 15,393
---------- ----------
71,443 392,313
Allowance for doubtful accounts (1,621) (15,097)
---------- ----------
Total current trade, notes and other receivables, net $ 69,822 $ 377,216
========== ==========
(a) See Note 5 for more information.
F-25
8. Intangible Assets, Net and Goodwill:
-----------------------------------
A summary of these assets at December 31, 2006 and 2005 is as follows (in
thousands):
2006 2005
---- ----
Intangibles:
Customer relationships, net of accumulated amortization of $11,768
and $6,686 $ 46,967 $ 58,911
Trademarks and tradename, net of accumulated amortization of $227
and $268 1,642 4,140
Software, net of accumulated amortization of $701 -- 4,399
Patents, net of accumulated amortization of $298 and $142 2,032 2,188
Other, net of accumulated amortization of $1,727 and $1,488 645 1,446
Goodwill 8,151 13,999
----------- -----------
$ 59,437 $ 85,083
=========== ===========
During 2006, the Company recorded $4,400,000 of new intangible assets,
principally customer relationships (which are being amortized on a straight-line
basis over a weighted-average period of approximately five years), resulting
from acquisitions by the plastics manufacturing segment and the other operations
segment.
During 2005, in connection with the acquisitions of NSW and Idaho Timber, the
Company recorded customer relationship intangible assets and other intangible
assets which are amortized over their estimated useful lives, and goodwill which
is not being amortized. In addition, during October 2005 Conwed Plastics
acquired the manufacturing assets of a competitor for approximately $4,300,000,
and allocated $3,200,000 of the purchase price to intangible assets, principally
customer relationships. These intangible assets are being amortized on a
straight-line basis over their estimated useful lives. Intangible assets, net at
December 31, 2005 includes $16,500,000 related to ATX, which was sold in
September 2006.
Amortization expense on intangible assets was $7,700,000 and $5,800,000 for the
years ended December 31, 2006 and 2005, respectively. The estimated aggregate
future amortization expense for the intangible assets for each of the next five
years is as follows: 2007 - $7,100,000; 2008 - $6,600,000; 2009 - $6,100,000;
2010 - $5,800,000; and 2011 - $5,500,000.
At December 31, 2006 and 2005, goodwill included $8,200,000 at Conwed Plastics;
at December 31, 2005, goodwill also included $5,800,000 related to ATX.
9. Other Assets:
-------------
A summary of non-current other assets at December 31, 2006 and 2005 is as
follows (in thousands):
2006 2005
---- ----
Real Estate $ 176,728 $ 166,188
Unamortized debt expense 16,216 17,993
Restricted cash 20,603 27,018
Prepaid mining interest 184,315 --
Other 3,827 29,402
----------- -----------
$ 401,689 $ 240,601
=========== ===========
The Company's prepaid mining interest relates to its investment in Fortescue,
which is more fully explained in Note 6.
F-26
10. Property, Equipment and Leasehold Improvements, Net:
---------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2006 and 2005 is as follows (in thousands):
Depreciable
Lives
(in years) 2006 2005
---------- ---- ----
Buildings and leasehold improvements 3-45 $ 131,122 $ 136,460
Machinery and equipment 3-25 101,104 93,740
Network equipment 5-15 30,587 14,524
Corporate aircraft 10 87,981 87,981
Computer equipment and software 2-5 3,921 9,520
General office furniture and fixtures 2-10 7,131 8,933
Construction in progress N/A 3,291 4,978
Other 3-7 5,144 7,645
----------- ------------
370,281 363,781
Accumulated depreciation and amortization (136,065) (126,760)
----------- ------------
$ 234,216 $ 237,021
=========== ============
11. Trade Payables, Expense Accruals, Other Current Liabilities and Other
---------------------------------------------------------------------
Non-Current Liabilities:
-----------------------
A summary of trade payables and expense accruals at December 31, 2006 and 2005
is as follows (in thousands):
2006 2005
---- ----
Trade payables $ 16,061 $ 26,080
Payables related to securities 15,883 24,268
Accrued compensation, severance and other employee benefits 42,320 80,515
Taxes other than income 1,684 7,228
Accrued interest payable 20,739 21,997
Due to Level 3 -- 25,490
Other 31,052 45,058
--------- ---------
$ 127,739 $ 230,636
========= =========
At December 31, 2005, other current liabilities includes $29,100,000 related to
the defined benefit pension plans.
A summary of other non-current liabilities at December 31, 2006 and 2005 is as
follows (in thousands):
2006 2005
---- ----
Postretirement and postemployment benefits $ 6,078 $ 8,165
Pension liability 40,351 73,729
Liabilities related to real estate activities 4,015 4,334
Other 39,824 35,665
--------- ---------
$ 90,268 $ 121,893
========= =========
F-27
12. Indebtedness:
------------
The principal amount, stated interest rate and maturity date of outstanding debt
at December 31, 2006 and 2005 are as follows (dollars in thousands):
2006 2005
---- ----
Parent Company Debt:
Senior Notes:
Bank credit facility $ -- $ --
7 3/4% Senior Notes due 2013, less debt discount of $355 and $395 99,645 99,605
7% Senior Notes due 2013, net of debt premium of $904 and $1,009 375,904 376,009
Subordinated Notes:
7 7/8% Senior Subordinated Notes due 2006, less debt discount of $9 -- 21,667
3 3/4% Convertible Senior Subordinated Notes due 2014 350,000 350,000
8.65% Junior Subordinated Deferrable Interest Debentures
due 2027 98,200 98,200
Subsidiary Debt:
Repurchase agreements 181,763 92,094
Aircraft financing 41,335 43,448
Industrial Revenue Bonds (with variable interest) -- 9,815
Capital leases due 2007 through 2015 with a weighted average
interest rate of 12.2% 9,418 10,101
Symphony credit agreement -- 27,108
Other due 2007 through 2011 with a weighted average interest
rate of 11.7% 3,196 34,335
----------- -----------
Total debt 1,159,461 1,162,382
Less: current maturities (184,815) (175,664)
----------- -----------
Long-term debt $ 974,646 $ 986,718
=========== ===========
Parent Company Debt:
In June 2006, the Company entered into a new credit agreement with various bank
lenders for a $100,000,000 unsecured credit facility that matures in five years
and bears interest based on the Eurocurrency rate or the prime rate. The
Company's existing credit agreement was terminated. At December 31, 2006, no
amounts were outstanding under this bank credit facility.
In April 2004, the Company sold $350,000,000 principal amount of its 3 3/4%
Convertible Senior Subordinated Notes due 2014 in a private placement
transaction. The notes are convertible into the Company's common shares at
$22.97 per share at any time before their maturity, subject to certain
restrictions contained in the notes, at a conversion rate of 43.5414 shares per
each $1,000 principal amount of notes subject to adjustment (an aggregate of
15,239,490 shares).
Subsidiary Debt:
Debt due within one year includes $181,800,000 and $92,100,000 as of December
31, 2006 and 2005, respectively, relating to repurchase agreements. At December
31, 2006, these fixed rate repurchase agreements have a weighted average
interest rate of approximately 5.3%, mature at various dates through June 2007
and are secured by non-current investments with a carrying value of
$182,900,000.
F-28
12. Indebtedness, continued:
------------
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by certain
of its corporate aircraft. This debt bears interest based on a floating rate,
requires monthly payments of principal and interest and matures in ten years.
The interest rate at December 31, 2006 was 9.3%. The subsidiary has entered into
an interest rate swap agreement for this financing, which fixed the interest
rate at approximately 5.7%. The subsidiary would have paid $300,000 and $700,000
at December 31, 2006 and 2005, respectively, if the swap were terminated.
Changes in interest rates in the future will change the amounts to be received
under the agreement, as well as interest to be paid under the related variable
debt obligation. The Parent company has guaranteed this financing.
Capital leases primarily consist of a sale-leaseback transaction related to
certain corporate aircraft; the lease term expires in 2015.
Symphony had a $50,000,000 revolving credit facility, of which $27,100,000 was
outstanding at December 31, 2005. As discussed more fully in Note 5, Symphony's
outstanding debt was satisfied as part of its sale in July 2006.
Other subsidiary debt at December 31, 2005 included a mortgage financing related
to Square 711 that was repaid in connection with the sale of that property in
February 2006. The mortgage balance was $32,000,000 at December 31, 2005.
The Company's debt instruments require maintenance of minimum Tangible Net
Worth, limit distributions to shareholders and limit Indebtedness and Funded
Debt, all as defined in the agreements. In addition, the debt instruments
contain limitations on investments, liens, contingent obligations and certain
other matters. As of December 31, 2006, cash dividends of approximately
$885,300,000 would be eligible to be paid under the most restrictive covenants.
At December 31, 2006, $247,500,000 of other assets (primarily investments and
property) are pledged for indebtedness aggregating $233,000,000.
Counterparties to interest rate and currency swap agreements are major financial
institutions, that management believes are able to fulfill their obligations.
Management believes any losses due to default by the counterparties are likely
to be immaterial.
The aggregate annual mandatory redemptions of debt during the five year period
ending December 31, 2011 are as follows: 2007 - $184,800,000; 2008 - $5,600,000;
2009 - $3,000,000; 2010 - $3,100,000; and 2011 - $33,900,000.
The weighted average interest rate on short-term borrowings (consisting of
subsidiary revolving credit agreements at December 31, 2005 and repurchase
agreements at December 31, 2006 and 2005) was 5.3% and 4.7% at December 31, 2006
and 2005, respectively.
13. Common Shares, Stock Options and Preferred Shares:
-------------------------------------------------
The Board of Directors from time to time has authorized acquisitions of the
Company's common shares. In December 1999, the Company's Board of Directors
increased to 6,000,000 the maximum number of shares that the Company is
authorized to purchase. During the three year period ended December 31, 2006,
the Company acquired 13,902 common shares at an average price of $25.45 per
common share, all in connection with stock option exercises. At December 31,
2006, the Company is authorized to repurchase 1,452,393 common shares.
Effective January 1, 2006, the Company adopted SFAS 123R using the modified
prospective method. As a result of the adoption of SFAS 123R, compensation cost
increased by $15,200,000 for the year ended December 31, 2006 and net income
decreased by $9,800,000 for the year ended December 31, 2006. Had the Company
used the fair value based accounting method for 2005 and 2004, compensation cost
would have been higher by $1,600,000 and $1,000,000, respectively, and primary
and diluted earnings per share would not have changed materially. As of December
31, 2006, total unrecognized compensation cost related to nonvested share-based
compensation plans was $31,900,000; this cost is expected to be recognized over
a weighted-average period of 1.8 years.
F-29
13. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
As of December 31, 2006, the Company has two share-based plans: a fixed stock
option plan and a senior executive warrant plan. The fixed stock option plan
provides for grants of options or rights to non-employee directors and certain
employees up to a maximum grant of 450,000 shares to any individual in a given
taxable year. The maximum number of common shares that may be acquired through
the exercise of options or rights under this plan cannot exceed 2,519,150. The
plan provides for the issuance of stock options and stock appreciation rights at
not less than the fair market value of the underlying stock at the date of
grant. Options granted to employees under this plan are intended to qualify as
incentive stock options to the extent permitted under the Internal Revenue Code
and become exercisable in five equal annual instalments starting one year from
date of grant. Options granted to non-employee directors become exercisable in
four equal annual instalments starting one year from date of grant. No stock
appreciation rights have been granted. As of December 31, 2006, 1,516,150 shares
were available for grant under the plan.
The senior executive warrant plan provides for the issuance, subject to
shareholder approval, of warrants to purchase up to 2,000,000 common shares to
each of the Company's Chairman and President at an exercise price equal to 105%
of the closing price per share of a common share on the date of grant. On March
6, 2006, the Company's Board of Directors approved, subject to shareholder
approval, the grant of warrants to purchase 2,000,000 common shares to each of
the Company's Chairman and President at an exercise price equal to $28.515 per
share (105% of the closing price per share of a common share on that date). In
May 2006, shareholder approval was received and the warrants were issued. The
warrants expire in 2011 and vest in five equal tranches with 20% vesting on the
date shareholder approval was received and an additional 20% vesting in each
subsequent year. At December 31, 2006, 4,000,000 warrants were outstanding and
800,000 were exercisable but had no aggregate intrinsic value as the exercise
price exceeded the market value. Both the outstanding and exercisable warrants
had a weighted-average remaining contractual term of 4.2 years. No warrants were
exercised or forfeited during 2006.
During the second quarter of 2000, pursuant to shareholder approval, warrants to
purchase 1,200,000 common shares were issued to each of the Company's Chairman
and President. The warrants were exercisable through May 15, 2005 at an exercise
price of $7.99 per common share (105% of the closing price of a common share on
the date of grant). In June 2004, Joseph S. Steinberg, President of the Company,
sold all of his warrants to Jefferies based on the value of $16.67 per Leucadia
share. In September 2004, Ian M. Cumming, Chairman of the Board of the Company,
and others (principally family members) sold warrants to purchase 723,000 of the
Company's common shares to Jefferies based on a value of $18.34 per Leucadia
share. Jefferies exercised all of the warrants during 2004. Additionally, in
September 2004, Mr. Cumming and others (principally family members) exercised
warrants to purchase 477,000 shares at an exercise price of $7.99 per share.
During 2004, the Company filed two registration statements covering the shares
owned by Jefferies and each were effective for a thirty day period.
F-30
13. Common Shares, Stock Options and Preferred Shares, continued:
-------------------------------------------------
A summary of activity with respect to the Company's stock options for the three
years ended December 31, 2006 is as follows:
Weighted-
Common Weighted- Average
Shares Average Remaining Aggregate
Subject Exercise Contractual Intrinsic
to Option Prices Term Value
--------- ------ ---- -----
Balance at December 31, 2003 1,458,360 $ 9.18
Granted 1,455,000 $21.68
Exercised (330,300) $ 8.62 $ 2,900,000
=============
Cancelled (28,200) $ 9.96
-----------
Balance at December 31, 2004 2,554,860 $16.36
Granted 12,000 $18.03
Exercised (431,600) $ 8.55 $ 5,200,000
=============
Cancelled (180,000) $21.75
-----------
Balance at December 31, 2005 1,955,260 $17.60
Granted 1,037,000 $27.42
Exercised (300,010) $12.79 $ 4,400,000
=============
Cancelled (34,000) $23.40
-----------
Balance at December 31, 2006 2,658,250 $21.90 4.3 years $ 16,800,000
=========== ========= =============
Exercisable at December 31, 2006 526,350 $14.92 2.5 years $ 7,000,000
=========== ========= =============
The following summary presents the weighted-average assumptions used for
grants made during each of the three years in the period ended December 31,
2006:
2006 2005 2004
--------------------------------- ----------- ----------
Options Warrants Options Options
------- -------- ------- -------
Risk free interest rate 4.47% 4.95% 3.77% 3.29%
Expected volatility 22.85% 23.05% 23.58% 19.06%
Expected dividend yield .90% .41% .69% .38%
Expected life 4.0 years 4.3 years 4.3 years 3.7 years
Weighted-average fair value per grant $6.25 $9.39 $4.29 $4.15
The expected life assumptions were based on historical behavior and incorporated
post-vesting forfeitures for each type of award and population identified. The
expected volatility was based on the historical behavior of the Company's stock
price.
At December 31, 2006 and 2005, 4,174,400 and 2,474,410, respectively, of the
Company's common shares were reserved for stock options and 15,239,490 of the
Company's common shares were reserved for the 3 3/4% Convertible Senior
Subordinated Notes. At December 31, 2006, 4,000,000 of the Company's common
shares were reserved for warrants.
At December 31, 2006 and 2005, 6,000,000 of preferred shares (redeemable and
non-redeemable), par value $1 per share, were authorized and not issued.
F-31
14. Net Securities Gains:
--------------------
The following summarizes net securities gains for each of the three years in the
period ended December 31, 2006 (in thousands):
2006 2005 2004
---- ---- ----
Net realized gains on securities $ 129,734 $ 222,258 $ 140,581
Write-down of investments (a) (12,940) (12,230) (4,589)
Net unrealized gains (losses) on trading securities 365 (1,212) 572
--------- --------- ---------
$ 117,159 $ 208,816 $ 136,564
========= ========= =========
(a) Consists of a provision to write down investments in certain available for
sale securities in 2006, 2005 and 2004.
Proceeds from sales of investments classified as available for sale were
$2,932,800,000, $1,979,300,000 and $1,435,900,000 during 2006, 2005 and 2004,
respectively. Gross gains of $134,200,000, $204,600,000 and $135,900,000 and
gross losses of $3,200,000, $2,400,000 and $1,600,000 were realized on these
sales during 2006, 2005 and 2004, respectively.
15. Other Results of Operations Information:
---------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2006 consists of the following (in thousands):
2006 2005 2004
---- ---- ----
Interest on short-term investments $ 10,909 $ 7,537 $ 1,693
Dividend income 12,019 6,817 9,279
Interest on fixed maturities 91,634 46,440 25,606
Interest on notes receivable 8,092 1,880 945
Other investment income 3,703 977 1,663
Gains on sale of real estate and other assets, net of costs 75,729 25,366 45,231
Gain on sale of associated companies 27,508 -- --
Recovery of bankruptcy claims 7,371 -- --
Banking and lending, including gains on sale of loan portfolios
of $16,304 in 2004 154 293 26,341
Rental income 7,023 11,870 23,176
Winery revenues 20,822 18,868 13,840
Other 29,714 28,766 31,173
---------- ---------- ----------
$ 294,678 $ 148,814 $ 178,947
========== ========== ==========
In January 2004, the Company exercised an option to sell two of its corporate
aircraft for total proceeds of approximately $38,800,000. The option was
received in connection with the purchase of two new corporate aircraft. The
Company completed the sales in July 2004, and reported a pre-tax gain of
$11,300,000.
In February 2006, 711 Developer, LLC ("Square 711"), a 90% owned subsidiary of
the Company, completed the sale of 8 acres of unimproved land in Washington,
D.C. for aggregate cash consideration of $121,900,000. The land was acquired by
Square 711 in September 2003 for cash consideration of $53,800,000. After
satisfaction of mortgage indebtedness on the property of $32,000,000 and other
closing payments, the Company received net cash proceeds of $75,700,000, and
recorded a pre-tax gain of $48,900,000.
F-32
15. Other Results of Operations Information, continued:
---------------------------------------
Taxes, other than income or payroll, amounted to $3,900,000, $3,200,000 and
$3,000,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Advertising costs amounted to $900,000, $900,000 and $600,000 for the years
ended December 31, 2006, 2005 and 2004, respectively.
Research and development costs charged to expense were $16,500,000 for the year
ended December 31, 2006; such costs were not material for the years ended
December 31, 2005 and 2004.
16. Income Taxes:
-------------
The principal components of deferred taxes at December 31, 2006 and 2005 are as
follows (in thousands):
2006 2005
---- ----
Deferred Tax Asset:
Securities valuation reserves $ 46,550 $ 46,473
Property and equipment 28,741 31,547
Other assets 25,397 35,224
NOL carryover 1,899,654 1,870,100
Other liabilities 51,009 60,622
------------ ------------
2,051,351 2,043,966
Valuation allowance (911,777) (804,829)
------------ ------------
1,139,574 1,239,137
------------ ------------
Deferred Tax Liability:
Unrealized gains on investments (65,507) (21,947)
Depreciation (22,131) (30,241)
Other (60,063) (51,849)
------------ ------------
(147,701) (104,037)
------------ ------------
Net deferred tax asset $ 991,873 $ 1,135,100
============ ============
As of December 31, 2006, the Company had consolidated federal NOLs of
$529,000,000, none of which expire prior to 2023, that may be used to offset the
taxable income of any member of the Company's consolidated tax group. In
addition, the Company has $4,690,000,000 of federal NOLs that are only available
to offset the taxable income of certain subsidiaries. Except for $20,000,000 of
NOLs that expire in 2011, none of the remaining NOLs expire prior to 2017.
Capital loss carryforwards of $10,000,000, which expire in 2007, and foreign
NOLs of $6,000,000 are not reflected in the table since the Company does not
expect it will be able to use the carryforwards before they expire. The Company
also has various state NOLs that expire at different times. Uncertainties that
may affect the utilization of the Company's tax attributes include future
operating results, tax law changes, rulings by taxing authorities regarding
whether certain transactions are taxable or deductible and expiration of
carryforward periods.
The increase in the valuation allowance during 2006 is principally due to the
utilization of previously unrecognized capital losses in the Company's 2005
federal income tax return, which resulted in a larger NOL than previously
estimated.
As of December 31, 2004, the Company carried a valuation allowance that fully
reserved for its net deferred tax asset, because the Company could not
demonstrate it would have the future taxable income necessary to realize that
asset. During 2005, as a result of the consummation of certain transactions and
ongoing operating profits, the Company prepared updated projections of future
taxable income. The Company's revised projections of future taxable income
enabled it to conclude that it is more likely than not that it will have future
taxable income sufficient to realize a portion of the Company's net deferred tax
asset; accordingly, $1,135,100,000 of the deferred tax valuation allowance was
reversed as a credit to income tax expense during 2005. In future years the
Company will record income tax provisions equal to its effective income tax
rate, unless there is a further adjustment to the valuation allowance.
F-33
16. Income Taxes, continued:
------------
The Company's conclusion that a portion of the deferred tax asset is more likely
than not to be realized was strongly influenced by its historical ability to
generate significant amounts of taxable income. The Company's estimate of future
taxable income considered all available evidence, both positive and negative,
about its current operations and investments, included an aggregation of
individual projections for each material operation and investment and included
all future years that the Company estimated it would have available NOLs. The
Company believes that its estimate of future taxable income is reasonable but
inherently uncertain, and if its current or future operations and investments
generate taxable income greater than the projected amounts, further adjustments
to reduce the valuation allowance are possible. Conversely, if the Company
realizes unforeseen material losses in the future, or its ability to generate
future taxable income necessary to realize a portion of the deferred tax asset
is materially reduced, additions to the valuation allowance could be recorded.
The Company's total comprehensive income in 2004 enabled it to realize certain
acquired deferred tax assets which had been fully reserved for at the
acquisition of WilTel. The resulting reduction in the valuation allowance for
deferred tax assets ($22,300,000 in 2004) was applied to reduce the recorded
amount of identifiable intangible assets to zero.
Under certain circumstances, the ability to use the NOLs and future deductions
could be substantially reduced if certain changes in ownership were to occur. In
order to reduce this possibility, the Company's certificate of incorporation
includes a charter restriction that prohibits transfers of the Company's common
stock under certain circumstances.
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 2006 was as follows, excluding amounts allocated to
equity in associated companies and discontinued operations (in thousands):
2006 2005 2004
---- ---- ----
State income taxes $ 3,682 $ 3,848 $ 3,066
Resolution of state tax contingencies (8,000) -- --
Federal income taxes:
Current 1,721 -- (31,143)
Deferred 44,203 -- 7,242
Reversal of valuation allowance -- (1,135,100) --
Currently payable foreign income taxes 165 214 291
----------- ----------- -----------
$ 41,771 $(1,131,038) $ (20,544)
=========== =========== ===========
The table below reconciles the expected statutory federal income tax to the
actual income tax provision (benefit) (in thousands):
2006 2005 2004
---- ---- ----
Expected federal income tax $ 46,837 $ 47,052 $ 37,388
State income taxes, net of federal income tax benefit 2,393 2,501 1,993
Reversal of valuation allowance -- (1,135,100) --
Resolution of tax contingencies (8,000) -- (27,300)
Permanent differences 434 -- (5,700)
Federal income tax carryback refund -- -- (3,858)
Recognition of acquired WilTel federal tax benefits -- (46,951) (6,481)
Discontinued operations tax loss benefit -- 1,321 (18,161)
Other 107 139 1,575
----------- ----------- -----------
Actual income tax provision (benefit) $ 41,771 $(1,131,038) $ (20,544)
=========== =========== ===========
F-34
16. Income Taxes, continued:
------------
Reflected above as resolution of tax contingencies are reductions to the
Company's income tax provision for the favorable resolution of certain federal
and state income tax contingencies. The Internal Revenue Service has completed
its audit of the Company's consolidated federal income tax returns for the years
1996 through 1999, without any material payment required from the Company.
The statute of limitations with respect to the Company's federal income returns
have expired for all years through 2001. Prior to May 2001, WilTel was included
in the consolidated federal income tax return of its former parent, The Williams
Companies Inc. ("Williams"). Pursuant to a tax settlement agreement between
WilTel and Williams, the Company has no liability for any audit adjustments made
to Williams' consolidated tax returns; however, adjustments to Williams' prior
years tax returns could affect certain of the Company's tax attributes that
impact the calculation of alternative minimum taxable income.
17. Pension Plans and Postretirement Benefits:
-----------------------------------------
In September 2006, the FASB issued Statement of Financial Accounting Standards
No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and
132(R)" ("SFAS 158"), which requires companies to recognize on their balance
sheet a net liability or asset for the funded status of their defined benefit
pension and other postretirement plans, recognize changes in funded status
through comprehensive income and provide additional footnote disclosures. SFAS
158 is effective for publicly traded calendar year-end companies as of December
31, 2006. In addition, SFAS 158 requires companies to measure the funded status
of their plans as of the date of its fiscal year-end, with limited exceptions,
effective for fiscal years ending after December 15, 2008. The incremental
effect on the Company's consolidated balance sheet as a result of the adoption
of SFAS 158 was to decrease total liabilities by $1,200,000, decrease deferred
tax assets by $400,000 and increase accumulated other comprehensive income by
$800,000.
The information presented below for defined benefit pension plans is presented
separately for the Company's plans and the plans formerly administered by
WilTel. Pursuant to the WilTel sale agreement the responsibility for WilTel's
defined benefit pension plans was retained by the Company. The Company presents
the information separately since the WilTel plan's investment strategies,
assumptions and results are significantly different than those of the Company.
The Company:
Prior to 1999, the Company maintained defined benefit pension plans covering
employees of certain units who also met age and service requirements. Effective
December 31, 1998, the Company froze its defined benefit pension plans. A
summary of activity with respect to the Company's defined benefit pension plan
for 2006 and 2005 is as follows (in thousands):
F-35
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
2006 2005
---- ----
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 58,123 $ 58,286
Interest cost (a) 2,668 2,951
Actuarial (gain) loss (1,200) 2,314
Benefits paid (4,715) (5,428)
---------- ----------
Projected benefit obligation at December 31, $ 54,876 $ 58,123
========== ==========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 43,476 $ 47,643
Actual return on plan assets 2,022 1,375
Employer contributions 7,000 --
Benefits paid (4,715) (5,428)
Administrative expenses (130) (114)
---------- ----------
Fair value of plan assets at December 31, $ 47,653 $ 43,476
========== ==========
Funded Status at end of year $ (7,223) $ (14,647)
========== ==========
(a) Includes charges to expense of $800,000 and $900,000 for 2006 and 2005,
respectively, relating to discontinued operations obligations.
As of December 31, 2006 and 2005, $19,100,000 and $21,800,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $7,200,000 and $14,600,000,
respectively, was reflected as accrued pension cost. The Company is currently
evaluating whether to make any contributions to the Company's defined benefit
pension plan in 2007.
Pension expense related to the defined benefit pension plan charged to
operations included the following components (in thousands):
2006 2005 2004
---- ---- ----
Interest cost $ 1,916 $ 2,045 $ 2,191
Expected return on plan assets (1,052) (905) (1,019)
Actuarial loss 905 848 652
Amortization of prior service cost 3 3 3
--------- --------- ---------
Net pension expense $ 1,772 $ 1,991 $ 1,827
========= ========= =========
At December 31, 2006, the plan's assets consisted of U.S. government and
agencies bonds (32%), investment grade bonds (60%), cash equivalents (7%) and
other (1%). At December 31, 2005, the plan's assets consisted of U.S. government
and agencies bonds (43%), investment grade bonds (24%), cash equivalents (32%)
and other (1%).
The defined benefit pension plan assets are invested in short-term investment
grade fixed income investments in order to maximize the value of its invested
assets by minimizing exposure to changes in market interest rates. This
investment strategy provides the Company with more flexibility in managing the
plan should interest rates rise and result in a decrease in the discounted value
of benefit obligations. The current investment strategy substantially requires
investments in investment grade securities, and a final average maturity target
for the portfolio of one and one-half years and a one year maximum duration.
F-36
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 1.25% real rate of return for risk-free investments
(primarily U.S. government and agency bonds) for the target duration and .25%
default risk premium for the portion of the portfolio invested in non-U.S.
government and agency bonds. The combination of these underlying assumptions
resulted in the selection of the 4% expected long-term rate of return assumption
for 2006. Because pension expense includes the cost of expected plan
administrative expenses, the 4% assumption is not reduced for such expenses.
Several subsidiaries provide certain health care and other benefits to certain
retired employees under plans which are currently unfunded. The Company pays the
cost of postretirement benefits as they are incurred. Amounts charged to expense
were not material in each of the three years ended December 31, 2006.
A summary of activity with respect to the Company's postretirement plans for
2006 and 2005 is as follows (in thousands):
2006 2005
---- ----
Accumulated postretirement benefit obligation at January 1, $ 4,773 $ 4,715
Interest cost 229 247
Contributions by plan participants 145 167
Actuarial (gain) loss (321) 224
Benefits paid (545) (580)
------- -------
Accumulated postretirement benefit obligation at December 31, $ 4,281 $ 4,773
======= =======
The Company expects to spend $400,000 on postretirement benefits during 2007. At
December 31, 2006, the assumed health care cost trend rate for 2007 used in
measuring the accumulated postretirement benefit obligation is 9.5% and, at
December 31, 2005, such rate for 2006 was 9%. At December 31, 2006 and 2005, the
assumed health care cost trend rates were assumed to decline to an ultimate rate
of 5% by 2014. If the health care cost trend rates were increased or decreased
by 1%, the accumulated postretirement obligation as of December 31, 2006 would
have increased or decreased by $300,000. The effect of these changes on interest
cost for 2006 would be immaterial.
At December 31, 2006, the amounts in accumulated other comprehensive income
relating to the Company's defined benefit pension plan and other benefits plans
that have not yet been recognized in net periodic benefit cost are as follows
(in thousands):
Other
Pension Plan Benefits Plans
------------ --------------
Net loss (gain) $ 19,008 $ (903)
Prior service cost (credit) 45 (323)
--------- ---------
$ 19,053 $ (1,226)
========= =========
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income into net periodic benefit
cost in 2007 is $1,100,000; such amount for the prior service cost is not
material. The estimated net gain and prior service credit for the other benefits
plans that will be amortized from accumulated other comprehensive income into
net periodic benefit cost in 2007 are $100,000 and $100,000, respectively.
At December 31, 2005, the defined benefit pension plan's unrecognized net losses
were $21,800,000 and the unrecognized prior service cost was not material.
F-37
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
The Company uses a December 31 measurement date for its plans. The assumptions
used relating to the defined benefit plan and postretirement plans are as
follows:
Pension Benefits Other Benefits
-------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
Discount rate used to determine
benefit obligation at December 31, 4.90% 4.87% 5.75% 5.25%
Weighted-average assumptions used
to determine net cost for years ended
December 31,:
Discount rate 4.87% 5.25% 5.25% 5.25%
Expected long-term return on plan assets 4.00% 3.25% N/A N/A
The discount rate for pension benefits was selected to result in an estimated
projected benefit obligation on a plan termination basis, using current rates
for annuity settlements and lump sum payments weighted for the assumed elections
of participants. The discount rate for other benefits was based on the expected
future benefit payments in conjunction with the Citigroup Pension Discount
Curve.
The following benefit payments are expected to be paid (in thousands):
Pension Benefits Other Benefits
---------------- --------------
2007 $ 4,199 $ 405
2008 4,282 408
2009 4,712 413
2010 3,891 401
2011 3,970 394
2012 - 2016 20,593 1,696
WilTel:
Effective on the date of sale, the Company froze WilTel's defined benefit
pension plans. A summary of activity with respect to the plans for 2006 and 2005
is as follows (in thousands):
2006 2005
---- ----
Projected Benefit Obligation:
Projected benefit obligation at beginning of period $ 186,054 $ 147,888
Interest cost 9,856 9,410
Service cost -- 4,612
Actuarial (gain) loss (11,502) 29,758
Curtailment gain -- (2,334)
Benefits paid (7,684) (3,280)
---------- ----------
Projected benefit obligation at December 31, $ 176,724 $ 186,054
========== ==========
Change in Plan Assets:
Fair value of plan assets at beginning of period $ 97,905 $ 74,601
Actual return on plan assets 11,976 4,815
Employer contributions 43,052 21,769
Benefits paid (7,684) (3,280)
Administrative expenses (1,659) --
---------- ----------
Fair value of plan assets at December 31, $ 143,590 $ 97,905
========== ==========
Funded Status at end of year $ (33,134) $ (88,149)
========== ==========
F-38
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
As of December 31, 2006 and 2005, $24,300,000 and $40,700,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income and $33,100,000 and
$88,100,000, respectively, was reflected as accrued pension cost.
The Company is currently evaluating whether to make any contributions to the
WilTel plan in 2007.
Pension expense for the WilTel plans charged to results of continuing operations
in 2006 and to results of discontinued operations in 2005 and 2004 included the
following components (in thousands):
2006 2005 2004
---- ---- ----
Interest cost $ 9,856 $ 9,410 $ 7,829
Service cost -- 4,612 3,980
Expected return on plan assets (6,954) (6,509) (5,391)
Actuarial loss 1,579 2,953 46
---------- ---------- --------
Net pension expense $ 4,481 $ 10,466 $ 6,464
========== ========== ========
At December 31, 2006, the plans' assets consisted of equity securities (57%),
debt securities (21%) and cash equivalents (22%). At December 31, 2005, the
plans' assets consisted of equity securities (70%), debt securities (28%) and
cash equivalents (2%).
The investment objectives of the plans emphasize long-term capital appreciation
as a primary source of return and current income as a supplementary source.
In connection with having frozen the plan, the Company is reviewing the target
allocation, which currently is as follows:
Target
------
Equity securities:
Large cap stocks 40%
Small cap stocks 10%
International stocks 20%
-----
Total equity securities 70%
Fixed income/bonds 30%
-----
Total 100%
=====
Investment performance objectives are based upon a benchmark index or mix of
indices over a market cycle. The investment strategy designates certain
investment restrictions for domestic equities, international equities and fixed
income securities. These restrictions include the following:
o For domestic equities, there will generally be no more than 5% of any
manager's portfolio at market in any one company and no more than 150%
of any one sector of the appropriate index for any manager's
portfolio. Restrictions are also designated on outstanding market
value of any one company at 5% for large to medium equities and 8% for
small to medium equities.
o For international equities, there will be no more than 8% in any one
company in a manager's portfolio, no fewer than three countries in a
manager's portfolio, no more than 10% of the portfolio in countries
not represented in the EAFE index, no more than 150% of any one sector
of the appropriate index and no currency hedging is permitted.
F-39
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
o Fixed income securities will all be rated BBB- or better at the time
of purchase, there will be no more than 8% at market in any one
security (U.S. government and agency positions excluded), no more than
a 30-year maturity in any one security and investments in standard
collateralized mortgage obligations are limited to securities that are
currently paying interest, receiving principal, do not contain
leverage and are limited to 10% of the market value of the portfolio.
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 2% real rate of return for risk-free investments,
..3% inflation risk premium (considering the long-term nature of plan
investments), .9% default risk premium for the portion of the portfolio invested
in corporate bonds, and 2.25% to 2.6% in equity risk premium (depending on asset
class) in excess of corporate bond returns. The Company then weighted these
assumptions by the long-term target allocations, reduced the result by .2% to
reflect net investment expenses after considering expected returns in excess of
benchmarks, which resulted in the selection of the 7.5% expected long-term rate
of return assumption for 2006. Because the actuarial assumptions for pension
cost include an explicit allowance for non-investment administrative expenses,
the 7.5% assumption is not reduced for such expenses.
At December 31, 2006 and 2005, the accumulated other comprehensive income
relating to WilTel's plans that has not yet been recognized in net periodic
benefit cost consists of cumulative losses of $24,300,000 and $40,700,000,
respectively.
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income into net periodic benefit
cost in 2007 is $800,000.
The measurement date for WilTel's plans is December 31. The assumptions used for
2006 and 2005 are as follows:
Pension Benefits
----------------
2006 2005
---- ----
Weighted-average assumptions used to determine
benefit obligation at December 31,:
Discount rate 5.70% 5.40%
Rate of compensation increase N/A 3.50%
Weighted-average assumptions used to determine
net cost for the period ended December 31,:
Discount rate 5.40% 5.75%
Expected long-term return on plan assets 7.50% 7.00%
Rate of compensation increase N/A 3.50%
The timing of expected future benefit payments was used in conjunction with the
Citigroup Pension Discount Curve to develop a discount rate that is
representative of the high quality corporate bond market, adjusted for current
rates which might be available for annuity settlements.
The following pension benefit payments are expected to be paid (in thousands):
2007 $ 2,810
2008 2,517
2009 3,161
2010 3,706
2011 4,000
2012 - 2016 38,473
F-40
17. Pension Plans and Postretirement Benefits, continued:
-----------------------------------------
The Company and its consolidated subsidiaries have defined contribution pension
plans covering certain employees. Contributions and costs are a percent of each
covered employee's salary. Amounts charged to expense related to such plans were
$2,000,000, $1,700,000 and $1,400,000 for the years ended December 31, 2006,
2005 and 2004, respectively.
18. Commitments:
------------
The Company and its subsidiaries rent office space and office equipment under
noncancellable operating leases with terms varying principally from one to
twenty years. Rental expense (net of sublease rental income) was $5,700,000 in
2006, $4,400,000 in 2005 and $4,900,000 in 2004. Future minimum annual rentals
(exclusive of month-to-month leases, real estate taxes, maintenance and certain
other charges) under these leases at December 31, 2006 are as follows (in
thousands):
2007 $ 5,842
2008 4,051
2009 3,094
2010 1,811
2011 1,851
Thereafter 6,489
---------
23,138
Less: sublease income (3,656)
---------
$ 19,482
=========
In connection with the sale of certain subsidiaries and certain non-recourse
financings, the Company has made or guaranteed the accuracy of certain
representations. No material loss is expected in connection with such matters.
Pursuant to an agreement that was entered into before the Company sold CDS to
HomeFed in 2002, the Company agreed to provide project improvement bonds for the
San Elijo Hills project. These bonds, which are for the benefit of the City of
San Marcos, California and other government agencies, are required prior to the
commencement of any development at the project. CDS is responsible for paying
all third party fees related to obtaining the bonds. Should the City or others
draw on the bonds for any reason, CDS and one of its subsidiaries would be
obligated to reimburse the Company for the amount drawn. At December 31, 2006,
$18,300,000 was outstanding under these bonds, $16,100,000 of which expires in
2007 and the remainder thereafter.
As more fully discussed in Note 4, CLC has entered into an agreement with third
party lenders consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000. The Company has guaranteed 30% of the obligations outstanding
under both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2006, $74,200,000 was outstanding under the
senior secured credit facility and (euro)21,000,000 was outstanding under the
senior secured bridge credit facility; as a result, the Company's outstanding
guaranty at that date was $22,300,000 and (euro)6,300,000, respectively. The
Company has also committed to provide financing to CLC which is currently
estimated to be (euro)156,000,000 ($205,000,000 at exchange rates in effect on
February 15, 2007), of which the Company's share will be 30% ($26,100,000 of
which has been loaned as of December 31, 2006).
19. Litigation:
----------
The Company and its subsidiaries are parties to legal proceedings that are
considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position. The
Company does not believe that any of the foregoing actions will have a material
adverse effect on its consolidated financial position or liquidity, but any
amounts paid could be material to results of operations for the period.
F-41
19. Litigation, continued:
----------
The Company is a defendant in Special Situations Fund III, L.P., et al v.
Leucadia National Corporation, et al, a consolidated action involving a petition
for appraisal and a class action pending in the Delaware Chancery Court related
to the Company's 2005 acquisition of the minority interest in MK Resources. The
pending appraisal petition seeks a judicial determination of the fair value of
approximately 3,979,400 shares of common stock of MK Resources as of August 19,
2005, the date of the merger of one of the Company's subsidiaries into MK
Resources. The class action complaint seeks compensatory damages in an
unspecified amount, costs, disbursements and any further relief that the court
may deem just and proper, and in the alternative, seeks rescissory damages, in
each case taking into account the $1.27 per share consideration paid to the
minority stockholders in the merger. Based on discovery to date, the plaintiffs
have claimed that the fair value of each share of MK Resources at the date of
the merger ranged from $4.75 to $10.16 per share (with respect to a total of
approximately 10,500,000 shares of MK Resources), while the Company believes
that the fair value of each share of MK Resources at that date was $0.57 per
share.
The trial in this case is currently scheduled for March 12-16, 2007. The Company
believes that the material allegations of the complaints are without merit and
intends to defend these actions vigorously. While the Company does not believe
it is probable that a loss will be incurred, if the Company is unsuccessful in
this matter, an adverse determination could be material.
20. Earnings (Loss) Per Common Share:
--------------------------------
For the year ended December 31, 2006, the numerators for basic and diluted per
share computations for income from continuing operations were $129,800,000 and
$138,600,000, respectively. For the year ended December 31, 2005, the numerators
for basic and diluted per share computations for income from continuing
operations were $1,220,300,000 and $1,234,500,000, respectively. For the year
ended December 31, 2004, the numerators for basic and diluted per share
computations for income from continuing operations were $203,800,000 and
$210,100,000, respectively. The calculations for diluted earnings (loss) per
share assumes the 3 3/4% Convertible Notes had been converted into common shares
for the periods they were outstanding and earnings increased for the interest on
such notes, net of the income tax effect, unless the effect is antidilutive.
The denominators for basic per share computations were 216,233,000, 215,531,000
and 213,384,000 for 2006, 2005 and 2004, respectively. The denominators for
diluted per share computations reflect the dilutive effect of 412,000, 504,000
and 1,558,000 options and warrants for 2006, 2005 and 2004, respectively (the
treasury stock method was used for these calculations), and 15,239,000,
15,239,000 and 10,550,000 shares related to the 3 3/4% Convertible Notes for
2006, 2005 and 2004, respectively.
21. Fair Value of Financial Instruments:
-----------------------------------
The following table presents fair value information about certain financial
instruments, whether or not recognized on the balance sheet. Fair values are
determined as described below. These techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. The fair value amounts presented do not purport to represent and should
not be considered representative of the underlying "market" or franchise value
of the Company. The methods and assumptions used to estimate the fair values of
each class of the financial instruments described below are as follows:
(a) Investments: The fair values of marketable equity securities, fixed maturity
securities and investments held for trading purposes (which include securities
sold not owned) are substantially based on quoted market prices, as disclosed in
Note 6. The fair value of the Company's investment in the Inmet common shares,
all of which are restricted as discussed in Note 6, is based on quoted market
prices. The fair values of the Company's other securities that are accounted for
under the cost method (aggregating $104,600,000 and $73,600,000 at December 31,
2006 and 2005, respectively) were not practicable to estimate; the fair values
were assumed to be the carrying amount.
(b) Cash and cash equivalents: For cash equivalents, the carrying amount
approximates fair value.
(c) Notes receivables: The fair values of variable rate notes receivable are
estimated to be the carrying amount.
F-42
21. Fair Value of Financial Instruments, continued:
-----------------------------------
(d) Loan receivables of banking and lending subsidiaries: The carrying amount
approximates fair value.
(e) Long-term and other indebtedness: The fair values of non-variable rate debt
are estimated using quoted market prices and estimated rates that would be
available to the Company for debt with similar terms. The fair value of variable
rate debt is estimated to be the carrying amount.
(f) Derivative instruments: The fair values of the interest rate swap and
currency rate swap agreements are based on rates currently available for similar
agreements.
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2006 and 2005 are as follows (in thousands):
2006 2005
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets:
Investments:
Current $ 903,973 $ 903,973 $ 1,323,562 $ 1,323,562
Non-current 1,465,849 1,687,611 977,327 1,041,446
Cash and cash equivalents 287,199 287,199 386,957 386,957
Notes receivable:
Current 6,633 6,633 6,413 6,413
Non-current 2,244 2,244 3,787 3,787
Loan receivables of banking and lending
subsidiary, net of allowance:
Current 749 749 1,056 1,056
Non-current 1,146 1,146 1,376 1,376
Financial Liabilities:
Debt:
Current 184,815 185,867 175,664 176,052
Non-current 974,646 1,135,117 986,718 1,038,252
Securities sold not owned 5,697 5,697 24,268 24,268
Derivative Instruments:
Interest rate swaps (268) (268) (677) (677)
Foreign currency swaps (2,430) (2,430) (2,546) (2,546)
22. Segment Information:
-------------------
The Company's reportable segments consist of its operating units, which offer
different products and services and are managed separately. Idaho Timber
primarily remanufactures, manufactures and/or distributes wood products. Conwed
Plastics manufactures and markets lightweight plastic netting used for a variety
of purposes. The Company's domestic real estate operations consist of a variety
of commercial properties, residential land development projects and other
unimproved land, all in various stages of development and all available for
sale. The Company's medical product development segment is conducted through
Sangart, which became a majority-owned subsidiary in November 2005. Other
operations primarily consist of the Company's wineries, Caribbean-based
telecommunications services and residual banking and lending activities that are
in run-off.
F-43
22. Segment Information, continued:
-------------------
Associated companies include equity interests in entities that the Company
accounts for on the equity method of accounting. Investments in associated
companies include Premier, HomeFed, Goober, CLC, JPOF II, EagleRock, Wintergreen
and Safe Harbor. JPOF II, EagleRock, Wintergreen and Safe Harbor are entities
engaged in investing and/or securities transactions activities.
Corporate assets primarily consist of investments and cash and cash equivalents
and corporate revenues primarily consist of investment income and securities
gains and losses. Corporate assets include the Company's investment in
Fortescue. Corporate assets, revenues, overhead expenses and interest expense
are not allocated to the operating units.
Conwed Plastics has a manufacturing facility located in Belgium, which is the
only foreign operation with non-U.S. revenue or assets that the Company
consolidates, and it is not material. Unconsolidated non-U.S. based investments
include 38% of Light and Power Holdings Ltd., the parent company of the
principal electric utility in Barbados, the 30% ownership interest in CLC and
the investment in Fortescue. From time to time the Company invests in the
securities of non-U.S. entities or in investment partnerships that invest in
non-U.S. securities.
Certain information concerning the Company's segments for 2006, 2005 and 2004 is
presented in the following table. Consolidated subsidiaries are reflected as of
the date of acquisition, which was May 2005 for Idaho Timber and November 2005
for Sangart. Associated Companies are only reflected in the table below under
identifiable assets employed.
F-44
22. Segment Information, continued:
-------------------
2006 2005 2004
---- ---- ----
(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 345.7 $ 239.0 $ --
Conwed Plastics 106.4 93.6 64.4
Domestic Real Estate 86.7 29.9 63.5
Medical Product Development .7 .1 --
Other Operations 42.8 59.0 70.8
Corporate (b) 280.4 268.3 180.9
--------- --------- -----------
Total consolidated revenues and other income $ 862.7 $ 689.9 $ 379.6
========= ========= ===========
Income from continuing operations before income
taxes and equity in income
(losses) of associated companies:
Manufacturing:
Idaho Timber $ 12.0 $ 8.2 $ --
Conwed Plastics 17.9 14.2 7.9
Domestic Real Estate 44.0 4.1 20.7
Medical Product Development (21.1) (1.4) --
Other Operations (14.4) 7.5 18.6
Corporate (b) 95.4 101.8 59.6
--------- --------- -----------
Total consolidated income from continuing operations
before income taxes and equity in income (losses) of
associated companies $ 133.8 $ 134.4 $ 106.8
========= ========= ===========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 132.3 $ 162.7 $ --
Conwed Plastics 83.6 81.9 50.4
Domestic Real Estate 198.1 182.7 253.2
Medical Product Development 12.2 7.0 --
Other Operations 257.8 245.0 403.7
Investments in Associated Companies 773.0 375.5 460.8
Corporate 3,846.8 4,062.0 2,070.1
Assets of discontinued operations -- 144.1 1,562.2
-------- --------- -----------
Total consolidated assets $ 5,303.8 $ 5,260.9 $ 4,800.4
========= ========= ===========
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains on the Company's
consolidated statements of operations.
(b) Net securities gains for Corporate aggregated $116,600,000, $199,500,000
and $123,100,000 during 2006, 2005 and 2004, respectively, which primarily
resulted from the sale of publicly traded debt and equity securities that
had been classified as available for sale securities. Security gains
include a gain from the sale of Level 3 of $37,400,000 in 2006 and a gain
from the sale of WMIG of $146,000,000 in 2005. For 2006, 2005 and 2004,
security gains include provisions of $12,900,000, $12,200,000 and
$4,600,000, respectively, to write down investments in certain available
for sale securities. The write-downs of the available for sale securities
resulted from declines in market value determined to be other than
temporary.
F-45
22. Segment Information, continued:
-------------------
(c) For the years ended December 31, 2006, 2005 and 2004, income from
continuing operations has been reduced by depreciation and amortization
expenses of $39,500,000, $32,600,000 and $28,700,000, respectively; such
amounts are primarily comprised of Corporate ($11,600,000, $10,700,000 and
$11,400,000, respectively), manufacturing ($17,500,000, $14,200,000 and
$5,200,000, respectively) and other operations ($6,400,000, $5,700,000 and
$8,200,000, respectively). Depreciation and amortization expenses for other
segments are not material.
(d) For the years ended December 31, 2006, 2005 and 2004, income from
continuing operations has been reduced by interest expense of $79,400,000,
$65,500,000 and $60,600,000, respectively; such amounts are primarily
comprised of Corporate ($70,900,000, $63,200,000 and $55,300,000,
respectively) and other operations ($8,000,000, $1,200,000 and $3,300,000,
respectively). In 2006, interest expense for other operations was comprised
of Premier during the period it was a consolidated subsidiary. Interest
expense for other segments is not material.
F-46
23. Selected Quarterly Financial Data (Unaudited):
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2006:
----
Revenues and other income $ 291,608 $ 224,426 $ 170,243 $ 176,395
========== =========== =========== =========
Income from continuing operations $ 82,589 $ 36,375 $ 3,740 $ 7,065
========== =========== =========== =========
Income (loss) from discontinued operations, net of taxes $ (1,433) $ 280 $ (2,717) $ (90)
========== =========== =========== ========
Gain (loss) on disposal of discontinued operations, net of taxes $ (463) $ 365 $ 59,454 $ 4,234
========== =========== ========== =========
Net income $ 80,693 $ 37,020 $ 60,477 $ 11,209
========== =========== =========== =========
Basic earnings (loss) per common share:
Income from continuing operations $ .38 $ .17 $ .02 $ .03
Income (loss) from discontinued operations (.01) -- (.01) --
Gain (loss) on disposal of discontinued operations -- -- .27 .02
------- ------- ------ -------
Net income $ .37 $ .17 $ .28 $ .05
======= ======= ======= =======
Number of shares used in calculation 216,112 216,201 216,291 216,334
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income from continuing operations $ .37 $ .17 $ .02 $ .03
Income (loss) from discontinued operations (.01) -- (.01) --
Gain (loss) on disposal of discontinued operations - -- .26 .02
------- ------ ------ -----
Net income $ .36 $ .17 $ .27 $ .05
======= ====== ====== ======
Number of shares used in calculation 231,765 231,777 231,906 216,707
======= ======= ======= =======
2005:
----
Revenues and other income $ 53,417 $ 166,930 $ 248,275 $ 221,261
========== =========== =========== =========
Income (loss) from continuing operations $ (8,049) $ 1,204,734 $ 45,214 $ (21,559)
========== =========== =========== =========
Income from discontinued operations, net of taxes $ 10,662 $ 11,799 $ 58,770 $ 34,098
========== =========== =========== =========
Gain on disposal of discontinued operations, net of taxes $ -- $ 54,578 $ 130 $ 245,664
========== =========== =========== =========
Net income $ 2,613 $ 1,271,111 $ 104,114 $ 258,203
========== =========== =========== =========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ (.04) $ 5.60 $ .21 $ (.10)
Income from discontinued operations .05 .05 .27 .16
Gain on disposal of discontinued operations -- .25 -- 1.14
------- ------- ------ -------
Net income $ .01 $ 5.90 $ .48 $ 1.20
======= ======= ======= =======
Number of shares used in calculation 215,218 215,303 215,595 215,966
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ (.04) $ 5.23 $ .21 $ (.10)
Income from discontinued operations .05 .05 .26 .16
Gain on disposal of discontinued operations -- .24 -- 1.14
------- ------ ------ ------
Net income $ .01 $ 5.52 $ .47 $ 1.20
======= ====== ====== ======
Number of shares used in calculation 215,218 231,026 231,328 215,966
======= ======= ======= =======
Income from continuing operations includes credits to income tax expense of
$1,100,000,000 and $25,100,000 for the second and third quarters of 2005,
respectively, resulting from reversals of the deferred income tax valuation
allowance.
In 2006 and 2005, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-47
24. Subsequent Event:
----------------
In January 2007, the Company entered into an agreement to acquire a 75%
interest in the telecommunications business of Telco Group, Inc. ("Telco")
for $120,000,000 in cash, subject to working capital adjustments.
Consummation of the transaction, which is subject to customary closing
conditions including receipt of regulatory approvals, is expected to occur
during the first half of 2007. Telco, which operates under the brand name
STi Prepaid and variations thereof, is a provider of international prepaid
phone cards, prepaid wireless and other telecommunications services in the
U.S.
F-48
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2006, 2005 and 2004
(In thousands)
Additions Deductions
------------------------------------------------- -------------------------------------------------
Charged
Balance at to Costs Balance
Beginning and Write Sale of at End
Description of Period Expenses Recoveries Other Offs Receivables Other of Period
----------- --------- -------- ---------- ----- ----- ----------- ----- ---------
2006
----
Loan receivables of
banking and lending
subsidiaries $ 536 $ (166) $ 66 $ -- $ 130 $ -- $ -- $ 306
Trade, notes and other
receivables 14,896 1,255 128 -- 6,395 8,417 -- 1,467
---------- --------- -------- ------------ --------- ---------- --------- ----------
Total allowance for
doubtful accounts $ 15,432 $ 1,089 $ 194 $ -- $ 6,525 $ 8,417 $ -- $ 1,773
========== ========= ======== ============ ========= ========== ========= ==========
Deferred tax asset
valuation allowance $ 804,829 $ -- $ -- $ 106,948(a) $ -- $ -- $ -- $ 911,777
========== ========= ======== ============ ========= ========== ========= =========
2005
----
Loan receivables of
banking and lending
subsidiaries $ 946 $ (323) $ 90 $ -- $ 177 $ -- $ -- $ 536
Trade, notes and other
receivables 7,488 7,995 144 5,215 5,701 245 -- 14,896
---------- --------- -------- ------------ --------- ---------- --------- ---------
Total allowance for
doubtful accounts $ 8,434 $ 7,672 $ 234 $ 5,215 $ 5,878 $ 245 $ -- $ 15,432
========== ========= ======== ============ ========= ========== ========= =========
Deferred tax asset
valuation allowance $2,185,275 $ -- $ -- $ -- $ -- $ -- $1,380,446(b)$ 804,829
========== ========= ======== ============ ========= ========== ========== =========
2004
----
Loan receivables of
banking and lending
subsidiaries $ 24,236 $ (8,301) $ 11,215 $ -- $ 11,331 $ 14,873 $ -- $ 946
Trade, notes and other
receivables 2,268 4,967 4,860 -- 4,607 -- -- 7,488
---------- --------- -------- ------------ --------- ---------- --------- ----------
Total allowance for
doubtful accounts $ 26,504 $ (3,334) $ 16,075 $ -- $ 15,938 $ 14,873 $ -- $ 8,434
========== ========= ======== ============ ========= ========== ========= ==========
Deferred tax asset
valuation allowance $2,237,753 $ -- $ -- $ -- $ -- $ -- $52,478(c) $2,185,275
========== ========= ======== ============ ========= ========== ======== ==========
(a) The increase in the valuation allowance is principally due to the
utilization of previously unrecognized capital losses in the Company's
2005 federal income tax return, which resulted in a larger NOL than
previously estimated.
(b) During 2005, as a result of the consummation of certain transactions
and ongoing operating profits, the Company prepared updated
projections of future taxable income. The Company's revised
projections of future taxable income enabled it to conclude that it is
more likely than not that it will have future taxable income
sufficient to realize a portion of the Company's net deferred tax
asset; accordingly, $1,135,100,000 of the deferred tax valuation
allowance was reversed as a credit to income tax expense.
(c) Principally results from the recognition of acquired tax benefits, of
which $22,300,000 was applied to reduce the carrying amount of
acquired non-current intangible assets to zero, $3,900,000 resulted
from a carryback refund claim and $6,500,000 resulted from the use of
acquired tax attributes to offset the federal income tax provision
that would have otherwise been recorded during 2004.
(d) Amounts in the schedule include activity related to discontinued
operations.
F-49