SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K/A
(Amendment No. 1)
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2008
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
--------------------------------------------------------------------------------
(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:
Title of Each Class Name of Each Exchange on Which Registered
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. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [x] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [ ]
(Do not check if a smaller reporting company)
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, 2008 (computed by reference to the
last reported closing sale price of the Common Shares on the New York Stock
Exchange on such date): $8,492,086,000.
On February 20, 2009, the registrant had outstanding 238,498,598 Common Shares.
DOCUMENTS INCORPORATED BY REFERENCE:
--------------------------------------------------------------------------------
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2009 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
1
EXPLANATORY NOTE
This Report on Form 10-K/A amends and restates in its entirety Item 15
of the Annual Report on Form 10-K, of Leucadia National Corporation (the
"Company") for the fiscal year ended December 31, 2008 to reflect that the
financial statements referred to in Item 15(c)(1), (2) and (3) have been filed
herewith pursuant to Item 3-09(b) of Regulation S-X.
2
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, 2008 and 2007.................................. F-2
Consolidated Statements of Operations for the years ended December 31, 2008,
2007 and 2006........................................................................... F-3
Consolidated Statements of Cash Flows for the years ended December 31, 2008,
2007 and 2006........................................................................... F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2008, 2007 and 2006........................................................ F-6
Notes to Consolidated Financial Statements................................................. F-7
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).
(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.
All documents referenced below were filed pursuant to the Securities
Exchange Act of 1934 by the Company, file number 1-5721, unless otherwise
indicated.
3
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 December 1,
2008 (filed as Exhibit 3.1 to the Company's Current Report on
Form 8-K dated December 2, 2008).*
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 3.6 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2005 (the "2005 10-K")).*
3.7 Certificate of Amendment of the Certificate of Incorporation
dated as of May 23, 2007 (filed as Exhibit 4.7 to the
Company's Registration Statement on Form S-8 (No.
333-143770)).*
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 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).*
10.5 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).*
10.6 Leucadia National Corporation 2003 Senior Executive Annual
Incentive Bonus Plan, as amended May 16, 2006 (filed as Annex
A to the 2006 Proxy Statement).*
10.7 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).*
10.8 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).*
10.9 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")).*
4
10.10 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).*
10.11 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).*
10.12 Information Concerning Executive Compensation (filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K dated
January 24, 2008).*
10.13 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).*
10.14 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).*
10.15 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).*
10.16 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).*
10.17 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).*
10.18 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).*
10.19 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).*
10.20 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")).*
10.21 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).*
10.22 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).*
10.23 Leucadia National Corporation 2006 Senior Executive Warrant
Plan (filed as Annex B to the 2006 Proxy Statement).*
10.24 Asset Purchase and Contribution Agreement, dated as of
January 23, 2007, by and among Baldwin Enterprises, Inc.,
STiPrepaid, LLC, Samer Tawfik, Telco Group, Inc., STi
Phonecard Inc., Dialaround Enterprises Inc., STi Mobile Inc.,
Phonecard Enterprises Inc.,VOIP Enterprises Inc., STi PCS,
LLC, Tawfik & Partners, SNC, STiPrepaid & Co., STi Prepaid
Distributors & Co. and ST Finance, LLC (filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2007 (the "1st Quarter 2007
10-Q")).*
5
10.25 Registration Rights Agreement, dated as of March 8, 2007,
among STi Prepaid, LLC and ST Finance, LLC (filed as Exhibit
10.2 to the 1st Quarter 2007 10-Q).*
10.26 Amended and Restated Limited Liability Company Agreement,
dated as of March 8, 2007, by and among STi Prepaid, LLC, BEI
Prepaid, LLC and ST Finance, LLC (filed as Exhibit 10.3 to the
1st Quarter 2007 10-Q).*
10.27 Master Agreement for the Formation of a Limited Liability
Company dated as of February 28, 2007, among Jefferies Group,
Inc., Jefferies & Company, Inc. and Leucadia National
Corporation (filed as Exhibit 10.4 to the 1st Quarter 2007
10-Q).*
10.28 Amended and Restated Limited Liability Company Agreement of
Jefferies High Yield Holdings, LLC, dated as of April 2, 2007,
by and among Jefferies Group, Inc., Jefferies & Company, Inc.,
Leucadia National Corporation, Jefferies High Yield Partners,
LLC, Jefferies Employees Opportunity Fund LLC and Jefferies
High Yield Holdings, LLC (filed as Exhibit 10.5 to the 1st
Quarter 2007 10-Q).*
10.29 Stock Purchase Agreement by and among BEI-RZT Corporation,
Gaylord Hotels, Inc. and Gaylord Entertainment Company
(Mainland Agreement), dated June 1, 2007 (filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2007).*
10.30 Investment Agreement dated as of April 20, 2008, by and
between Leucadia National Corporation and Jefferies Group,
Inc. (filed as Exhibit 10.1 to the Company's Current Report on
Form 8-K filed on April 21, 2008).*
10.31 Letter Agreement dated April 20, 2008, between Leucadia
National Corporation and Jefferies Group, Inc. (filed as
Exhibit 10.2 to the Company's Current Report on Form 8-K filed
on April 21, 2008).*
10.32 Share Forward Transaction Agreement, dated January 11, 2008
(filed as Exhibit 1 to the Company's Schedule 13D dated
January 10, 2008 with respect to AmeriCredit Corp.).*
21 Subsidiaries of the registrant.*
23.1 Consent of PricewaterhouseCoopers LLP with respect to the
incorporation by reference into the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).*
23.2 Consent of independent auditors from Ernst & Young LLP, with
respect to the inclusion in this Annual Report on Form 10-K of
the financial statements of Pershing Square IV, L.P. and
Pershing Square IV A, L.P. and with respect to the
incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8
(No. 333-143770), and Form S-3 (No. 333-145668).
23.3 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of Premier Entertainment
Biloxi, LLC and with respect to the incorporation by reference
in the Company's Registration Statements on Form S-8 (No.
333-51494), Form S-8 (No. 333-143770), and Form S-3 (No.
333-145668).
23.4 Consent of independent auditors from PricewaterhouseCoopers
LLP, with respect to the inclusion in this Annual Report on
Form 10-K of the financial statements of HFH ShortPLUS Fund,
L.P. and HFH ShortPLUS Master Fund, Ltd. and with respect to
the incorporation by reference in the Company's Registration
Statements on Form S-8 (No. 333-51494), Form S-8 (No.
333-143770), and Form S-3 (No. 333-145668).
6
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.*
31.4 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.5 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.6 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
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.*
32.4 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.**
32.5 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.**
32.6 Certification of Principal Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.**
(c) Financial statement schedules.
(1) Pershing Square IV, L.P. financial statements as of and
for the year ended December 31, 2008 (unaudited), and
as of December 31, 2007 and for the period from June 1,
2007 (commencement of operations) to December 31, 2007
(audited) and Pershing Square IV A, L.P. financial
statements as of and for the year endeded December 31,
2008 (unaudited), and as of December 31, 2007 and for
the period from June 1, 2007 (commencement of
operations) to December 31, 2007 (audited).
(2) Premier Entertainment Biloxi, LLC financial statements
as of and for the year ended December 31, 2006
(unaudited) and as of August 9, 2007 and for the period
from January 1, 2007 through August 9, 2007 (audited).
(3) HFH ShortPLUS Fund, L.P. financial statements as of and
for the year ended December 31, 2008 (unaudited) and as
of and for the year ended December 31, 2007 (audited),
and HFH ShortPLUS Master Fund, Ltd.financial statements
as of and for the year ended December 31, 2008
(unaudited) and as of and for the year ended
December 31, 2007 (audited).
----------------------------
* Incorporated by reference.
** Furnished herewith pursuant to item 601(b) (32) of Regulation S-K.
7
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
March 25, 2009 By: /s/ Barbara L. Lowenthal
---------------------
Barbara L. Lowenthal
Vice President and Comptroller
8
FINANCIAL STATEMENTS
Pershing Square IV, L.P.
Year Ended December 31, 2008
(Unaudited)
Pershing Square IV, L.P.
Financial Statements
Year Ended December 31, 2008
(Unaudited)
Contents
Financial Statements
Statement of Assets, Liabilities and Partners' Capital .............. 1
Statement of Operations.............................................. 2
Statement of Changes in Partners' Capital ........................... 3
Statement of Cash Flows ............................................. 4
Notes to Financial Statements ....................................... 5
Consolidated Financial Statements of Pershing Square IV A, L.P.
Pershing Square IV, L.P.
Statement of Assets, Liabilities and Partners' Capital
December 31, 2008
(Unaudited)
Assets
Investment in Pershing Square IV A, L.P. $ 373,490,155
------------------
Total assets $ 373,490,155
==================
Partners' capital
Partners' capital $ 373,490,155
------------------
Total partners' capital $ 373,490,155
==================
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
3
Pershing Square IV, L.P.
Statement of Operations
Year Ended December 31, 2008
(Unaudited)
Net realized and unrealized losses allocated from
investment in Pershing Square IV A, L.P.
Net realized loss from investments in securities $ (587,544,670)
Net change in unrealized loss from investments in securities 66,417,787
Net realized loss on derivative contracts (257,867,878)
Net change in unrealized loss on derivative contracts (971,357)
-------------------
Net realized and unrealized loss allocated from investment in
Pershing Square IV A, L.P. $ (779,966,118)
Net investment loss allocated from investment in
Pershing Square IV A, L.P.
Investment income
Dividends (net of withholding $303,349) 2,762,841
Interest 2,097,657
Total expenses (7,078,899)
-------------------
Net investment loss allocated from investment in Pershing Square
IV A, L.P. (2,218,401)
Partnership investment income
Reimbursement of expenses 64,831
-------------------
Net investment loss (2,153,570)
--------------
Net loss $ (782,119,688)
==============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
4
Pershing Square IV, L.P.
Statement of Changes in Partners' Capital
Year Ended December 31, 2008
(Unaudited)
Partners' capital at beginning of year $ 1,127,609,843
Limited partners capital contributions 28,000,000
Net loss (782,119,688)
--------------------
Partners' capital at end of year $ 373,490,155
====================
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
5
Pershing Square IV, L.P.
Statement of Cash Flows
Year Ended December 31, 2008
(Unaudited)
Cash flows from operating activities
Net loss $ (782,119,688)
Adjustments to reconcile net loss to net cash used in operating activities:
Decrease in investment in Pershing Square IV A, L.P. 754,184,519
Decrease in accrued expenses (44,961)
Decrease in withholding tax payable (19,870)
-------------------
Net cash used in operating activities (28,000,000)
Cash flows from financing activities
Capital contributions 28,000,000
-------------------
Net change in cash and cash equivalents --
Cash and cash equivalents at beginning of year --
-------------------
Cash and cash equivalents at end of year $ --
===================
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
6
Pershing Square IV, L.P.
Notes to Financial Statements
December 31, 2008
(Unaudited)
1. Organization
Pershing Square IV, L.P. (the "Partnership") was organized as a limited
partnership under the laws of the state of Delaware on May 22, 2007 and
commenced operations on June 1, 2007. The objective of the Partnership is to
invest all of its assets in Pershing Square IV A, L.P. (the "Subsidiary
Partnership"). The Subsidiary Partnership is an exempted limited partnership
formed under the limited liability partnership laws of the Cayman Islands on May
31, 2007 and commenced operations on June 1, 2007. The investment objective of
the Partnership and the Subsidiary Partnership (collectively, the "PSIV
Partnerships") is to create significant capital appreciation by investing in
stock, total return swaps and call options of Target Corporation.
The Partnership is a "master" fund in a "master-feeder" structure whereby
Pershing Square International IV, Ltd. (the "Fund") invests all of its assets in
the Partnership. The Partnership is also a "feeder" fund in a "master-feeder"
structure as the Partnership invests all of its assets in the Subsidiary
Partnership.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, serves as the "General Partner" to the PSIV
Partnerships. The General Partner is responsible for making all investment
decisions on behalf of the PSIV Partnerships and is solely responsible for the
development and implementation of the PSIV Partnerships' investment policy and
strategy. William A. Ackman is the managing member of the General Partner and is
primarily responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of PS Management GP, LLC, the
general partner of PSCM.
Pursuant to an Administration Agreement dated May 2007, Goldman Sachs (Cayman)
Trust, Limited (the "Administrator") has been appointed administrator to the
PSIV Partnerships. The Administrator provides certain administrative and
accounting services and receives customary fees, plus out of pocket expenses,
based on the nature and extent of services provided.
See attached consolidated financial statements of Pershing Square IV A, L.P.
7
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. Significant Accounting Policies
Basis of Presentation
The financial statements of the Partnership have been prepared in accordance
with accounting principles generally accepted in the United States. The
following is a summary of the significant accounting and reporting policies used
in preparing the financial statements.
Valuation of Investment in the Subsidiary Partnership
The Partnership's investment in the Subsidiary Partnership is valued at fair
value, which represents the Partnership's proportionate interest in the
partners' capital of the Subsidiary Partnership at December 31, 2008. The
limited partners' interests of the Subsidiary Partnership are entirely owned by
the Partnership and Pershing Square IV-I L.P. ("PSIV-I"), an affiliated entity
managed by PSCM. The performance of the Partnership is directly affected by the
performance of the Subsidiary Partnership. Attached to these financial
statements are the audited consolidated financial statements of the Subsidiary
Partnership, including the consolidated condensed schedule of investments and
significant accounting and reporting policies, which are an integral part of
these financial statements. Valuation of the investment held by the Partnership
is discussed in the notes of the Subsidiary Partnership's financial statements.
As of December 31, 2008, the Partnership has approximately 91.77% ownership
interest in the Subsidiary Partnership.
Fair Value of Financial Instruments
The fair value of the Partnership's assets and liabilities, which qualify as
financial instruments under Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments," approximates the
carrying amounts presented in the statement of assets, liabilities and partners'
capital.
Investment Transactions and Related Investment Income
The Partnership records its proportionate share of the Subsidiary Partnership's
income, expenses and realized and unrealized gains and losses. The Partnership
accounts for its own income and expenses on an accrual basis.
Use of Estimates
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
See attached consolidated financial statements of Pershing Square IV A, L.P.
8
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. Significant Accounting Policies (continued)
Taxation
No Federal, state or local income taxes have been provided on income or loss of
the Partnership since the partners are individually liable for the taxes on
their share of the Partnership's income or loss. The only taxes payable by the
Partnership on its income are withholding taxes applicable to certain investment
income. As a result, no income tax liability or expense has been recorded in the
accompanying financial statements.
3. Guarantees
The Partnership enters into contracts that contain a variety of
indemnifications. The Partnership's maximum exposure under these arrangements is
unknown. However, the Partnership has not had prior claims or losses pursuant to
these contracts and expects the risk of loss to be remote.
4. Related Party Transactions
The Partnership is not charged a management fee nor performance allocation at
the Partnership level. Management fees and performance allocation are charged
indirectly through the Partnership's investment in the Subsidiary Partnership.
During the year ended December 31, 2008, Pershing Square, L.P. ("PSLP"), an
affiliated investment fund managed by PSCM, had an investment in the
Partnership. PSLP was not charged a management fee nor performance allocation by
PSCM in relation to its investment in the Partnership and indirectly through its
investment in the Subsidiary Partnership. At December 31, 2008, PSLP owned 2.14%
of the total partners' capital of the Partnership.
On June 30, 2008, the Fund and the Partnership were re-opened to allow an
additional contribution in the Fund of $28,000,000 made by Pershing Square
International Ltd., an affiliated fund managed by PSCM.
5. Allocation of Net Income/(Loss)
In accordance with the Partnership Agreement (the "Agreement"), net income or
loss is allocated as of the last business day of each Fiscal Period, as defined,
to all partners in proportion to each partner's capital account at the time of
such allocation.
See attached consolidated financial statements of Pershing Square IV A, L.P.
9
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
6. Partner's Capital
In accordance with the Agreement, a limited partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Partnership to do so. The General Partner has extended the Lock-Up Date for
up to one year beyond December 31, 2009 of the Partnership and the Subsidiary
Partnership.
7. Financial Highlights
The following represents the ratios to average limited partners' capital and
total return information for the year ended December 31, 2008:
Ratios to average limited partners' capital:
Expenses 0.73%
======
Net investment loss (0.22)%
======
Total return (67.91)%
======
The above ratios and total return are calculated for all limited partners taken
as a whole. Individual partner's ratios and returns may vary from the above
based on different management fee and performance allocation arrangements and
timing of capital transactions.
8. Subsequent Events
Beginning January 1, 2009, the General Partner elected to waive all future
management fees and the performance allocation for all investors in the
Partnership. During the period from January 1, 2009 to February 28, 2009,
performance for the Partnership was (60%).
On January 31, 2009, the Fund redeemed its entire investment in the Partnership
and subsequently subscribed its entire investment into the Subsidiary
Partnership. Pershing Square IV Trade-Co, L.P. ("PSIV TradeCo LP"), a Delaware
Limited Partnership, was formed on January 13, 2009. PSIV TradeCo LP is a wholly
owned subsidiary of the Partnership. PSIV TradeCo LP, may invest in stock, total
return swaps and/or call options of Target Corporation.
See attached consolidated financial statements of Pershing Square IV A, L.P.
10
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
8. Subsequent Events (continued)
On February 8, 2009, the General Partner decided to waive the lock-up and
permitted investors to redeem on February 28, 2009 from the Partnership. Any
investor that elected not to redeem on February 28, 2009 will be committed until
the Lock-Up Date. Redemptions on February 28, 2009 for the Partnership totaled
approximately $51,490,000. In addition, the General Partner will also permit
investors in the Partnership to apply a highwater mark adjustment to their
existing, or new, investments in any affiliated entities managed by PSCM to
compensate for losses incurred in the Partnership.
On March 1, 2009, the PSIV Partnerships, the Fund, PSIV-I and Pershing Square
International IV-I, Ltd., an affiliated entity managed by PSCM, (collectively
the "PSIV entities"), opened for new and additional capital contributions. Total
contributions received on March 1, 2009 by the PSIV entities were $68,997,000.
Contributions from William A. Ackman, affiliated entities managed by PSCM,
certain employees and advisory board members represented $67,672,000 of the
total contributions received. Total contributions received on March 1, 2009 by
the Partnership were $1,175,000. Contributions from certain employees and
advisory board members represented $850,000 of the total contributions received
by the Partnership.
See attached consolidated financial statements of Pershing Square IV A, L.P.
11
CONSOLIDATED FINANCIAL STATEMENTS
Pershing Square IV A, L.P.
Year Ended December 31, 2008
(Unaudited)
Pershing Square IV A, L.P.
Consolidated Financial Statements
Year Ended December 31, 2008
(Unaudited)
Contents
Consolidated Financial Statements
Consolidated Statement of Assets, Liabilities and Partners' Capital .......... 1
Consolidated Condensed Schedule of Investments ............................... 2
Consolidated Statement of Operations.......................................... 3
Consolidated Statement of Changes in Partners' Capital ....................... 4
Consolidated Statement of Cash Flows ......................................... 5
Notes to Consolidated Financial Statements ................................... 6
Pershing Square IV A, L.P.
Consolidated Statement of Assets, Liabilities and Partners' Capital
(Stated in United States Dollars)
December 31, 2008
(Unaudited)
Assets
Cash and cash equivalents $ 7,500,000
Due from brokers 38,494,447
Investments in securities, at fair value (cost $1,050,018,441) 389,245,072
Net unrealized gain on swap contracts 5,068,275
Dividend receivable 4,778
Interest receivable 896
--------------
Total assets $ 440,313,468
==============
Liabilities and partners' capital
Due to broker $ 32,389,275
Net unrealized loss on swap contracts 134,834
Accrued expenses and other liabilities 811,812
--------------
Total liabilities 33,335,921
Partners' capital 406,977,547
--------------
Total liabilities and partners' capital $ 440,313,468
==============
The accompanying notes are an integral part of the consolidated
financial statements.
3
Pershing Square IV A, L.P.
Consolidated Condensed Schedule of Investments
(Stated in United States Dollars)
December 31, 2008
(Unaudited)
Percentage
Shares/ of Partners'
Contracts Description/Name Fair Value Capital
-------------------------------------------------------------------------------------------------------------------
Investments in Securities
Equity Securities
United States:
Retail
2,601,875 Target Corp. $ 89,842,744 22.07%
-----------------------------
Total Equity Securities (cost $80,646,000) 89,842,744 22.07
Equity Option Contracts
United States:
Retail
Target Corp., Calls, Strike Prices $40.00 -
58,925,962 $51.04, 04/02/09 - 03/19/10 299,402,328 73.57
-----------------------------
Total Equity Option Contracts
(cost $969,372,441) 299,402,328 73.57
-----------------------------
Total Investments in Securities $ 389,245,072 95.64%
(cost $1,050,018,441)
=============================
Derivative Contracts
Credit Default Swaps, buy protection
United States:
Banking $ (134,834) (0.03)%
Total Return Swaps, long exposure
United States:
Banking 5,068,275 1.25
-----------------------------
Total Derivative Contracts $ 4,933,441 1.22%
=============================
The accompanying notes are an integral part of the consolidated
financial statements.
4
Pershing Square IV A, L.P.
Consolidated Statement of Operations
(Stated in United States Dollars)
Year Ended December 31, 2008
(Unaudited)
Net realized and unrealized loss from investments
Net realized loss from investments in securities $ (613,261,514)
Net change in unrealized loss from investments in securities 61,609,793
Net realized loss on derivative contracts (280,816,758)
Net change in unrealized loss on derivative contracts 5,451,528
------------------
Net loss from investments $ (827,016,951)
Investment income
Dividends (net of withholding taxes of $303,349) 2,865,077
Interest 2,165,567
------------------
Total investment income 5,030,644
Partnership expenses
Management fee 2,299,475
Professional fees 4,899,706
Interest 267,389
Withholding tax 67,505
------------------
Total expenses 7,534,075
------------------
Net investment loss (2,503,431)
---------------
Net loss $ (829,520,382)
===============
The accompanying notes are an integral part of the consolidated
financial statements.
5
Pershing Square IV A, L.P.
Consolidated Statement of Changes in Partners' Capital
(Stated in United States Dollars)
Year Ended December 31, 2008
(Unaudited)
Limited General
Total Partners Partner
----------------------------------------------------------------------
Partners' capital at beginning of year $ 1,128,247,929 $ 1,127,674,674 $ 573,255
Capital contributions 108,250,000 108,250,000* --
Net loss (829,520,382) (829,131,651) (388,731)
------------------- ------------------- ---------------
Partners' capital at end of year $ 406,977,547 $ 406,793,023 $ 184,524
=================== =================== ===============
* William A. Ackman contributed $5,000,000 as a limited partner.
The accompanying notes are an integral part of the consolidated
financial statements.
6
Pershing Square IV A, L.P.
Consolidated Statement of Cash Flows
(Stated in United States Dollars)
Year Ended December 31, 2008
(Unaudited)
Cash flows from operating activities
Net loss $ (829,520,382)
Adjustments to reconcile net loss to net cash used in operating activities:
Net realized loss from investments in securities 613,261,514
Net change in unrealized loss from investments in securities (61,609,793)
Net change in unrealized loss on derivative contracts (5,451,528)
Purchases of investments (528,548,589)
Proceeds from investments sold 646,993,967
Increase in due to/from brokers (5,773,222)
Increase in dividend receivable (4,778)
Decrease in interest receivable 629,581
Increase in accrued expenses and other liabilities 568,132
-------------------
Net cash used in operating activities (169,455,098)
Cash flows from financing activities
Capital contributions 108,250,000
-------------------
Net change in cash and cash equivalents (61,205,098)
Cash and cash equivalents at beginning of year 68,705,098
-------------------
Cash and cash equivalents at end of year $ 7,500,000
===================
Supplemental disclosure of cash flow information
Cash paid during the year for interest $ 267,389
===================
The accompanying notes are an integral part of the consolidated
financial statements.
7
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements
December 31, 2008
(Unaudited)
1. Organization
Pershing Square IV A, L.P. (the "Subsidiary Partnership") is an exempted limited
partnership formed under the limited liability partnership laws of the Cayman
Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment
objective of the Subsidiary Partnership is to create significant capital
appreciation by investing in stock, total return swaps and call options of
Target Corporation.
The Subsidiary Partnership acts as the master fund in a "master-feeder"
structure whereby Pershing Square IV, L.P. ("PSIV LP") and Pershing Square IV-I,
L.P. ("PSIV-I LP") invest all of their capital in the Subsidiary Partnership.
PSIV LP and PSIV-I LP (collectively, the "Partnerships") were organized as
limited partnerships under the laws of the state of Delaware on May 22, 2007 and
June 27, 2008, respectively, and commenced operations on June 1, 2007 and June
30, 2008, respectively. The Partnerships are also "master" funds in a
"master-feeder" structure whereby Pershing Square International IV, Ltd. ("PSIV
Ltd") invests all of its assets in PSIV LP and Pershing Square International
IV-I, Ltd ("PSIV-I Ltd") invests all of its assets in PSIV-I LP. PSIV Ltd and
PSIV-I Ltd (collectively, the "Funds") are exempted companies formed under the
limited liability laws of the Cayman Islands on May 15, 2007 and May 23, 2008,
respectively, and are registered under the Cayman Islands Mutual Funds Law.
Pershing Square IV B, L.P. (the "PSIV B") is a wholly owned subsidiary of the
Subsidiary Partnership and was incorporated on July 17, 2007 under the laws of
the state of Delaware. Since inception there has been no activity in PSIV B and
PSIV B did not hold any assets on behalf of the Subsidiary Partnership at
December 31, 2008.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, serves as the "General Partner" to the Subsidiary
Partnership and the Partnerships (collectively, the "PSIV Partnerships"). The
General Partner is responsible for making all investment decisions on behalf of
the PSIV Partnerships and is solely responsible for the development and
implementation of the PSIV Partnerships' investment policy and strategy. William
A. Ackman is the managing member of the General Partner and is primarily
responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of PS Management GP, LLC, the
general partner of PSCM.
8
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
1. Organization (continued)
Pursuant to an Administration Agreement dated May 2007, Goldman Sachs (Cayman)
Trust, Limited (the "Administrator") has been appointed administrator to the
PSIV Partnerships and Funds. The Administrator provides certain administrative
and accounting services and receives customary fees, plus out of pocket
expenses, based on the nature and extent of services provided.
2. Significant Accounting Policies
Basis of Presentation
The Subsidiary Partnership's consolidated financial statements and the following
significant accounting policies have been prepared in accordance with accounting
principles generally accepted in the United States of America and are stated in
United States dollars. The following is a summary of the significant accounting
and reporting policies used in preparing the consolidated financial statements.
Basis of Consolidation
The Subsidiary Partnership's policy is to consolidate all subsidiaries that are
wholly owned. The consolidated financial statements include the results of the
Subsidiary Partnership and its subsidiary, PSIV B. Intercompany transactions
have been eliminated on consolidation.
Investment Transactions and Related Investment Income
The Subsidiary Partnership records its securities transactions and the related
revenue and expenses on a trade date basis. Generally, realized gains and losses
from security transactions are calculated on a highest cost relief method.
Dividends are recorded on the ex-dividend date, net of any applicable foreign
withholding taxes. Interest is recorded on the accrual basis.
Valuation of Investments
In general, the Subsidiary Partnership values investments at their last sales
price on the date of determination. If no sales occurred on such date, such
investments are valued at the mean of the last "bid" and "ask" price on the last
business day such investments were traded. Investments for which no such market
prices are available are valued at fair value by the General Partner based upon
counterparty and independent third party prices. All unrealized gains and losses
are reflected on the consolidated statement of operations.
9
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
Cash and Cash Equivalents
The Subsidiary Partnership considers all highly liquid financial instruments
with a maturity of three months or less to be cash equivalents. As of December
31, 2008, cash and cash equivalents consist of a money market fund invested in
U.S. Treasury securities and are held with an affiliate of the Administrator.
Fair Value of Financial Instruments
The fair value of the Subsidiary Partnership's assets and liabilities which
qualify as financial instruments under Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial Instruments,"
approximates the carrying amounts presented in the consolidated statement of
assets, liabilities and partners' capital.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
Income Taxes
The Subsidiary Partnership is not subject to any income or capital gains taxes
in the Cayman Islands since the partners are individually liable for the taxes
on their share of the Subsidiary Partnership's income or loss. The only taxes
payable by the Subsidiary Partnership on its income are withholding taxes
applicable to dividend income. As a result, no income tax liability or expense
has been recorded in the accompanying consolidated financial statements.
10
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. Significant Accounting Policies (continued)
New Accounting Pronouncements
On July 13, 2006, the Financial Accounting Standards Board ("FASB") released
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN
48). FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the consolidated financial
statements. FIN 48 requires the evaluation of tax positions taken or expected to
be taken in the course of preparing the Subsidiary Partnership's tax returns to
determine whether the tax positions are "more-likely-than-not" of being
sustained by the applicable tax authority. Tax positions not deemed to meet the
more-likely-than-not threshold would be recorded as a tax benefit or expense in
the current year. Adoption of FIN 48 was deferred to fiscal years beginning
after December 15, 2008 and is to be applied to all open tax years as of the
effective date. At this time, the Subsidiary Partnership is evaluating the
implications of FIN 48 and its impact on the consolidated financial statements,
if any, has not yet been determined. The Subsidiary Partnership elected to defer
adoption of FIN 48, allowable under FASB Staff Position ("FSP") FIN 48-3, and
will adopt for the fiscal year ending December 31, 2009, as required.
In March 2008, the FASB released Statement No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB Statement
No. 133" ("FAS 161"). FAS 161 requires enhanced disclosure about an entity's
derivative and hedging activities, thereby improving the transparency of
financial reporting. FAS 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008. The
Subsidiary Partnership believes the implications of FAS 161 would have no impact
to partners' capital.
3. Fair Value Measurement
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement on Financial Accounting Standards No. 157, "Fair Value Measurements"
("FAS 157"). This standard clarifies the definition of fair value for financial
reporting, establishes a framework for measuring fair value and requires
additional disclosures about the use of fair value measurements. FAS 157 is
effective for financial statements issued for fiscal years beginning after
November 15, 2007 and interim periods within those fiscal years. FAS 157
requires a categorization of assets and liabilities stated at fair value based
upon an assessment of the valuation inputs and techniques used by the Subsidiary
Partnership. There are three levels of categorization under FAS 157 as follows:
11
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
3. Fair Value Measurement (continued)
Level 1 - Inputs are unadjusted quoted prices in active markets at the
measurement date. The assets and liabilities in this category
will generally include equities listed in active markets,
treasuries ("on the run") and listed options.
Level 2 - Inputs (other than quoted prices included in Level 1) are
obtained directly or indirectly from observable market data
at the measurement date. The assets and liabilities in this
category will generally include equity options, credit default
swaps, total return swaps and certain derivatives.
Level 3 - Inputs reflect the Partnership's best estimate of what market
participants would use in pricing the assets and liabilities at
the measurement date. The assets and liabilities in this
category will generally include private investments and certain
derivatives.
The Partnership's assets and liabilities measured at fair value as of December
31, 2008 are categorized in the below table:
--------------------------------------------------------------------------------------------------------------
Fair Value Measurements at December 31, 2008
--------------------------------------------------------------------------------------------------------------
Description Level 1 Level 2 Level 3 Total
--------------------------------------------------------------------------------------------------------------
Assets:
Investments in securities $ 89,842,744 $ 299,402,328 +/- $ -- $ 389,245,072
Derivative contracts -- 5,068,275 ^ -- 5,068,275
------------ ------------------- ------------- --------------------
Total Assets $ 89,842,744 $ 304,470,603 $ -- $ 394,313,347
============ =================== ============= ====================
Liabilities:
Derivative contracts $ -- $ (134,834)^ $ -- $ (134,834)
============ =================== ============= ====================
Total Liabilities $ -- $ (134,834) $ -- $ (134,834)
============ =================== ============= ====================
+/- Level 2 investments in securities include OTC call options which are
fair valued by the General Partner using prices obtained from four
different counterparties.
^ Level 2 derivative contracts include credit default swaps and total
return swaps, which are valued by an independent third party.
12
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
4. Due to/from Brokers
Due from brokers include cash balances held at the Subsidiary Partnership's
clearing broker and cash collateral pledged to counterparties. Due to brokers
include cash collateral received from counterparties.
The Subsidiary Partnership has agreements with its counterparties whereby the
Partnership receives and is required to pledge collateral. As of December 31,
2008, the Subsidiary Partnership had pledged $5,680,000 of cash collateral in
connection with its derivative trading activities. Due to broker consists of
cash received from one broker to collateralize the Subsidiary Partnership's OTC
call options purchased from that broker.
5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk
or Concentrations of Credit Risk
In the normal course of business, the Subsidiary Partnership enters into
derivative contracts for investment purposes. Typically, derivative contracts
serve as components of the Subsidiary Partnership's investment strategy and are
utilized primarily to structure the portfolio to economically match the
investment objectives of the Subsidiary Partnership. These instruments are
subject to various risks similar to non-derivative instruments, including
market, credit, liquidity, and operational risks. The Subsidiary Partnership
manages these risks on an aggregate basis along with the risks associated with
its investing activities as part of its overall risk management policies.
The Subsidiary Partnership's derivative trading activities are primarily the
purchase and sale of OTC options, credit default swaps and total return swaps.
All derivatives are reported at fair value (as described in Note 2) in the
consolidated statement of assets, liabilities and partners' capital and changes
in fair value are reflected in the consolidated statement of operations.
Total return swaps represent agreements between two parties to make payments
based upon the performance of certain underlying assets. The Subsidiary
Partnership is obligated to pay, or entitled to receive as the case may be, the
net difference in the value determined at the onset of the swap versus the value
determined at the termination or reset date of the swap. Therefore, the amounts
required for the future satisfaction of the swaps may be greater or less than
the amounts recorded on the consolidated statement of assets, liabilities and
partners' capital. The ultimate gain or loss depends upon the prices at which
the underlying financial instruments of the swaps are valued on the settlement
date. At December 31, 2008, the Subsidiary Partnership holds total return swaps
with affiliated entities (see Note 6).
13
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk
or Concentrations of Credit Risk (continued)
A credit default swap contract represents an agreement in which one party, the
protection buyer, pays a fixed fee, the premium, in return for a payment by the
other party, the protection seller, contingent upon a specified credit event
relating to an underlying reference asset. While there is no credit event, the
protection buyer pays the protection seller the periodic premium. If a specified
credit event occurs, there is an exchange of cash flows and/or securities
designed so that the net payment to the protection buyer reflects the loss
incurred by creditors of the reference asset in the event of its default. The
nature of the credit event is established by the buyer and the seller at the
inception of the transaction and such events include bankruptcy, insolvency,
rating agency downgrade and failure to meet payment obligations when due.
The Subsidiary Partnership clears all of its securities transactions through
major U.S.-registered broker dealers, primarily through Goldman Sachs & Co.,
pursuant to customer agreements. At December 31, 2008, substantially all
investments, derivative contracts and amounts due from brokers are positions
with and amounts due from six brokers. The Subsidiary Partnership had
substantially all its counterparty concentration with these brokers and their
affiliates.
Receivables and payables on derivative contracts are reported net by
counterparty on the consolidated statement of assets, liabilities and partners'
capital, provided the legal right of offset exists.
At December 31, 2008, the following derivative contracts were included in the
Subsidiary Partnership's consolidated statement of assets, liabilities and
partners' capital:
Assets Liabilities
-------------- ----------------
OTC options $ 299,402,328 $ --
Swaps 6,727,838 1,794,397
-------------- --------------
Total $ 306,130,166 $ 1,794,397
============== ==============
14
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
5. Derivative Contracts and Financial Instruments with Off-Balance Sheet Risk
or Concentrations of Credit Risk (continued)
The swaps and OTC options balances above represent the Subsidiary Partnership's
assets and liabilities from OTC derivative contracts by brokers and are not
representative of the outstanding credit risk to the Subsidiary Partnership due
to the existence of netting agreements. After taking into effect the offsetting
permitted under Financial Accounting Standards Board Interpretation No. 39,
Offsetting of Amounts Related to Certain Contracts, the Subsidiary Partnership
views its credit exposure to be $277,626,494 at December 31, 2008, representing
the fair value of derivative contracts in net asset position net of derivative
contracts in net liability position and any collateral received or pledged to
counterparties.
The Subsidiary Partnership receives and pledges collateral from/to certain of
its counterparties in accordance with bilateral collateral agreements. The
Subsidiary Partnership's credit exposure is offset by cash collateral of
$32,389,275 that the Subsidiary Partnership received from one counterparty at
December 31, 2008. The Subsidiary Partnership pledged cash collateral of
$5,680,000 to one counterparty to cover margin requirements for certain
derivative positions at December 31, 2008. The Subsidiary Partnership has
exposure to credit default swap contracts to hedge against the Subsidiary
Partnership's credit exposure on derivative contracts. At December 31, 2008, the
Subsidiary Partnership has exposure to credit default swap contracts on these
counterparties with notional values of 425,000,000 on Deutsche Bank AG,
386,471,000 on Credit Suisse Group AG, 88,927,000 on Citigroup Inc. and
62,480,000 on BNP Paribas.
6. Related Party Transactions
In accordance with the Partnership Agreement (the "Agreement"), PSCM provides
management and administrative services to the Subsidiary Partnership. As
compensation for such services, PSCM receives a quarterly management fee in
advance equal to 0.0625% (0.25% on an annual basis) of the balance in the
limited partners' capital account as of the last business day of the previous
calendar quarter, taking into account contributions made on the first day of
such calendar quarter. The management fee for the year ended December 31, 2008
was $2,299,475. The General Partner may, in its sole discretion, elect to waive
the management fee with respect to any limited partner. Subsequent to year end
the General Partner decided to waive all future fees for all investors (see Note
11).
15
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
6. Related Party Transactions (continued)
As of December 31, 2008, the Subsidiary Partnership had unrealized gain on swap
contracts with an affiliated entity managed by PSCM of $5,068,275. This amount
relates to total return swap contracts with the affiliated entity whereby the
Subsidiary Partnership has economic exposure to various credit default swaps
held by the affiliated entity. The credit default swap contracts were purchased
for the purpose of hedging the Subsidiary Partnership's credit exposure to
certain option contract counterparties. The Subsidiary Partnership has the same
terms and economic attributes as if it were the direct buyer of these credit
default swap contracts and therefore all income and loss associated with these
swap contracts are reflected in the Subsidiary Partnership's consolidated
statement of operations.
During the year ended December 31, 2008, Pershing Square, L.P. ("PSLP") and
Pershing Square International Ltd. ("PSINTL"), affiliated investment funds
managed by PSCM, had an investment in the Partnerships and the Funds,
respectively. PSLP and PSINTL were not charged a management fee nor a
performance allocation.
On June 30, 2008, PSIV Ltd and PSIV LP were re-opened to allow an additional
contribution of $28,000,000 made by PSINTL. PSIV-I Ltd and PSIV-I LP also
commenced operations on June 30, 2008 and accepted contributions of $32,521,000
and $39,479,000, respectively, which were made by PSINTL and PSLP, respectively.
William A. Ackman made a contribution of $5,000,000 on July 9, 2008 in PSIV-I
Ltd. when PSIV-I Ltd. was re-opened.
7. Guarantees
The Subsidiary Partnership enters into contracts that contain a variety of
indemnifications. The Subsidiary Partnership's maximum exposure under these
arrangements is unknown. However, the Subsidiary Partnership has not had prior
claims or losses pursuant to these contracts and expects the risk of loss to be
remote.
8. Allocation of Net Income/(Loss)
In accordance with the Agreement, net income or loss is allocated as of the last
business day of each Fiscal Period, as defined, to all partners in proportion to
each partner's capital account at the time of such allocation.
16
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
8. Allocation of Net Income/(Loss) (continued)
At the end of each fiscal year or upon a limited partner's full withdrawal, for
each limited partner's capital account which has been allocated net income,
there shall be allocated to the capital accounts of the General Partner, 20% of
the excess of the net income allocated to such limited partner's capital account
above the loss carryforward (the "Performance Allocation"), if any, and the
management fee with respect to the limited partner's capital account. The
General Partner in its sole discretion has reduced the Performance Allocation to
10% for those limited partners that made initial contributions of at least $100
million. For the year ended December 31, 2008, there was no Performance
Allocation.
The General Partner may, in its sole discretion, elect to waive or reduce the
Performance Allocation with respect to any limited partner. Subsequent to year
end the General Partner decided to waive all future Performance Allocation for
all investors (see Note 11).
9. Partners' Capital
In accordance with the Agreement, a limited partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Subsidiary Partnership to do so. The General Partner has extended the
Lock-Up Date for up to one year beyond December 31, 2009 of the Subsidiary
Partnership.
10. Financial Highlights
The following represents the ratios to average limited partners' capital and
total return information for the year ended December 31, 2008.
Ratios to average limited partners' capital:
Expenses 0.75%
===========
Net investment loss (0.25)%
===========
Total return (67.91)%
===========
The above ratios and total return are calculated for all limited partners taken
as a whole. Individual partner's ratios and returns may vary from the above
based on different management fee and Performance Allocation arrangements and
the timing of capital transactions.
17
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
11. Subsequent Events
Effective January 1, 2009, the General Partner elected to waive all future
management fees and the performance allocation for all investors in the
Partnerships and the Funds. During the period from January 1, 2009 to February
28, 2009, consolidated performance for the Subsidiary Partnership was (60%).
On January 31, 2009, PSIV Ltd and PSIV-I Ltd withdrew their entire investment in
PSIV LP and PSIV-I LP, respectively, and subsequently subscribed their entire
investment into the Subsidiary Partnership. Pershing Square IV Trade-Co, L.P.
("PSIV TradeCo LP"), a Delaware Limited Partnership, was formed on January 13,
2009. PSIV TradeCo LP is a wholly owned subsidiary of Pershing Square IV, L.P.
Pershing Square IV-I Trade-Co, L.P. ("PSIV-I TradeCo LP"), a Delaware Limited
Partnership, was formed on January 13, 2009. PSIV-I TradeCo LP is a wholly owned
subsidiary of Pershing Square IV-I, L.P. Pershing Square International IV
Trade-Co, Ltd. ("PSIV TradeCo Ltd"), was incorporated as an exempted company on
January 8, 2009 under the laws of the Cayman Islands. PSIV TradeCo Ltd is a
wholly owned subsidiary of Pershing Square International IV, Ltd. Pershing
Square International IV-I Trade-Co, Ltd. ("PSIV-I TradeCo Ltd"), was
incorporated as an exempted company on January 8, 2009 under the laws of the
Cayman Islands. PSIV-I TradeCo Ltd is a wholly owned subsidiary of Pershing
Square International IV-I, Ltd. These newly formed entities, (collectively, the
"TradeCos"), may invest in stock, total return swaps and/or call options of
Target Corporation.
On February 8, 2009, the General Partner decided to waive the lock-up and
permitted investors to withdraw on February 28, 2009 from the Partnerships and
the Funds. Any investor that elected not to withdraw on February 28, 2009 will
be committed until the Lock-Up Date. Redemptions on February 28, 2009 totaled
approximately $88,550,000. In addition, the General Partner will also permit
investors in the Partnerships or the Funds to apply a highwater mark adjustment
to their existing, or new, investments with any affiliated entities managed by
PSCM to compensate for losses incurred in the Partnerships or in the Funds.
On March 1, 2009, the Partnerships and the Funds opened for new and additional
capital contributions. Total contributions received on March 1, 2009 by the
Partnerships and the Funds collectively were $68,997,000. Contributions from
William A. Ackman, affiliates of the General Partner, affiliated entities
managed by PSCM, certain employees and advisory board members represented
$67,672,000 of the total contributions received.
18
FINANCIAL STATEMENTS
Pershing Square IV, L.P.
Period from June 1, 2007 (commencement of operations) to December 31, 2007 with
Report of Independent Registered Public Accounting Firm
Pershing Square IV, L.P.
Financial Statements
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CONTENTS
Audited Financial Statement Schedules Index
Report of Independent Registered Public Accounting Firm ................. 1
Statement of Assets, Liabilities and Partners' Capital .................. 2
Statement of Operations.................................................. 3
Statement of Changes in Partners' Capital ............................... 4
Statement of Cash Flows ................................................. 5
Notes to Financial Statements ........................................... 6
Financial Statements of Pershing Square IV A, L.P.
Report of Independent Registered Public Accounting Firm
The General Partner
Pershing Square IV, L.P.
We have audited the accompanying statement of asset, liabilities and partners'
capital of Pershing Square IV, L.P. (the "Partnership") as of December 31, 2007,
and the related statements of operations, changes in partners' capital and cash
flows for the period from June 1, 2007 (commencement of operations) to December
31, 2007. These financial statements are the responsibility of the Partnership's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. We were not engaged to perform an
audit of the Partnership's internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Partnership's internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pershing Square IV, L.P. at
December 31, 2007, and the results of its operations, the changes in its
partners' capital and its cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ ERNST & YOUNG
March 19, 2008
1
Pershing Square IV, L.P.
Statement of Assets, Liabilities and Partners' Capital
(Stated in United States Dollars)
December 31, 2007
ASSETS
Investment in Pershing Square IV A, L.P. $1,127,674,674
--------------
Total assets $1,127,674,674
==============
LIABILITIES AND PARTNERS' CAPITAL
Accrued expenses $ 44,961
Withholding tax payable 19,870
--------------
Total liabilities 64,831
Partners' capital 1,127,609,843
--------------
Total liabilities and partners' capital $1,127,674,674
==============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
2
Pershing Square IV, L.P.
Statement of Operations
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
NET REALIZED AND UNREALIZED LOSSES ALLOCATED
FROM INVESTMENT IN PERSHING SQUARE IV A, L.P.
Net realized loss from investments in $ (40,790,512)
securities
Net change in unrealized loss from
investments in securities (722,016,297)
Net realized loss on derivative contracts (93,937,016)
Net change in unrealized loss on derivative (517,824)
contracts --
Net loss allocated from investment in
Pershing Square IV A, L.P. $(857,261,649)
NET INVESTMENT INCOME ALLOCATED FROM
INVESTMENT IN
PERSHING SQUARE IV A, L.P.
INVESTMENT INCOME
Interest 18,557,238
Dividends 383,405
Total expenses (4,104,320)
-------------
Net investment income allocated from
investment in Pershing Square IV A, L.P. 14,836,323
PARTNERSHIP EXPENSES
Professional fees (44,961)
Withholding tax (19,870)
-------------
Total expenses (64,831)
-------------
-------------
Net investment income 14,771,492
-------------
Net loss $(842,490,157)
=============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
3
Pershing Square IV, L.P.
Statement of Changes in Partners' Capital
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
Limited partners capital contributions $ 1,970,100,000
Net loss (842,490,157)
---------------
Partners' capital at end of period $ 1,127,609,843
===============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
4
Pershing Square IV, L.P.
Statement of Cash Flows
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (842,490,157)
Adjustments to reconcile net loss to net cash used in
operating activities:
Increase in investment in Pershing Square IV A, L.P. (1,127,674,674)
Increase in accrued expenses 44,961
Increase in withholding tax payable 19,870
---------------
Net cash used in operating activities (1,970,100,000)
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions 1,970,100,000
---------------
Net change in cash and cash equivalents --
Cash and cash equivalents at beginning of period --
---------------
Cash and cash equivalents at end of period $ --
===============
The accompanying notes and attached consolidated financial statements of
Pershing Square IV A, L.P. are an integral part of the financial statements.
5
Pershing Square IV, L.P.
Notes to Financial Statements
December 31, 2007
1. ORGANIZATION
Pershing Square IV, L.P. (the "Partnership") is organized as a limited
partnership under the laws of the state of Delaware on May 22, 2007 and
commenced operations on June 1, 2007. The objective of the Partnership is to
invest all of its assets in Pershing Square IV A, L.P. (the "Subsidiary
Partnership"). The Subsidiary Partnership is an exempted limited partnership
formed under the limited liability partnership laws of the Cayman Islands on May
31, 2007 and commenced operations on June 1, 2007. The investment objective of
the Partnership and the Subsidiary Partnership (collectively, the "PSIV
Partnerships") is to create significant capital appreciation by investing in
stock, total return swaps and call options of Target Corporation.
The Partnership is a "master" fund in a "master-feeder" structure whereby
Pershing Square International IV, Ltd. (the "Fund") invests all of its assets in
the Partnership. The Partnership is also a "feeder" fund in a "master-feeder"
structure as the Partnership invests all of its assets in the Subsidiary
Partnership.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, will serve as the "General Partner" to the PSIV
Partnerships. The General Partner is responsible for making all investment
decisions on behalf of the PSIV Partnerships and is solely responsible for the
development and implementation of the PSIV Partnerships' investment policy and
strategy. William A. Ackman is the managing member of the General Partner and is
primarily responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of the general partner of
PSCM.
Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs
(Cayman) Trust, Limited (the "Administrator") has been appointed administrator
to the PSIV Partnerships. The Administrator is compensated for its services in
accordance with the fees stated in this Administration Agreement.
6
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The financial statements of the Partnership have been prepared in accordance
with accounting principles generally accepted in the United States of America
and are stated in United States dollars. The following is a summary of the
significant accounting and reporting policies used in preparing the financial
statements.
CASH AND CASH EQUIVALENTS
The Partnership considers all highly liquid financial instruments with a
maturity of three months or less to be cash equivalents.
VALUATION OF INVESTMENT IN THE SUBSIDIARY PARTNERSHIP
The Partnership's investment in the Subsidiary Partnership is valued at fair
value, which represents the Partnership's proportionate interest in the
partners' capital of the Subsidiary Partnership at December 31, 2007, determined
from audited financial statements prepared in accordance with accounting
principles generally accepted in the United States. The performance of the
Partnership is directly affected by the performance of the Subsidiary
Partnership. Attached are the audited financial statements of the Subsidiary
Partnership, including the consolidated condensed schedule of investments and
significant accounting and reporting policies, which are an integral part of
these financial statements. Valuation of the investment held by the Partnership
is discussed in the notes of the Subsidiary Partnership's financial statements.
As of December 31, 2007, the Partnership has approximately 99.95% ownership
interest in the Subsidiary Partnership.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Partnership's assets and liabilities, which qualify as
financial instruments under Statement of Financial Accounting Standards No. 107,
"Disclosures About Fair Value of Financial Instruments," approximates the
carrying amounts presented in the statement of assets, liabilities and partners'
capital.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME
The Partnership records its investment transactions and the related revenue and
expenses on a trade-date basis. All unrealized gains and losses from the
Partnership's investment in the Subsidiary Partnership are reflected in the
statement of operations.
7
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
TAXATION
No Federal, state or local income taxes have been provided on income or loss of
the Partnership since the partners are individually liable for the taxes on
their share of the Partnership's income or loss. The only taxes payable by the
Partnership on its income are withholding taxes applicable to certain investment
income. As a result, no income tax liability or expense has been recorded in the
accompanying financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
On July 13, 2006, the Financial Accounting Standards Board ("FASB") released
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN
48). FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the financial statements. FIN
48 requires the evaluation of tax positions taken or expected to be taken in the
course of preparing the Partnership's tax returns to determine whether the tax
positions are "more-likely-than-not" of being sustained by the applicable tax
authority. Tax positions not deemed to meet the more-likely-than-not threshold
would be recorded as a tax benefit or expense in the current year. Adoption of
FIN 48 was deferred to fiscal years beginning after December 15, 2007 and is to
be applied to all open tax years as of the effective date. At this time, the
Partnership is evaluating the implications of FIN 48 and its impact on the
financial statements has not yet been determined.
In September 2006, the FASB issued Statement on Financial Accounting Standards
No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the
definition of fair value for financial reporting, establishes a framework for
measuring fair value and requires additional disclosures about the use of fair
value measurements. FAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and interim periods within those
fiscal years. The Partnership does not believe that adoption of FAS 157 will
impact the amounts reported in the financial statements. However, once adopted,
additional disclosures will be required about the inputs used to develop the
measurements of fair value and the effect of these fair value measurements on
earnings reported in the statement of operations.
8
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
3. GUARANTEES
The Partnership enters into contracts that contain a variety of
indemnifications. The Partnership's maximum exposure under these arrangements is
unknown. However, the Partnership has not had prior claims or losses pursuant to
these contracts and expects the risk of loss to be remote.
4. RELATED PARTY TRANSACTIONS
The Partnership is not charged a management fee nor performance allocation at
the Partnership level. Management fees and performance allocation are charged
indirectly through the Partnership's investment in the Subsidiary Partnership.
During the period from June 1, 2007 (commencement of operations) to December 31,
2007, Pershing Square, L.P. ("PSLP"), an affiliated investment fund managed by
PSCM, had an investment in the Partnership. PSLP was not charged a management
fee nor performance allocation by PSCM in relation to its investment in the
Partnership and indirectly through its investment in the Subsidiary Partnership.
At December 31, 2007, PSLP owned 2.20% of the total partners' capital of the
Partnership.
5. ALLOCATION OF NET INCOME/(LOSS)
In accordance with the Partnership Agreement (the "Agreement"), net income or
loss is allocated as of the last business day of each Fiscal period, as defined,
to all partners in proportion to each partner's capital account at the time of
such allocation.
6. PARTNER'S CAPITAL
In accordance with the Agreement, a Limited Partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Partnership to do so and has also extended the Lock-Up Date for up to one
year beyond December 31, 2009 of the Subsidiary Partnership and the Fund.
9
Pershing Square IV, L.P.
Notes to Financial Statements (continued)
7. FINANCIAL HIGHLIGHTS
The following represents the ratios to average limited partners' capital and
total return information for the financial highlights for the period from June
1, 2007 (commencement of operations) to December 31, 2007:
Ratios to average limited partners' capital:
Expenses 0.24%
===============
Net investment income 0.83%
===============
Total return (42.77)%
===============
The above ratios and total return are calculated for all limited partners taken
as a whole and have not been annualized. Individual partner's ratios or returns
may vary from the above based on different management fee and performance
allocation arrangements.
10
CONSOLIDATED FINANCIAL STATEMENTS
Pershing Square IV A, L.P.
Period from June 1, 2007 (commencement of operations) to December 31, 2007 with
Report of Independent Registered Public Accounting Firm
Pershing Square IV A, L.P.
Consolidated Financial Statements
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CONTENTS
Audited Consolidated Financial Statement Schedules Index
Report of Independent Registered Public Accounting Firm ................. 1
Consolidated Statement of Assets, Liabilities and Partners' Capital ..... 2
Consolidated Condensed Schedule of Investments .......................... 3
Consolidated Statement of Operations..................................... 4
Consolidated Statement of Changes in Partners' Capital .................. 5
Consolidated Statement of Cash Flows .................................... 6
Notes to Consolidated Financial Statements .............................. 7
Report of Independent Registered Public Accounting Firm
The General Partner
Pershing Square IV A, L.P.
We have audited the accompanying consolidated statement of assets, liabilities
and partners' capital of Pershing Square IV A, L.P. (the "Subsidiary
Partnership"), including the consolidated condensed schedule of investments, as
of December 31, 2007, and the related consolidated statements of operations,
changes in partners' capital and cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007. These financial statements
are the responsibility of the Subsidiary Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Subsidiary Partnership's internal control over financial
reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Subsidiary Partnership's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pershing Square IV
A, L.P. at December 31, 2007, and the results of its operations, the changes in
its partners' capital and its cash flows for the period from June 1, 2007
(commencement of operations) to December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ ERNST & YOUNG
March 19, 2008
1
Pershing Square IV A, L.P.
Statement of Consolidated Assets, Liabilities and Partners' Capital
(Stated in United States Dollars)
December 31, 2007
ASSETS
Cash and cash equivalents $ 68,705,098
Due from brokers 109,158,091
Investments in securities, at fair value (cost 1,059,342,171
$1,781,725,333)
Interest receivable 630,477
--------------
Total assets $1,237,835,837
==============
LIABILITIES AND PARTNERS' CAPITAL
Collateral received $ 108,826,141
Net unrealized loss on swap contracts 518,087
Accrued expenses and other liabilities 243,680
--------------
Total liabilities 109,587,908
Partners' capital 1,128,247,929
--------------
Total liabilities and partners' capital $1,237,835,837
==============
The accompanying notes are an integral part of the consolidated financial
statements.
2
Pershing Square IV A, L.P.
Consolidated Condensed Schedule of Investments
(Stated in United States Dollars)
December 31, 2007
PERCENTAGE
OF
SHARES / PARTNERS'
CONTRACTS DESCRIPTION/NAME FAIR VALUE CAPITAL
--------------------------------------------------------------------------------
INVESTMENTS IN SECURITIES
EQUITY SECURITIES
United States:
Retail
5,884,200 Target Corp. $ 294,210,000 26.08%
------------------------
Total Equity Securities (cost 294,210,000 26.08
$347,082,231)
EQUITY OPTION CONTRACTS
United States:
Retail
Target Corp., Calls, Strike
Prices $41.62 - $53.12,
75,717,131 10/02/08 - 01/15/10 765,132,171 67.82
------------------------
TOTAL EQUITY OPTION CONTRACTS (cost
$1,434,643,102) 765,132,171 67.82
------------------------
TOTAL INVESTMENTS IN SECURITIES (cost $1,059,342,171 93.90%
$1,781,725,333) ========================
DERIVATIVE CONTRACTS
TOTAL RETURN SWAPS
United States:
Banking $ (518,087) (0.05)%
------------------------
TOTAL DERIVATIVE CONTRACTS $ (518,087) (0.05)%
========================
The accompanying notes are an integral part of the consolidated financial
statements.
3
Pershing Square IV A, L.P.
Consolidated Statement of Operations
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
NET REALIZED AND UNREALIZED LOSS FROM
INVESTMENTS
Net realized loss from investments in $ (40,811,094)
securities
Net change in unrealized loss from
investments in securities (722,383,162)
Net realized loss on derivative contracts (93,984,727)
Net change in unrealized loss on derivative (518,087)
contracts
-------------
Net loss from investments $(857,697,070)
INVESTMENT INCOME
Interest 18,566,663
Dividends 383,600
-------------
Total investment income 18,950,263
PARTNERSHIP EXPENSES
Management fee 2,651,777
Professional fees 1,173,267
Other 280,051
Interest 169
-------------
Total expenses 4,105,264
-------------
Net investment income 14,844,999
-------------
Net loss $(842,852,071)
=============
The accompanying notes are an integral part of the consolidated financial
statements.
4
Pershing Square IV A, L.P.
Consolidated Statement of Changes in Partners' Capital
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
LIMITED GENERAL
TOTAL PARTNERS PARTNER
----------------------------------------------
Capital contributions $1,971,100,000 $1,970,100,000 $1,000,000
Net Loss (842,852,071) (842,425,326) (426,745)
----------------------------------------------
Partners' capital at end of $1,128,247,929 $1,127,674,674 $ 573,255
period ==============================================
The accompanying notes are an integral part of the consolidated financial
statements.
5
Pershing Square IV A, L.P.
Consolidated Statement of Cash Flows
(Stated in United States Dollars)
Period from June 1, 2007 (commencement of operations) to December 31, 2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (842,852,071)
Adjustments to reconcile net loss to net cash used in
operating activities:
Net realized loss from investments in securities 40,811,094
Net change in unrealized loss from investments in 722,383,162
securities
Net change in unrealized loss on swap contracts 518,087
Purchases of investments (2,834,455,274)
Proceeds from investments sold 1,011,918,847
Increase in due from brokers (109,158,091)
Increase in interest receivable (630,477)
Increase in collateral received 108,826,141
Increase in accrued expenses and other liabilities 243,680
---------------
Net cash used in operating activities (1,902,394,902)
CASH FLOWS FROM FINANCING ACTIVITIES
Capital contributions 1,971,100,000
---------------
Net change in cash and cash equivalents 68,705,098
Cash and cash equivalents at beginning of period --
---------------
Cash and cash equivalents at end of period $ 68,705,098
===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 169
===============
The accompanying notes are an integral part of the consolidated financial
statements.
6
10
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements
December 31, 2007
1. ORGANIZATION
Pershing Square IV A, L.P. (the "Subsidiary Partnership") is an exempted limited
partnership formed under the limited liability partnership laws of the Cayman
Islands on May 31, 2007 and commenced operations on June 1, 2007. The investment
objective the Subsidiary Partnership is to create significant capital
appreciation by investing in stock, total return swaps and call options of
Target Corporation.
The Subsidiary Partnership acts as the master fund in a "master-feeder"
structure whereby Pershing Square IV, L.P. invests all of its capital in the
Subsidiary Partnership. Pershing Square IV, L.P. (the "Partnership") is
organized as a limited partnership under the laws of the state of Delaware on
May 22, 2007 and commenced operations on June 1, 2007. The Partnership is also a
"master" fund in a "master-feeder" structure whereby Pershing Square
International IV, Ltd. invests all of its assets in the Partnership. Pershing
Square International IV, Ltd. (the "Fund") is an exempted company formed under
the limited liability laws of the Cayman Islands on May 15, 2007 and is
registered under the Cayman Islands Mutual Funds Law.
Pershing Square IV B, L.P. (the "PSIV B") is a wholly owned subsidiary of the
Subsidiary Partnership and was incorporated on July 17, 2007 under the laws of
the state of Delaware. At December 31, 2007, PSIV B did not hold any assets on
behalf of the Subsidiary Partnership.
Pershing Square Holdings GP, LLC, a limited liability company organized under
the laws of the state of Delaware and registered as a foreign company under the
laws of the Cayman Islands, will serve as the "General Partner" to the
Subsidiary Partnership and the Partnership (collectively, the "PSIV
Partnerships"). The General Partner is responsible for making all investment
decisions on behalf of the PSIV Partnerships and is solely responsible for the
development and implementation of the PSIV Partnerships' investment policy and
strategy. William A. Ackman is the managing member of the General Partner and is
primarily responsible for managing the PSIV Partnerships.
The General Partner delegates administrative functions relating to the
management of the PSIV Partnerships to Pershing Square Capital Management, L.P.
("PSCM"), a limited partnership organized under the laws of the state of
Delaware. William A. Ackman is the managing member of the general partner of
PSCM.
Pursuant to an Administration Agreement entered into in May 2007, Goldman Sachs
(Cayman) Trust, Limited (the "Administrator") has been appointed administrator
to the PSIV Partnerships. The Administrator is compensated for its services in
accordance with the fees stated in this Administration Agreement.
7
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Subsidiary Partnership's consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America and are stated in United States dollars. The following
is a summary of the significant accounting and reporting policies used in
preparing the consolidated financial statements.
BASIS OF CONSOLIDATION
The consolidated financial statements include the results of the Subsidiary
Partnership and its subsidiary, PSIV B. Intercompany transactions have been
eliminated on consolidation.
INVESTMENT TRANSACTIONS AND RELATED INVESTMENT INCOME
The Subsidiary Partnership records its securities transactions and the related
revenue and expenses on a trade date basis. Dividends are recorded on the
ex-dividend date, net of any applicable foreign withholding taxes. Interest is
recorded on the accrual basis.
VALUATION OF INVESTMENTS
In general, the Subsidiary Partnership values investments at their last sales
price on the date of determination. If no sales occurred on such date, such
investments are valued at the mean of the last "bid" and "ask" price on the last
business day such investments were traded. Investments for which no such market
prices are available are valued at fair value by the General Partner based upon
counterparty and independent third party prices. At December 31, 2007, such
investments consisted of over-the-counter ("OTC") options with a value of
$765,132,171, and total return swap contracts with a value of ($518,087). All
unrealized gains and losses are reflected on the consolidated statement of
operations.
CASH AND CASH EQUIVALENTS
The Subsidiary Partnership considers all highly liquid financial instruments
with a maturity of three months or less to be cash equivalents. As of December
31, 2007, all cash and cash equivalents are held with an affiliate of the
Administrator.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of the Subsidiary Partnership's assets and liabilities which
qualify as financial instruments under Statement of Financial Accounting
Standards No. 107, "Disclosures About Fair Value of Financial Instruments,"
approximates the carrying amounts presented in the consolidated statement of
assets, liabilities and partners' capital.
8
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
INCOME TAXES
The Subsidiary Partnership is not subject to any income or capital gains taxes
in the Cayman Islands since the partners are individually liable for the taxes
on their share of the Subsidiary Partnership's income or loss. The only taxes
payable by the Subsidiary Partnership on its income are withholding taxes
applicable to dividend income. As a result, no income tax liability or expense
has been recorded in the accompanying consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
On July 13, 2006, the Financial Accounting Standards Board ("FASB") released
FASB Interpretation No. 48 "Accounting for Uncertainty in Income Taxes" (FIN
48). FIN 48 provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the consolidated financial
statements. FIN 48 requires the evaluation of tax positions taken or expected to
be taken in the course of preparing the Subsidiary Partnership's tax returns to
determine whether the tax positions are "more-likely-than-not" of being
sustained by the applicable tax authority. Tax positions not deemed to meet the
more-likely-than-not threshold would be recorded as a tax benefit or expense in
the current year. Adoption of FIN 48 was deferred to fiscal years beginning
after December 15, 2007 and is to be applied to all open tax years as of the
effective date. At this time, the Subsidiary Partnership is evaluating the
implications of FIN 48 and its impact on the consolidated financial statements
has not yet been determined.
In September 2006, the FASB issued Statement on Financial Accounting Standards
No. 157, "Fair Value Measurements" ("FAS 157"). This standard clarifies the
definition of fair value for financial reporting, establishes a framework for
measuring fair value and requires additional disclosures about the use of fair
value measurements. FAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007 and interim periods within those
fiscal years. The Subsidiary Partnership does not believe that adoption of FAS
157 will impact the amounts reported in the consolidated financial statements.
However, once adopted, additional disclosures will be required about the inputs
used to develop the measurements of fair value and the effect of these fair
value measurements on earnings reported in the consolidated statement of
operations.
9
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
3. DUE FROM BROKERS
Due from brokers include cash balances held at the Subsidiary Partnership's
clearing broker and cash collateral received.
4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
OR CONCENTRATIONS OF CREDIT RISK
In the normal course of business, the Subsidiary Partnership enters into
derivative contracts for investment purposes. Typically, derivative contracts
serve as components of the Subsidiary Partnership's investment strategies and
are utilized primarily to structure the portfolio to economically match the
investment objectives of the Subsidiary Partnership. These instruments are
subject to various risks similar to non-derivative instruments, including
market, credit, liquidity, and operational risks. The Subsidiary Partnership
manages these risks on an aggregate basis along with the risks associated with
its investing activities as part of its overall risk management policies.
The Subsidiary Partnership's derivative trading activities are primarily the
purchase and sale of OTC options, credit default swaps and total return swaps.
All derivatives are reported at fair value (as described in Note 2) in the
consolidated statement of assets, liabilities and partners' capital and changes
in fair value are reflected in the consolidated statement of operations.
Total return swaps represent agreements between two parties to make payments
based upon the performance of certain underlying assets. The Subsidiary
Partnership is obligated to pay, or entitled to receive as the case may be, the
net difference in the value determined at the onset of the swap versus the value
determined at the termination or reset date of the swap. Therefore, the amounts
required for the future satisfaction of the swaps may be greater or less than
the amounts recorded on the consolidated statement of assets, liabilities and
partners' capital. The ultimate gain or loss depends upon the prices at which
the underlying financial instruments of the swaps are valued on the settlement
date. At December 31, 2007, the Subsidiary Partnership holds total return swaps
with affiliated entities (see Note 5).
The Subsidiary Partnership clears all of its securities transactions through
major U.S.-registered broker dealers pursuant to customer agreements. At
December 31, 2007, substantially all investments, derivative contracts and
amounts due from broker are positions with and amounts due from these brokers.
The Subsidiary Partnership had substantially all its counterparty concentration
with these brokers.
10
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
4. DERIVATIVE CONTRACTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
OR CONCENTRATIONS OF CREDIT RISK (CONTINUED)
Collateral received consists of cash received from one broker to collateralize
the Subsidiary Partnership's OTC call options purchased from that broker. At
December 31, 2007, collateral received by the Subsidiary Partnership represents
103.58% of the fair value of OTC call options purchased from that broker. The
Subsidiary Partnership is restricted in its use of the collateral and may use up
to 50% of the value of the collateral received. No collateral has been sold or
repledged as of December 31, 2007.
5. RELATED PARTY TRANSACTIONS
In accordance with the Partnership Agreement (the "Agreement"), PSCM provides
management and administrative services to the Subsidiary Partnership. As
compensation for such services, PSCM receives a quarterly management fee in
advance equal to 0.0625% (0.25% on an annual basis) of the balance in the
limited partners' capital account as of the last business day of the previous
calendar quarter, taking into account contributions made on the first day of
such calendar quarter. The management fee for the period from June 1, 2007
(commencement of operations) to December 31, 2007 was $2,651,777. The General
Partner may, in its sole discretion, elect to waive the management fee with
respect to any limited partner.
As of December 31, 2007, the Subsidiary Partnership had unrealized loss on swap
contracts with affiliated entities managed by PSCM of $518,087. This amount
relates to total return swap contracts with the affiliated entities whereby the
Subsidiary Partnership has economic exposure to various credit default swaps
held by the affiliated entities. The credit default swap contracts were
purchased for the purpose of hedging the Subsidiary Partnership's credit
exposure to certain option contract counterparties. The Subsidiary Partnership
has the same terms and economic attributes as if it were the direct buyer of
these credit default swap contracts and therefore all income and loss associated
with these swap contracts are reflected in the Subsidiary Partnership's
consolidated statement of operations.
During the period from June 1, 2007 (commencement of operations) to December 31,
2007, Pershing Square, L.P. ("PSLP") and Pershing Square International Ltd.
("PSINTL"), affiliated investment funds managed by PSCM, had an investment in
the Partnership and the Fund, respectively. PSLP and PSINTL were not charged a
management fee nor a performance allocation.
11
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
6. GUARANTEES
The Subsidiary Partnership enters into contracts that contain a variety of
indemnifications. The Subsidiary Partnership's maximum exposure under these
arrangements is unknown. However, the Subsidiary Partnership has not had prior
claims or losses pursuant to these contracts and expects the risk of loss to be
remote.
7. ALLOCATION OF NET INCOME/(LOSS)
In accordance with the Agreement, net income or loss is allocated as of the last
business day of each Fiscal Period, as defined, to all partners in proportion to
each partner's capital account at the time of such allocation.
At the end of each fiscal year or upon a limited partners' full redemption, for
each limited partner's capital account which has been allocated net income,
there shall be allocated to the capital accounts of the General Partner, 20% of
the excess of the net income allocated to such limited partner's capital account
above the loss carryforward, if any, and the management fee with respect to the
limited partner's capital account. The General Partner in its sole discretion
has reduced the performance allocation to 10% for those limited partners that
made initial contributions of at least $100 million. For the period from June 1,
2007 (commencement of operations) to December 31, 2007, there was no performance
allocation.
The General Partner may, in its sole discretion, elect to waive or reduce the
performance allocation with respect to any limited partner.
8. PARTNERS' CAPITAL
In accordance with the Agreement, a limited partner commits capital until
December 31, 2009 (the "Lock-Up Date"). The General Partner, in its sole
discretion, may advance or extend the Lock-Up Date for up to one year beyond
December 31, 2009 if the General Partner believes it is in the best interest of
the Subsidiary Partnership to do so.
12
Pershing Square IV A, L.P.
Notes to Consolidated Financial Statements (continued)
9. FINANCIAL HIGHLIGHTS
The following represents the ratios to average limited partners' capital and
total return information for the financial highlights for the period from June
1, 2007 (commencement of operations) to December 31, 2007.
Ratios to average limited partners' capital:
Expenses 0.24%
============
Net investment income 0.83%
============
Total return (42.77)%
============
The above ratios and total return are calculated for all limited partners taken
as a whole and have not been annualized. Individual partner's ratios or returns
may vary from the above based on different management fee and performance
allocation arrangements.
13
CONSOLIDATED FINANCIAL STATEMENTS
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Period From January 1, 2007 Through August 9, 2007
(end of pre-emergence period)
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Financial Statements
Period From January 1, 2007 Through August 9, 2007
(end of pre-emergence period)
CONTENTS
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm...................1
Consolidated Statement of Financial Position..............................2
Consolidated Statement of Operations and Member's Equity..................4
Consolidated Statement of Cash Flows......................................5
Notes to Consolidated Financial Statements................................6
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Member:
In our opinion, the accompanying consolidated statement of financial position
and the related consolidated statements of operations and member's equity and of
cash flows present fairly, in all material respects, the financial position of
Premier Entertainment Biloxi LLC and Subsidiary at August 9, 2007 and the
results of their operations and their cash flows for the period from January 1,
2007 to August 9, 2007 (end of pre-emergence period), in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards as established by the Auditing Standards
Board (United States) and in accordance with the auditing 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
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
As discussed under the heading "Liquidity and Management's Plans" in Note 1 to
the consolidated financial statements, after considering the Company's operating
results for 2008 and the potential impacts of the Company's failure to meet debt
service obligations in 2009, which could include defaults under the related
credit agreements and immediate acceleration of related amounts due, the Company
is undertaking actions to improve operating results, obtain capital
contributions and modify credit agreements in order to avoid defaults under such
credit agreements.
As discussed in Note 1 to the consolidated financial statements, the Company
filed petitions on September 19, 2006 with the United States Bankruptcy Court
for the Southern District of Mississippi, Southern Division, for reorganization
under the provisions of Chapter 11 of the Bankruptcy Code. The Company's Joint
Plan of Reorganization was substantially consummated on August 10, 2007 and the
Company emerged from bankruptcy. In connection with its emergence from
bankruptcy, the Company did not qualify for fresh start accounting.
/s/ PricewaterhouseCoopers
March 25, 2008, except with respect to our opinion on the consolidated financial
statements insofar as it relates to the disclosures under the heading "Liquidity
and Management Plans" in Note 1, as to which the date is March 13, 2009
Las Vegas, Nevada
1
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Financial Position
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
ASSETS
Current assets:
Cash and cash equivalents $ 17,158,856
Insurance receivable 11,089,220
Accounts receivable, net of doubtful accounts of $47,107 732,069
Inventories 1,158,523
Prepaid insurance 6,184,072
Prepaid expenses - other 1,813,143
Other current assets 30,234
-----------------
Total current assets 38,166,117
Property and equipment, net 214,058,811
Other noncurrent assets:
Restricted cash 40,662,134
Other assets, net 854,718
-----------------
Total assets $ 293,741,780
=================
2
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Financial Position (continued)
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
LIABILITIES AND MEMBER'S EQUITY
Liabilities not subject to compromise:
Current liabilities:
Accounts payable $ 21,920,063
Accrued interest - related party 305,139
Amounts due to related parties 11,242,201
Accrued payroll and employee benefits 1,919,525
Gaming liabilities 1,211,896
Other accrued liabilities 5,640,958
Notes payable 9,084,267
---------------------
Total current liabilities 51,324,049
Long-term debt 16,730,358
Liabilities subject to compromise (Note 1) 208,624,318
---------------------
Total liabilities 276,678,725
Member's contributed capital 52,775,215
Accumulated deficit (35,712,160)
---------------------
Total member's equity 17,063,055
---------------------
Total liabilities and member's equity $ 293,741,780
=====================
See accompanying notes.
3
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Operations and Member's Equity
PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
REVENUES
Casino $ 12,317,597
Hotel 1,458,954
Food and beverage 3,070,697
Other 1,034,897
----------------------
Gross revenues 17,882,145
Less promotional allowances 2,053,719
----------------------
Net revenues 15,828,426
OPERATING EXPENSES
Casino 7,314,675
Hotel 587,673
Food and beverage 1,505,075
General and administrative 1,681,892
Insurance recoveries (11,391,658)
Management fees to related party 241,231
Pre-opening expenses 11,962,866
Utilities 310,226
Depreciation and amortization 1,664,898
Other operating 2,016,767
----------------------
Total operating expenses 15,893,645
----------------------
Loss from operations (65,219)
OTHER (INCOME) EXPENSE
Interest expense, net of capitalized
interest 11,068,508
Interest income (71,632)
----------------------
Total other (income) expense 10,996,876
Loss before reorganization items (11,062,095)
----------------------
Reorganization costs, net 211,826
----------------------
Net loss (11,273,921)
Member's equity at beginning of the period 28,336,976
----------------------
Member's equity at end of the period $ 17,063,055
======================
See accompanying notes.
4
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Consolidated Statement of Cash Flows
PERIOD FROM JANUARY 1, 2007 THROUGH AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
OPERATING ACTIVITIES
Net loss $ (11,273,921)
Depreciation and amortization 1,664,898
Amortization of deferred financing costs, discount and repayment premium 57,839
Insurance recoveries receivable (11,089,220)
Changes in operating assets and liabilities:
Accounts receivable (180,361)
Inventories (1,158,523)
Prepaid assets (4,605,260)
Other assets (59,458)
Accounts payable and accrued expenses 11,332,205
Accrued interest 4,603,386
-------------------------
Net cash used in operating activities (10,708,415)
INVESTING ACTIVITIES
Purchases of property and equipment (66,571,126)
Change in restricted cash 93,580,325
-------------------------
Net cash provided by investing activities 27,009,199
Net change in cash and cash equivalents 16,300,784
Cash and cash equivalents at beginning of period 858,072
-------------------------
Cash and cash equivalents at end of period $ 17,158,856
=========================
Cash paid during the period for:
Interest, net of capitalized interest $ 5,921,064
=========================
Supplemental schedule of noncash investing and financing activities:
Change in construction costs funded through accounts payable, amounts due to
related parties and liabilities subject to compromise $ 15,043,007
=========================
Unpaid interest reclassified to principal $ 3,218,465
=========================
Reorganization items - See Note 1
See accompanying notes.
5
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements
AUGUST 9, 2007 (END OF PRE-EMERGENCE PERIOD)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY
Premier Entertainment Biloxi LLC, a Delaware limited liability company formed on
October 16, 2003, (Premier Entertainment or the Company) owns and operates the
Hard Rock Hotel & Casino Biloxi (Hard Rock Biloxi). The liability of GAR LLC
(GAR), the Company's sole member, and officers of the Company is limited to the
maximum amount permitted under the laws of the state of Delaware.
Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003
as a Delaware corporation and is a wholly owned subsidiary of Premier
Entertainment. Under Mississippi law, certain expenditures are exempt from sales
tax if purchased with proceeds from industrial development revenue bonds issued
by the Mississippi Finance Corporation. Premier Finance was formed to fund the
capital expenditures that qualify for the tax-exempt status.
Hard Rock Biloxi is a single casino gaming facility located on an 8.5 acre site
on the Mississippi Gulf Coast and has approximately 1,375 slot machines, 50
table games, six live poker tables, five restaurants (including a Hard Rock Cafe
and Ruth's Chris Steakhouse), a full service spa, a 5,200 square foot pool 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 1,500
persons. Hard Rock Biloxi commenced operations on June 30, 2007.
Casino operations are subject to extensive regulation in the State of
Mississippi by the Mississippi Gaming Commission and Mississippi State Tax
Commission. The Company, its ownership and management are subjected to findings
of suitability reviews by the Mississippi Gaming Commission. In addition, the
laws, rules and regulations of state and local governments in Mississippi
require the Company to hold various licenses, registrations and permits and to
obtain various approvals for a variety of matters. In order to continue
operating, the Company must remain in compliance with all laws, rules and
regulations and pay gaming taxes on its gross gaming revenues. Failure to
maintain such approvals or obtain renewals when due, or failure to comply with
new laws or regulations or changes to existing laws and regulations would have
an adverse effect on the Company's business. Management believes it is currently
in compliance with all governmental rules and regulations.
6
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
LIQUIDITY AND MANAGEMENT'S PLANS
The Company has incurred losses and negative cash flows from operations since
inception and although management has reduced operating expenses and expects to
be able to meet operating obligations, it does not anticipate that cash flows
from operations during 2009 will be sufficient to meet its interest obligations
under the $180 million senior secured credit facility with BHR Holdings, Inc.,
(as further described below) without capital contributions from GAR or
modifications to the BHR credit facility.
Failure to meet the interest obligation under the BHR credit facility when due
would constitute a default under the BHR credit facility which would also create
a default under the 15% junior subordinated note with LUK-Ranch Entertainment,
LLC ("LRE") described in Note 7. Such defaults allow the respective lenders to
declare the notes immediately due and payable. Furthermore, a default under the
BHR credit facility provides Hard Rock Hotel Licensing, Inc. the right to
terminate the Hard Rock license agreement (Note 9) under certain conditions.
BHR and LRE are related parties that are controlled by Leucadia National
Corporation, who through its subsidiaries is also the controlling member of GAR.
Management intends to improve operating results by continued growth in revenues
as marketing and customer loyalty programs mature and by continued emphasis on
expense control and reductions. In addition, management intends to seek capital
contributions from GAR and or modifications to the BHR credit facility, in order
to meet its interest obligations under the BHR credit facility. There is no
assurance that management's plans will generate sufficient cash flows from
operations to meet the related party interest obligations or that modifications
to the BHR credit facility will be obtained. As such, there is substantial doubt
about the Company's ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
BANKRUPTCY FILING
On September 19, 2006 (the Petition Date), the Company filed voluntary petitions
for reorganization under Chapter 11 of Title 11 of the United States Code,
before the United States Bankruptcy Court (the Court) for the Southern District
of Mississippi, Southern Division (Case No. 06-50975 (ERG). The Company sought
the Court's assistance in gaining access to Hurricane Katrina - related
insurance proceeds over which U.S. Bank National Association, in its capacity as
trustee and disbursement agent (the Trustee) for the Company's 10 3/4% First
Mortgage Notes (the Notes) and a group of majority holders of the Notes had
denied access. Under Chapter 11, certain claims against the Company in existence
prior to the filing of the petitions were stayed while the Company continued
business operations as a debtor-in-possession.
As a debtor-in-possession, the Company followed the guidance of Statement of
Position 90-7, Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired
under the plan are reflected in the August 9, 2007 consolidated statement of
financial position as "liabilities subject to compromise." Certain revenues and
expenses resulting from the reorganization are reported as reorganization items
in the August 9, 2007 statement of operations and member's equity.
On December 11, 2006, the Company filed with the Court a plan of reorganization
(the Plan) and subsequently filed an amended Plan with the Court on February 22,
2007.
On July 30, 2007, the Court entered an order confirming the Plan, subject to a
modification which the Company filed on August 1, 2007. On August 10, 2007,
Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan
was substantially consummated (the Effective Date). As such, Premier
Entertainment and Premier Finance are no longer classified as
debtors-in-possession. The Court continues to retain jurisdiction of certain
matters including the ultimate resolution of the disputed escrow amount as
described below and resolution of certain other disputed claims.
7
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
Under the Plan, as approved by the Court, noteholders received principal of $160
million and accrued unpaid interest of $9.1 million in cash on the Effective
Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank.
$13.7 million of this amount represents a prepayment premium or penalty, to
which the noteholders may be entitled. The Company disputes that any prepayment
premium or penalty is due the noteholders and as such the disputed amount has
been placed in escrow pending resolution by the Court. In addition, the Company
placed $1 million in escrow for fees and expenses which may be incurred by the
Trustee in conjunction with the dispute resolution. Entitlement to the escrows
is expected to be determined by the Court during 2008. The Company believes it
is probable that the Court will approve payment of Trustee legal fees and
expenses and has fully reserved for that contingency. However, the Company does
not believe it is probable or remote that the Court will find in favor of the
noteholders with respect to the additional damages escrow, and any potential
loss can not be reasonably estimated. Accordingly, the Company has not accrued a
loss for the additional damages contingency.
On the Effective Date, Peoples Bank, holder of the senior secured reducing line
of credit facility received $1.3 million of principal plus interest at a reduced
rate of 7% from the Petition Date through the Effective Date. The reduction in
interest rate resulted in a $29,672 difference in interest costs.
Holders of other secured claims received 100% of their allowed claim, including
contractual interest on the Effective Date.
Holders of general unsecured claims received 50% of their allowed claim plus
post petition interest at the federal judgment rate of 5.02% on the Effective
Date and received the balance, with interest, on October 10, 2007. The reduction
in contractual interest rates and interest paid under the plan on certain
general unsecured claims resulted in $1.2 million difference in interest costs.
The Plan was funded by a $180 million senior secured credit facility dated
August 10, 2007 provided by BHR Holdings, Inc. (BHR), a related party, and a $20
million loan and security agreement dated August 10, 2007 provided by
International Game Technology (IGT).
The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is
prepayable at any time without penalty, and contains other covenants, terms and
conditions similar to those contained in the indenture that governed the Notes
8
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
(see Note 7). On the Effective Date, $160 million was advanced to the Company
under this facility. As of October 11, 2007, the full $180 million had been
advanced.
The IGT loan was initially funded on the Effective Date and $19.8 million had
been advanced as of August 17, 2007. The IGT loan is secured by certain IGT slot
machines, slot system, and non-IGT ancillary equipment and is payable in
thirty-five consecutive monthly installments based on a sixty-month amortization
with a balloon payment on the thirty-sixth month of the outstanding remaining
principal balance. Interest accrues at the "high Wall Street Journal prime
lending rate," (8.25% at August 9, 2007) and the first payment of principal and
interest was due September 20, 2007. The loan also includes a 2% loan fee of
$139,332 for the portion of the loan representing the non-IGT ancillary
equipment
On August 2, 2007, certain of the noteholders filed a notice of appeal of the
confirmation order and a motion for stay of the confirmation order pending
resolution of the appeal. On August 10, 2007, the motion for stay of the
confirmation was denied by both the Court and the United States District Court
for the Southern District of Mississippi.
The Company has filed a motion to dismiss the appeal on the basis of equitable
mootness due to the fact that the Plan has been substantially carried out. On
March 19, 2008 the United States District Court for the Southern District of
Mississippi granted the Company's motion to dismiss the appeal.
Liabilities Subject to Compromise
The following table summarizes the components of liabilities subject to
compromise included on the consolidated statement of financial position as of
August 9, 2007:
Senior note in default, including accrued interest $ 169,105,847
Equipment financing in default, including accrued interest 15,967,710
Accounts payable and other accrued liabilities (a) 23,550,761
-----------------------
Total liabilities subject to compromise $ 208,624,318
=======================
(a) Accounts payable and other accrued liabilities include $15.7 million
payable to related parties (see Note 8).
9
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
1. NATURE OF BUSINESS AND ORGANIZATION OF COMPANY (CONTINUED)
Liabilities subject to compromise refers to pre-petition obligations that may
have been impacted by the Chapter 11 reorganization process. At August 9, 2007,
liabilities subject to compromise represents the balances of pre-petition
liabilities as resolved by the Plan.
REORGANIZATION ITEMS, NET
The following table summarizes the components included in reorganization items,
net on the consolidated statement of operations and member's equity for the
period from January 1, 2007 through August 9, 2007:
Professional fees $ 3,738,148
Net gain on claim settlements (1,069,981)
Interest income (2,456,341)
----------------------
Total reorganization items, net $ 211,826
======================
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND USE OF ESTIMATES
The Company's accounting policies and its standards of financial disclosure are
in conformity with United States generally accepted accounting principles. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Significant estimates include the estimated
useful lives for depreciable assets, the estimated allowance for doubtful
accounts receivable, estimated cash flows in assessing the recoverability of
long-lived assets, and estimated liabilities for the slot bonus point program
and self insurance claims. Actual results could differ significantly from those
estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Premier
Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All
significant inter-company accounts and transactions have been eliminated.
10
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash includes cash required for gaming operations. For purposes of reporting the
statements of cash flows, the Company considers all cash accounts and all
short-term investments with maturity dates of ninety days or less when purchased
to be cash equivalents.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable are principally comprised of casino and hotel receivables,
which do not bear interest and are recorded at cost. The Company extends credit
to approved casino customers following background checks and investigations of
creditworthiness. The Company reserves an estimated amount of receivables that
may not be collected. The methodology for estimating the allowance includes
specific reserves and applying various percentages to aged receivables.
Historical collection rates are considered, as are customer relationships, in
determining specific allowances. As with many estimates, management must make
judgments about potential actions by third parties in establishing and
evaluating the allowance for bad debts.
INVENTORIES
Inventories, consisting principally of food, beverages and operating supplies,
are stated at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation and
amortization. The Company capitalizes the cost of purchases of property and
equipment and capitalizes the cost of improvements to property and equipment
that increase the value or extend the useful life of the asset. Maintenance and
repairs are charged to expense as incurred. Depreciation is computed using the
straight-line method over the following estimated useful lives of the assets:
Land improvements 20 years
Building 40 years
Furniture, fixtures, and equipment 3-10 years
11
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-lived Assets", long-lived assets to be held and used by the Company are
reviewed to determine whether any events or changes in circumstances indicate
the carrying amount of the asset may not be recoverable. Factors that might
indicate a potential impairment may include, but are not limited to, significant
decreases in the market value of the long-lived asset, a significant change in
the long-lived asset's physical condition, a change in industry conditions or a
reduction in cash flows associated with the use of the long-lived asset. If
these or other factors indicate the carrying amount of the asset may not be
recoverable, the Company determines whether an impairment has occurred through
the use of an undiscounted cash flow analysis of the asset at the lowest level
for which identifiable cash flows exist. If an impairment has occurred, the
Company recognizes a loss for the difference between the carrying amount and the
fair value of the asset. The fair value of the asset is measured using market
prices or, in the absence of market prices, is based on an estimate of
discounted cash flows. At August 9, 2007 and for the period January 1, 2007
through August 9, 2007, there has been no impairment of long-lived assets.
CAPITALIZATION OF INTEREST
In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34),
the Company capitalizes the interest cost associated with construction projects
as part of the cost of the project. Interest is typically capitalized on amounts
expended on the project using the weighted-average cost of outstanding
borrowings. Capitalization of interest starts when construction activities, as
defined in SFAS No. 34, begin and ceases when construction is substantially
complete. Such capitalized interest becomes part of the cost of the related
asset and is depreciated over the estimated useful life.
INTANGIBLE ASSETS
The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which
provides for an initial term of twenty years and the option to renew for two
successive ten-year terms. Under the license agreement, the Company has the
exclusive right to use the "Hard Rock" brand name in connection with its hotel
and casino resort. As consideration for the licensed rights as provided in the
license agreement, the Company paid a one-time territory fee of $500,000. This
cost was capitalized and is recorded as other assets on the consolidated
statement of financial position and is being amortized over a 20-year period
that began in September 2005.
12
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE AND PROMOTIONAL ALLOWANCES
Casino revenue is the aggregate net difference between gaming wins and losses,
with liabilities recognized for funds deposited by customers before gaming play
occurs, for chips outstanding and "ticket-in, ticket-out" coupons in the
customers' possession, and for accruals related to the anticipated payout of
progressive jackpots. Progressive slot machines, which contain base jackpots
that increase at a progressive rate based on the number of credits played, are
charged to revenue as the amount of the progressive jackpots increase. Sales
incentives to customers such as points earned in point-loyalty programs related
to gaming play are recorded as a reduction of gross casino revenues.
Hotel revenue recognition criteria are met at the time of occupancy. Food and
beverage revenue recognition criteria are met at the time of service. Advance
deposits for hotel rooms are recorded as liabilities until revenue recognition
criteria are met.
The retail value of accommodations, food and beverage, and other services
furnished to hotel/casino guests without charge is included in gross revenue and
then deducted as promotional allowances. The estimated retail value of such
promotional allowances is included in operating revenues as follows:
Food & beverage $ 1,546,760
Rooms 243,640
Other 263,319
-----------------------
Total $ 2,053,719
=======================
The estimated departmental cost of providing such promotional allowances is
included in casino operating expenses as follows:
Food & beverage $ 1,014,003
Rooms 118,385
Other 378,759
-----------------------
Total $ 1,511,147
=======================
13
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FREQUENT PLAYERS PROGRAM
The Company has established a promotional club to encourage repeat business from
frequent and active slot machine customers. Members earn points based on gaming
activity and such points can be redeemed for free slot play. The Company accrues
for club points as a reduction to gaming revenue based upon the estimates for
expected redemptions.
ADVERTISING COSTS
Costs for advertising are expensed as incurred. Advertising costs included in
casino expense was $350,956 for the period from January 1, 2007 through August
9, 2007.
SELF-INSURANCE
The Company is self-insured for employee medical insurance coverage up to an
individual stop loss of $50,000. Self-insurance liabilities are estimated based
on the Company's claims experience and are included in other accrued liabilities
on the consolidated statement of financial position. Such amount at August 9,
2007 was $345,817. At August 9, 2007, the total amount of claims exceeding the
stop loss was immaterial.
PRE-OPENING COSTS
Pre-opening costs are expensed as incurred, consistent with Statement of
Position 98-5, Reporting on the Costs of Start-up Activities (SOP 98-5).
Expenses incurred include payroll and payroll related expenses, marketing
expenses, rental expenses, outside services, legal and professional fees,
management fees to related party and other expenses related to the start-up
phase of operations.
INCOME TAXES
As a limited liability company, the Company has elected to be treated as a
partnership for income tax purposes; accordingly, any tax related to the
Company's income is the obligation of its member and no federal or state income
tax provision has been recorded in the Company's consolidated financial
statements.
14
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
3. HURRICANE INSURANCE RECOVERIES
On August 29, 2005, just two days before the Hard Rock Biloxi was originally
scheduled to open to the public, Hurricane Katrina hit the Mississippi Gulf
Coast and severely damaged the hotel and related structures and completely
destroyed the casino.
On August 15, 2005, the Company purchased a comprehensive blanket insurance
policy providing up to $181.1 million in coverage for damage to real and
personal property, including business interruption coverage. The insurance was
comprised of a $25.0 million primary layer underwritten by Industrial Risk
Insurers, a $25.0 million first excess layer underwritten by several insurance
carriers, and a second excess layer comprising $131.1 million underwritten by
several insurance carriers. The syndicated coverage was spread over twelve
different insurance carriers. The Company had a 3.0% deductible on its coverage,
but purchased three additional insurance policies to reduce the Company's
exposure related to that deductible.
As of August 9, 2007, the Company had reached final settlements with all but one
of its carriers under its blanket insurance policies and had collected total
insurance recoveries of $161.2 million. In January 2008, the Company settled the
remaining insurance claim. As of and for the period ended August 9, 2007, the
Company has recognized insurance recoveries of $11.4 million with an insurance
receivable of $11.1 million. Such receivable was collected in full on February
21, 2008. All other insurance recoveries were recognized in years ended prior to
2007.
4. RESTRICTED CASH
Restricted cash consists of cash and highly liquid instruments with original
maturities of 90 days or less, which carrying amounts approximate fair value.
The net proceeds from the issuance of the Notes, a portion of the equity
investment and the proceeds from the junior subordinated note were deposited
into a construction disbursement account and a tidelands lease reserve account
pursuant to the disbursement agreement of the Notes. These proceeds were
utilized to construct the property which was substantially completed in August
2005 and subsequently damaged by Hurricane Katrina. The insurance proceeds
related to Hurricane Katrina received prior to August 9, 2007 totaling $161.2
million have been deposited into the restricted accounts held by the Trustee.
These accounts were pledged to the Trustee as security for the Company's
obligations under the Notes, and could only be released to the Company in
accordance with the disbursement agreement or approval from the Court (see Note
1). The Company also has a $1.0 million certificate of deposit which is pledged
as security for the Company's obligations under the Hard
15
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
4. RESTRICTED CASH (CONTINUED)
Rock license agreement. In the accompanying consolidated statement of financial
position, restricted cash is classified as noncurrent as it is primarily
designated for the reconstruction of property and purchases of equipment.
Restricted cash at August 9, 2007 includes the following:
Construction disbursement $ 23,157,552
Tidelands lease reserve 880,872
Insurance proceeds in escrow (a) 15,623,710
-----------------------
Cash restricted by the Notes 39,662,134
Certificate of deposit restricted by the Hard
Rock license agreement 1,000,000
-----------------------
Total restricted cash $ 40,662,134
=======================
(a) Includes $1.3 million escrowed on behalf of Peoples Bank and $14.3
million escrowed on behalf of IGT pending determination of their
rights, if any to the insurance proceeds.
5. PROPERTY AND EQUIPMENT
Property and equipment held at August 9, 2007 consisted of the following:
Land $ 31,416,920
Building 131,072,698
Equipment 54,316,354
-----------------------
216,805,972
Less accumulated depreciation 2,747,161
-----------------------
Property and equipment, net $ 214,058,811
=======================
Depreciation expense totaled $1.6 million for the period from January 1, 2007
through August 9, 2007. Interest capitalized for the period from January 1, 2007
through August 9, 2007 was $2.7 million.
16
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
6. OTHER NONCURRENT ASSETS
Other assets, net consisted of the following at August 9, 2007:
Hard Rock license fee, net of accumulated amortization of
$48,589 $ 451,411
Deferred financing costs, net of accumulated amortization of
$182,813 242,187
Deposit 161,120
-----------------------
Other assets, net $ 854,718
=======================
Amortization expense for the Hard Rock license fee and the leasehold contract
was $15,137 for the period from January 1, 2007 through August 9, 2007. For the
Hard Rock license fee, the estimated amortization expense per year for the next
five years is $25,000.
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT
Long-term debt as of August 9, 2007 is as follows:
10 3/4% First Mortgage Notes due 2012 in default $ 160,000,000
15% Junior Subordinated Note due 2012 16,730,358
Variable rate IGT note payable in default 12,870,932
Variable rate Senior Secured Reducing Line of Credit
Facility in default 1,250,000
Fixed rate BHR note payable in default 9,084,267
------------------------
199,935,557
Less debt and loan agreements classified as liabilities
subject to compromise 174,120,932
Less notes payable current 9,084,267
------------------------
Long-term debt $ 16,730,358
========================
10 3/4% FIRST MORTGAGE NOTES DUE 2012
On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage
Notes due February 1, 2012 in a private placement offering which were
subsequently exchanged in an exchange offer registered on Form S-4. The Notes
were senior to all existing and future senior unsecured indebtedness, but were
subordinated to $14.1 million of senior secured indebtedness incurred to finance
17
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
the acquisition and installation of furniture, fixtures, and equipment. The
Notes were secured by a pledge of the Company's membership interests and
substantially all of the existing and future assets, except for assets securing
certain other indebtedness. In addition, the Trustee was named as a loss payee
on behalf of the noteholders under the Company's insurance policies.
Interest on the Notes was payable semiannually on each February 1 and August 1
through maturity. Under the governing indenture, the Notes may have been
redeemed, in whole or in part, at any time on or after February 1, 2008 at the
redemption prices (expressed as percentages of principal amount) set forth
below, plus accrued and unpaid interest, to the applicable redemption date, if
redeemed during the 12-month period beginning on February 1 of the years
indicated below:
-------------------------------------------------
YEAR PERCENTAGE
-------------------------------------------------
2008 105.38%
2009 102.69%
2010 and thereafter 100.00%
In addition, up to 35% of the Notes may have been redeemed at a premium on or
prior to February 1, 2007 with the net cash proceeds of an initial public
offering. As a result of the bankruptcy, the Notes are classified as liabilities
subject to compromise in the accompanying consolidated statement of financial
position. The Notes were paid in full on August 10, 2007 in accordance with the
Company's confirmed plan of reorganization (see Note 1).
15% JUNIOR SUBORDINATED NOTE DUE 2012
On January 13, 2004 the Company borrowed $10.0 million in the form of a junior
subordinated note due August 1, 2012 from Rank America, Inc., an affiliate of
The Rank Group Plc, and owner of Hard Rock Hotel Licensing, Inc. On April 25,
2006 the junior subordinated note was acquired by LUK-Ranch Entertainment, LLC
(LRE), a related party. Interest on the junior subordinated note accrues at a
rate of 15% per annum. Accrued interest at each semi annual interest payment
date of February 1 and August 1 is added to the principal balance to the extent
not paid. The Company will be required to pay a repayment premium of 3% of the
principal amount of the junior subordinated note when it is repaid. Such premium
is being accrued over the term of the junior subordinated note.
18
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
IGT NOTE PAYABLE
On January 5, 2005, the Company entered into a Commercial Sales and Security
Agreement with IGT (the IGT Agreement) for the financing of certain gaming
devices and systems. Pursuant to the IGT Agreement, the Company purchased
approximately 1,100 slot devices from IGT, as well as software licenses and
related equipment for the gaming system. Under the IGT Agreement, interest
accrued at the "high Wall Street Journal prime lending rate" (8.25% at August 9,
2007) and payments were based on a 60-month amortization payable in thirty-six
monthly installments of principal and accrued interest with the balance due on
the thirty-seventh month (November 2008). IGT was named as a loss payee under
the Company's insurance policies. As a result of the bankruptcy, the amount due
under the IGT Agreement is classified as liabilities subject to compromise in
the accompanying consolidated statement of financial position. In accordance
with the Company's confirmed plan of reorganization, $7.6 million of principal,
accrued pre-petition interest at the contract rate, and post-petition accrued
interest at the reduced rate of 5.02% was paid on August 10, 2007. The remaining
balance of principal and accrued interest was paid October 10, 2007 (see Note
1).
SENIOR SECURED REDUCING LINE OF CREDIT FACILITY
On August 26, 2005, the Company received a $1.3 million loan from The Peoples
Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility
(the Credit Facility). The Credit Facility was secured by a security interest in
certain collateral purchased by the Company and the lender was named as a loss
payee under the Company's blanket insurance policies. The Credit Facility had a
term of 66 months that included an initial funding period that ended on December
31, 2005.
Interest on the Credit Facility accrued at the rate of LIBOR plus 4.25% (9.7475%
at August 9, 2007). On December 31, 2005, the outstanding balance of the Credit
Facility was converted into a fully amortizing, five-year term loan due December
31, 2010, requiring quarterly payments of principal and interest. As a result of
the bankruptcy, the amounts due under the credit facility are classified as
liabilities subject to compromise in the accompanying consolidated statement of
financial position. In accordance with the Company's confirmed plan of
reorganization, the credit facility was paid in full, with post petition accrued
interest at the reduced rate of 7% per annum on August 10, 2007.
19
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT AND LOAN AND SECURITY AGREEMENT (CONTINUED)
BHR HOLDINGS, INC. FIXED RATE NOTE PAYABLE
On May 23, 2006, the Company received an $8.0 million loan from BHR, a related
party. An additional $0.1 million was received in September 2006. The note bears
interest at 12% per annum and the principal balance and all accrued and unpaid
interest is due on the earlier of May 23, 2007 or the date on which sufficient
insurance proceeds received from certain insurance carriers become available to
repay the note. Under the Fixed Rate Note, any interest not paid on the maturity
date shall be compounded by increasing the principal amount by the amount of
interest accrued through the maturity date. On May 23, 2007, $984,267 of accrued
and unpaid interest was added to the principal balance of the BHR Fixed Rate
Note. On February 26, 2008, the Company repaid the principal balance and accrued
interest due under the BHR Fixed Rate Note in full.
OTHER
On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The
Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0
million to comply with the terms and conditions of the Licensing Agreement with
Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate
of deposit in the amount of $1.0 million. The Letter of Credit reduces by
$100,000 on the first of each month beginning January 1, 2008 until it reaches
zero on October 1, 2008.
8. RELATED PARTY TRANSACTIONS
Roy Anderson, III a member of GAR, is the President, Chief Executive Officer and
majority stockholder of Roy Anderson Corp. (RAC), the Company's general
contractor.
In the aftermath of Hurricane Katrina, RAC performed remedial work in the amount
of $7.5 million, of which $2.9 million was outstanding and reflected in
liabilities subject to compromise in the August 9, 2007 consolidated statement
of financial position. In accordance with the Company's confirmed plan of
reorganization, this amount was paid in full with post petition interest as per
the Plan on September 30, 2007 (see Note 1).
On June 16, 2006, the Company entered into a $78.3 million guaranteed maximum
price construction agreement (Construction Agreement) with RAC to provide for
rebuilding the casino portion of the Hard Rock Biloxi and renovating and
repairing the existing hotel tower, low-rise building, parking garage and pool
20
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
and deck area that were severely damaged by Hurricane Katrina. Deductive change
orders were issued on October 25, 2006, May 25, 2007, and October 10, 2007,
reducing the amount of the guaranteed maximum price to $73.0 million. During the
period from January 1, 2007 through August 9, 2007, $42.0 million was paid to
RAC under the Construction Agreement and $4.6 million is outstanding and
reflected in amounts due to related parties in the August 9, 2007 consolidated
statement of financial position. Subsequent to August 9, 2007, the $4.6 million
was paid to RAC.
On June 16, 2006, the Company entered into a receivables purchase agreement with
BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR
agreed to purchase up to $40.0 million of receivables due to RAC by the Company
under the Construction Agreement if such receivables are past due for more than
ten days. As of August 9, 2007, $11.3 million of the amount due to RAC was paid
under this purchase agreement. The Company has reflected these amounts owing to
BHR as liabilities subject to compromise in the August 9, 2007 consolidated
statement of financial position. In accordance with the Company's confirmed plan
of reorganization, this amount was paid in full with post petition interest as
per the Plan on October 10, 2007 (see Note 1).
During the bankruptcy proceedings, LRE purchased certain third party claims
against the Company in the amount of $1.0 million. The Company has reflected
these amounts owing to LRE as liabilities subject to compromise in the August 9,
2007 consolidated statement of financial position. In accordance with the
Company's confirmed plan of reorganization, this amount was paid in full with
post petition interest as per the Plan on October 10, 2007 (see Note 1).
In 2006, in conjunction with a change of control of the Company's members, BHR
commenced a tender offer (the Offer) for all of the Company's outstanding
10 3/4% First Mortgage Notes at a price equal to 101% of the par value of the
Notes in satisfaction of the Company's obligation under the Indenture to make
such an offer upon the occurrence of a change of control as defined in the
Indenture. The offer expired with none of the Notes being tendered. In
connection with the Offer, GAR agreed to cause Premier to pay BHR a fee of $2.0
million, which will be paid only to the extent distributions from the Company
are available for such purpose. At August 9, 2007 the fee remains unpaid and is
included in amounts due to related parties on the consolidated statement of
financial position.
21
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS (CONTINUED)
In addition, the members of the Board of Managers of Premier are entitled to be
paid an annual management fee in an aggregate amount of $2.0 million, which will
be paid by Premier to the extent distributions from the Company are available
for such purpose. The Company began accruing for this fee on April 26, 2006 and
has accrued $2.6 million for this management fee in amounts due to related
parties on the August 9, 2007 consolidated statement of financial position.
As of August 9, 2007 LRE has paid $2.1 million of expenses on behalf of the
Company. Such amount is included in amounts due to related parties on the August
9, 2007 consolidated statement of financial position.
9. COMMITMENTS
OPERATING LEASES
The Company is committed under various operating lease agreements which were
assumed in the bankruptcy proceedings primarily related to property, submerged
tidelands and equipment. Generally, these leases include renewal provisions and
rental payments, which may be adjusted for taxes, insurance and maintenance
related to the property. Future minimum rental commitments under noncancelable
operating leases are as follows:
2007 $ 563,532
2008 1,358,660
2009 1,293,910
2010 1,293,940
2011 1,291,818
2012 1,294,135
Thereafter 27,762,291
-----------------------
$ 34,858,286
=======================
Total rent expense for these long-term lease obligations was $329,303 for the
period from January 1, 2007 through August 9, 2007.
22
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
9. COMMITMENTS (CONTINUED)
In October 2003, the Company entered into an agreement with the State of
Mississippi for the lease and use of approximately 5 acres of submerged
tidelands. The term of the lease is for a period of 30 years. For the initial
period commencing on October 27, 2003 until the opening date as defined in the
agreement, the Company was required to pay annual rent of $21,900. From the
opening date through the remainder of the lease term, the lease rate was to be
determined as fair value on that date. In conjunction with the opening of the
casino, the revised lease rate is $985,000 annually. This rate will be adjusted
every five years based on the greater of the Consumer Price Index change for the
period or by appraisal of the fair market rent.
In November 2003, the Company entered into an agreement with the City of Biloxi,
Mississippi to lease property and the related airspace for a period of 40 years.
For the initial three years of the lease beginning in October 2004, the Company
must pay monthly rent of $12,500. The rent will increase by the Consumer Price
Index beginning on the fifth anniversary date of execution of the lease and
continuing on each fifth anniversary date.
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi.
The annual lease fee is fixed for the first two years and then adjusts
thereafter by the greater of 3% or an adjustment based on the inflation index,
but in no event shall such adjustment exceed 5% annually.
OTHER COMMITMENTS
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual fee of $1.1 million which increases to $1.5 million over five years and
increases annually thereafter based on the consumer price index, plus fees based
on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to
three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to
one percent (1%) of the Licensing Fee Revenues during the term of the agreement.
In no event shall these fees be construed so as to allow licensor to share in
any revenue generated by the Company's gaming operations. Fee expense under the
license agreement was $231,489 for the period from commencement of operations on
June 30, 2007 through August 9, 2007 and is included in other operating expenses
on the consolidated statement of operations and member's equity. In April 2006,
the Company agreed to accrue $150,000 per month in lieu of any other fees due
under the terms of the license agreement until such time that the operations
commence. Pursuant to this agreement, $900,000 was expensed during the period
from January 1, 2007 through June 30, 2007 and is included in preopening
expenses on the consolidated statement of operations and member's equity. At
August 9, 2007, $3.5 million has been accrued and recorded in other accrued
liabilities in the accompanying consolidated statement of financial position.
23
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
9. COMMITMENTS (CONTINUED)
Such amounts were paid in full on November 30, 2007.
In December 2004, the Company entered into a lease which gives RCSH Operations,
LLC (RCSH) the right to operate a Ruth's Chris Steak House restaurant within the
Hard Rock Biloxi. The initial term is for ten years beginning July 1, 2007 and
RCSH has the right to extend the lease for four additional terms of five years
each. RCSH is obligated to pay minimum annual rent of $179,000 to the Company in
years one through five and $201,825 annually in years six through ten. In
addition to the minimum rent, RCSH is obligated to pay rent in the amount by
which 6% of RCSH's annual gross sales exceeds the minimum annual rent. Future
minimum rent payable to the Company under the lease with RCSH is as follows:
2007 $ 70,253
2008 179,000
2009 179,000
2010 179,000
2011 179,000
2012 190,413
Thereafter 908,213
-----------------------
$ 1,884,879
=======================
10. RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS NO. 159 In February 2007, the FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities--Including an Amendment of
FASB Statement No. 115," which permits entities to choose to measure many
financial instruments and certain other items at fair value. SFAS No. 159 will
become effective for the Company on January 1, 2008 (the first fiscal year
beginning after November 15, 2007). The Company is currently evaluating the
impact of adopting SFAS No. 159 but does not expect that the adoption will have
a material impact on its consolidated financial statements.
24
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
10. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)
SFAS NO. 157 In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements." The statement defines fair value, establishes a framework for
measuring fair value, expands disclosures about fair value measurements and does
not require any new fair value measurements. SFAS No. 157 will become effective
for the Company on January 1, 2008 (the first fiscal year beginning after
November 15, 2007). In February 2008, the FASB decided to issue final Staff
Positions that will partially defer the effective date of SFAS No. 157 for one
year for certain nonfinancial assets and nonfinancial liabilities and remove
certain leasing transactions from the scope of SFAS No. 157. The Company is
currently evaluating the impact of adopting SFAS No. 157 but does not expect
that the adoption will have a material impact on its consolidated financial
statements
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practical to estimate that
value:
o Cash and cash equivalents - The carrying amounts approximate fair
value because of the short maturity of these instruments.
o Restricted cash - The carrying amounts approximate fair value
because of the short maturity of these instruments.
o Long-term debt - As a result of the bankruptcy filing, the fair
value of the Company's long-term debt as of August 9, 2007 cannot be
estimated. As a result, the fair value is presented at its carrying
value. Debt obligations with a short remaining maturity are valued
at the carrying amount.
25
Premier Entertainment Biloxi LLC and Subsidiary
Debtor-In-Possession
Notes to Consolidated Financial Statements (continued)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated carrying amounts and fair values of the Company's financial
instruments at August 9, 2007 are as follows:
--------------------------------------
CARRYING FAIR
AMOUNT VALUE
--------------------------------------
FINANCIAL ASSETS:
Cash and cash equivalents $ 17,158,856 $ 17,158,856
Restricted cash 40,662,134 40,662,134
FINANCIAL LIABILITIES:
10 3/4% First mortgage notes 160,000,000 160,000,000
15% Junior subordinated note 16,730,358 16,730,358
IGT note payable 12,870,932 12,870,932
Senior secured reducing line of
credit facility 1,250,000 1,250,000
BHR note payable 9,084,267 9,084,267
26
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statement of Financial Position - Unaudited
December 31, 2006
Assets
Current assets:
Cash $ 858,072
Accounts receivable, net of doubtful accounts of $34,775 551,708
Prepaid insurance 2,504,357
Prepaid expenses - other 887,598
Other current assets 9,100
---------------
Total current assets 4,810,835
Property and equipment, net 134,094,320
Other noncurrent assets:
Restricted cash 134,242,459
Other assets, net 862,638
---------------
Total assets $ 274,010,252
===============
2
December 31, 2006
Liabilities and member's equity
Liabilities not subject to compromise:
Current liabilities:
Accounts payable $ 366,039
Accounts payable - construction in progress (includes related party amounts of $7,192,872) 7,341,775
Accrued interest (includes related party amount of $1,495,435) 1,495,435
Other accrued liabilities (includes related party amount of $4,090,136) 7,217,936
Notes payable 8,100,000
---------------
Total current liabilities 24,521,185
Long-term debt, less current maturities 14,430,810
Liabilities subject to compromise (Note 1) 206,721,281
---------------
Total liabilities 245,673,276
Member's contributed capital 52,775,215
Deficit accumulated during development stage (24,438,239)
---------------
Total member's equity 28,336,976
---------------
Total liabilities and member's equity $ 274,010,252
===============
See accompanying notes.
3
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statements of Operations and Member's Equity - Unaudited
Period From
Inception on
Year Ended March 27, 2003
December 31, through
2006 December 31, 2006
-------------- ------------------
Preopening expenses $ 13,860,298 $ 23,255,609
Hurricane-related expenses and write-downs 1,087,695 113,154,633
Insurance recoveries (42,370,737) (160,897,837)
Depreciation and amortization 796,450 1,245,371
------------- --------------
(Income) loss from operations (26,626,294) (23,242,224)
------------- --------------
Other income (expense):
Interest expense (21,727,344) (47,744,085)
Interest income 1,879,338 4,929,513
------------- --------------
Total other income (expense) (19,848,006) (42,814,572)
------------- --------------
Income (loss) before reorganization items 6,778,288 (19,572,348)
Reorganization items, net (Note 1) (4,865,891) (4,865,891)
------------- --------------
Net income (loss) 1,912,397 (24,438,239)
Member's equity at beginning of the period 26,424,579 --
Capital contribution from AA Capital -- 52,775,215
------------- --------------
Member's equity at end of the period $ 28,336,976 $ 28,336,976
============= ==============
See accompanying notes.
4
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
-----------------------------
Debtor-In-Possession
--------------------
Consolidated Statements of Cash Flows - Unaudited
Period From
Inception on
Year Ended March 27, 2003
December 31, Through December 31,
2006 2006
-------------- ------------------
Operating activities
Net income (loss) $ 1,912,397 $ (24,438,239)
Depreciation and amortization 796,450 1,245,371
Amortization of deferred financing costs, discount
and repayment premium 958,434 3,606,924
Reorganization items 6,479,361 6,479,361
Property and equipment write-downs 30,994 96,200,268
Other hurricane-related write-downs -- 638,473
Insurance recoveries (42,370,737) (160,897,837)
Changes in prepaid assets (1,872,375) (3,831,217)
Changes in other operating assets and liabilities 4,364,995 11,194,928
------------ -------------
Net cash used in operating activities (29,700,481) (69,801,968)
------------ -------------
Investing activities
Purchases of property and equipment (22,849,142) (174,094,721)
Insurance recoveries received 135,247,837 160,897,837
Purchases of government securities -- (32,946,442)
Sales of government securities 8,332,711 33,451,651
Acquisition of intangibles -- (965,672)
Change in restricted cash (100,051,158) (133,730,124)
------------ -------------
Net cash provided by (used in) investing activities 20,680,248 (147,387,471)
------------ -------------
Financing activities
Refunds of (payments for) deferred financing costs 31,301 (8,179,344)
Increase in line of credit -- 1,250,000
Proceeds from long-term debt -- 202,713,590
Proceeds from short-term borrowings 8,100,000 8,100,000
Capital contribution -- 15,180,810
Change in restricted cash -- (1,017,545)
------------ -------------
Net cash provided by financing activities 8,131,301 218,047,511
------------ -------------
Net change in cash (888,932) 858,072
Cash at beginning of period 1,747,004 --
------------ -------------
Cash at end of period $ 858,072 $ 858,072
============== =============
Cash paid during the period for:
Interest, net of capitalized interest $ 16,825,099 $ 34,944,752
============== =============
Supplemental schedule of noncash investing and financing activities:
Construction costs funded through accounts
payable and liabilities subject to compromise $ 27,085,853 $ 27,085,853
============== =============
Purchase of property and equipment funded
through notes payable $ -- $ 14,120,932
============== =============
Unpaid interest reclassified to principal
related to Junior Subordinated Note $ 1,933,324 $ 4,356,293
============== =============
See accompanying notes.
5
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited
1. Nature of Business and Summary of Significant Accounting Policies
Premier Entertainment Biloxi LLC, a Delaware limited liability company, (Premier
Entertainment or the Company) is a development stage company and was established
to own, construct and manage the operations of the Hard Rock Hotel & Casino
Biloxi (Hard Rock Biloxi). The personal liability of the member and officers of
the Company is limited to the maximum amount permitted under the laws of the
state of Delaware.
Premier Finance Biloxi Corp. (Premier Finance) was incorporated in October 2003
as a Delaware corporation and is a wholly owned subsidiary of Premier
Entertainment. Under Mississippi law, certain expenditures are exempt from sales
tax if purchased with proceeds from industrial development revenue bonds issued
by the Mississippi Finance Corporation. Premier Finance was formed to fund the
capital expenditures that qualify for the tax-exempt status.
The Company has incurred a net loss of $24.4 million for the period from
commencement of operations on March 27, 2003 through December 31, 2006.
Construction of the property was originally completed in August 2005. However,
on August 29, 2005, the Company's casino was destroyed and the casino related
facilities, low-rise building, hotel tower and parking garage sustained
significant damage as a result of Hurricane Katrina. Reconstruction of the
property began in June 2006 and the Company commenced operations on June 30,
2007. As of that date, the Company ceased to be a development-stage company.
Basis of Presentation
The Company's accounting policies and its standards of financial disclosure are
in conformity with United States generally accepted accounting policies.
Capital Structure
On January 23, 2004, GAR LLC (GAR) received 100 Class A common units
representing a 55% membership interest in the Company. AA Capital Equity Fund,
L.P., and AA Capital Biloxi Co-Investment Fund, L.P. (together AA), received 100
Class B common units and 100 Class A preferred units representing the remaining
45% membership interest in exchange for $52.8 million of members' equity through
conversion of the unpaid principal and accrued interest on a loan and security
agreement plus an incremental cash contribution of $15.2 million. On January 24,
2005, the LLC Operating Agreement was amended to establish 100 Class C common
non-voting units, a new Class of membership interest in the Company. On this
same date, sixty-six and two-thirds (66 2/3) of the Class C common units were
granted to Joseph Billhimer, the Company's President and Chief Operating
Officer.
6
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Change of Control
On April 25, 2006, LUK-Ranch Entertainment, LLC, (LRE), a Delaware limited
liability company and an indirect subsidiary of Leucadia National Corporation
(Leucadia), indirectly acquired a controlling interest in the Company by making
a capital contribution to GAR. GAR used this capital contribution to acquire
one-hundred percent (100%) of the equity interest held by AA in the Company for
an aggregate cash purchase price of $89 million.
The acquisition was made upon receipt of Mississippi Gaming Commission approval
of the acquisition of control, pursuant to a Unit Purchase Agreement by and
among GAR, AA, Leucadia, and HRHC Holdings, LLC dated as of April 6, 2006.
Pursuant to the agreement, GAR acquired all of AA's equity interest in the
Company, which, when added to GAR's existing equity interest in the Company,
represented 98% of the common equity of the Company on a fully diluted basis and
100% of the voting equity of the Company (the Transaction). LRE funded GAR's
acquisition of AA's equity interest in the Company by purchasing (i) 100% of the
Class B Common Units of GAR, representing approximately 45% of the total common
units of GAR and (ii) 100% of the Class A Preferred Units of GAR (approximately
$75.7 million at April 25, 2006), representing 100% of the preferred units in
GAR for aggregate cash consideration of $89 million. Under the terms of the GAR
operating agreement, LRE controls the Board of Managers of GAR and, as a result,
under the Company's operating agreement, LRE controls the board of managers of
the Company.
In June 2006, GAR increased its ownership to 100% of the common equity of the
Company by purchasing 100% of the Class C Common Units from Joseph Billhimer at
fair value.
As a result of the consummation of the Transaction, on May 5, 2006, BHR
Holdings, Inc. (BHR), a wholly owned indirect subsidiary of Leucadia and the
parent company of LRE, commenced a tender offer (the Offer) for all of the
outstanding $160 million principal amount of the Company's 10 3/4% First
Mortgage Notes due February 1, 2012 (the Notes) at a price equal to 101% of the
par value of the Notes, plus accrued and unpaid interest to the date of payment.
The Offer, which expired at noon on June 9, 2006, satisfied the Company's
obligation under the Indenture to make such an offer upon the occurrence of a
change of control as defined in the Indenture. In connection with the Offer, GAR
agreed to cause Premier to pay BHR a fee of $2.0 million, which will be paid
only to the extent distributions from the Company are available for such
purpose. A liability has been recorded for this fee and is included in other
accrued liabilities on the December 31, 2006 consolidated statement of financial
position.
7
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
In addition, the members of the Board of Managers of Premier are entitled to be
paid an annual management fee in an aggregate amount of $2.0 million which will
be paid by Premier to the extent distributions from the Company are available
for such purpose. The Company began accruing for this fee as of the date of the
Transaction and accrued $1.4 million for this management fee in other accrued
liabilities on the December 31, 2006 consolidated statement of financial
position.
Bankruptcy Filing
On September 19, 2006 (the Petition Date), the Company filed voluntary petitions
for reorganization under chapter 11 of title 11 of the United States Code,
before the United States Bankruptcy Court (the Court) for the Southern District
of Mississippi, Southern Division (Case No. 06-50975 (ERG)). The Company sought
the Court's assistance in gaining access to Hurricane Katrina - related
insurance proceeds over which U.S. Bank National Association, in its capacity as
trustee and disbursement agent (trustee and disbursement agent) for the Notes
and a group of majority holders of the Notes had denied access. Under Chapter
11, certain claims against the Company in existence prior to the filing of the
petitions were stayed while the Company continued business operations as a
debtor-in-possession.
As a debtor-in-possession, the Company followed the guidance of Statement of
Position 90-7, Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code. Accordingly, certain of the stayed claims which were impaired
under the plan are reflected in the December 31, 2006 consolidated statement of
financial position as "liabilities subject to compromise." Certain revenues and
expenses resulting from the reorganization are reported as reorganization items
in the December 31, 2006 statement of operations and member's equity.
On December 11, 2006, the Company filed with the Court a plan of reorganization
(the Plan) and subsequently filed an amended Plan with the Court on February 22,
2007.
8
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
On July 30, 2007, the Court entered an order confirming the Plan, subject to a
modification which the Company filed on August 1, 2007. On August 10, 2007,
Premier Entertainment and Premier Finance emerged from bankruptcy when the Plan
was substantially consummated (the Effective Date). As such, Premier
Entertainment and Premier Finance are no longer classified as
debtors-in-possession. The Court continues to retain jurisdiction of certain
matters including the ultimate resolution of the disputed escrow amount as
described below and resolution of certain other disputed claims.
Under the Plan, as approved by the Court, Noteholders received principal of $160
million and accrued unpaid interest of $9.1 million in cash on the Effective
Date. In addition, the Company placed $14.7 million in escrow with U.S. Bank.
$13.7 million of this amount represents a prepayment premium or penalty, which
the Noteholders may be entitled. The Company disputes that any prepayment
premium or penalty is due the Noteholders and as such the disputed amount has
been placed in escrow pending resolution by the Court. In addition, the Company
placed $1 million in escrow for fees and expenses which may be incurred by the
trustee in conjunction with the dispute resolution.
On the Effective Date, Peoples Bank, holder of the senior secured reducing line
of credit facility received $1.3 million of principal plus interest at a reduced
rate of 7% from the Petition Date through the Effective Date.
Holders of other secured claims received 100% of their allowed claim, including
contractual interest on the Effective Date.
Holders of general unsecured claims received 50% of their allowed claim plus
post petition interest at the federal judgment rate of 5.02% on the Effective
Date and received the balance, with interest, on October 10, 2007.
The Plan was funded by a $180 million senior secured credit facility dated
August 10, 2007 provided by BHR, an affiliate of the Company and a $20 million
loan and security agreement dated August 10, 2007 provided by International Game
Technology (IGT).
9
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
The BHR credit facility will mature February 2012, bears interest at 10 3/4%, is
prepayable at any time without penalty, and contains other covenants, terms and
conditions similar to those contained in the indenture that governed the Notes
(see Note 5). On the Effective Date, $160 million was advanced to the Company
under this facility. As of October 11, 2007, the full $180 million had been
advanced.
The IGT loan was funded on the Effective Date and is secured by certain IGT slot
machines, slot system, and non-IGT ancillary equipment and is payable in
thirty-five consecutive monthly installments based on a sixty-month amortization
with a balloon payment on the thirty-sixth month of the outstanding remaining
principal balance. Interest accrues at the "high Wall Street Journal prime
lending rate," currently 7.5% and the first payment of principal and interest
was due September 20, 2007. The loan also included a 2% loan fee of $139,332 for
the portion of the loan representing the non-IGT ancillary equipment.
On August 2, 2007, certain of the Noteholders filed a notice of appeal of the
confirmation order and a motion for stay of the confirmation order pending
resolution of the appeal. On August 10, 2007, the motion for stay of the
confirmation was denied by both the Court and the United States District Court
for the Southern District of Mississippi.
The Company has filed a motion to dismiss the appeal on the basis of equitable
mootness due to the fact that the Plan has been substantially carried out. A
hearing date on the appeal has not been set although the Company believes the
appeal is without merit, and intends to vigorously contest the appeal.
Liabilities Subject to Compromise
The following table summarizes the components of liabilities subject to
compromise included on the consolidated statement of financial position as of
December 31, 2006:
Senior note in default including accrued interest $ 167,166,667
F&E financing in default including accrued interest 15,559,469
Accounts payable and other accrued liabilities (a) 23,995,145
-------------
Total liabilities subject to compromise $ 206,721,281
=============
10
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
(a) Accounts payable and other accrued liabilities include $14.2 million
payable to affiliated parties (see Note 6).
Liabilities subject to compromise refers to pre-petition obligations that may
have been impacted by the Chapter 11 reorganization process. The amounts
represented the Company's estimate at December 31, 2006 of known or potential
obligations to be resolved in connection with the Chapter 11 proceedings.
In 2007 the resolution of liabilities recorded as of December 31, 2006 and
claims filed has resulted in a $1.3 million net reduction in those liabilities.
Such amount has been recognized as a gain in 2007.
Reorganization Items, Net
The following table summarizes the components included in reorganization items,
net on the consolidated statement of operations and member's equity for the year
ended December 31, 2006:
Professional fees $ (362,956)
Write-off of deferred financing costs and original issue discount (6,479,361)
Interest income 1,976,426
---------------
Total reorganization items, net $ (4,865,891)
===============
Insurance Recoveries
On August 15, 2005, the Company purchased a comprehensive blanket insurance
policy providing up to $181.1 million in coverage for damage to real and
personal property, including business interruption coverage. The insurance was
comprised of a $25.0 million primary layer underwritten by Industrial Risk
Insurers, a $25.0 million first excess layer underwritten by several insurance
carriers, and a second excess layer comprising $131.1 million underwritten by
several insurance carriers. The syndicated coverage was spread over twelve
different insurance carriers. The Company had a 3.0% deductible on its coverage,
but purchased three additional insurance policies to reduce the Company's
exposure related to that deductible.
11
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
As of December 31, 2006 the Company had reached final settlements with all but
one of its carriers under its blanket insurance policies and had collected a
total of $160.9 million. Only $12.6 million of $14.0 million face value of
insurance policies remained unsettled at December 31, 2006. In January 2008, the
Company settled the remaining insurance claim and by February 21, 2008 the
Company had collected an additional $11.4 million.
The Company recognized insurance recoveries of $42.4 million in 2006 and a total
of $160.9 million from the period of inception through December 31, 2006.
Principles of Consolidation
The consolidated financial statements include the accounts of Premier
Entertainment and its wholly owned subsidiary, Premier Finance Biloxi Corp. All
significant inter-company accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes.
Property and Equipment
Property and equipment are stated at cost. The Company capitalizes the cost of
purchases of property and equipment and capitalizes the cost of improvements to
property and equipment that increase the value or extend the useful life of the
asset. Maintenance and repairs are charged to expense as incurred. Depreciation
is computed using the straight-line method over the following estimated useful
lives of the assets:
Building 40 years
Furniture, fixtures, and equipment 5-10 years
12
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
The Company has included in the consolidated statements of operations and
members' equity depreciation expense related to office space and equipment that
was placed in service after Hurricane Katrina.
In accordance with SFAS No. 34, Capitalization of Interest Cost (SFAS No. 34),
the Company capitalizes the interest cost associated with major development and
construction projects as part of the cost of the project. Interest is typically
capitalized on amounts expended on the project using the weighted-average cost
of outstanding borrowings. Capitalization of interest starts when construction
activities, as defined in SFAS No. 34, begin and ceases when construction is
substantially complete or development activity is suspended for more than a
brief period. Accordingly, the Company suspended the capitalization of interest
after Hurricane Katrina and resumed capitalization of interest in third quarter
2006 when construction of the facility recommenced.
Long-Lived Assets
Long-lived assets to be held and used by the Company are reviewed to determine
whether any events or changes in circumstances indicate the carrying amount of
the asset may not be recoverable. Factors that might indicate a potential
impairment may include, but are not limited to, significant decreases in the
market value of the long-lived asset, a significant change in the long-lived
asset's physical condition, a change in industry conditions or a reduction in
cash flows associated with the use of the long-lived asset. If these or other
factors indicate the carrying amount of the asset may not be recoverable, the
Company determines whether an impairment has occurred through the use of an
undiscounted cash flow analysis of the asset at the lowest level for which
identifiable cash flows exist. If an impairment has occurred, the Company
recognizes a loss for the difference between the carrying amount and the fair
value of the asset. The fair value of the asset is measured using market prices
or, in the absence of market prices, is based on an estimate of discounted cash
flows. The Company has included an impairment charge in its consolidated
statements of operations and members' equity of $1.1 million and $113.2 million
for the year ended December 31, 2006 and the period from inception through
December 31, 2006, respectively, as a result of the damage caused by Hurricane
Katrina.
13
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Intangible Assets
The Company has a license agreement with Hard Rock Hotel Licensing, Inc., which
provides for an initial term of twenty years and the option to renew for two
successive ten-year terms. Under the license agreement, the Company has the
exclusive right to use and develop the "Hard Rock" brand name in connection with
a hotel and casino resort in Biloxi, Mississippi. As consideration for the
licensed rights as provided in the license agreement, the Company paid a
one-time territory fee of $500,000. This cost was capitalized and is recorded as
other assets on the consolidated statement of financial position and is being
amortized over a 20-year period that began in September 2005.
Deferred Financing Costs and Debt Discount
The costs of issuing long-term debt are capitalized as other assets and, along
with the original issue discount, are amortized over the term of the related
debt. At September 19, 2006 in conjunction with the bankruptcy filing previously
described, the Company wrote off the unamortized balance of the cost of issuing
the Notes in the amount of $4.9 million and the related original issue discount
of $1.6 million. These costs were written off to accurately adjust the amount of
the Notes allowed by the Bankruptcy Court as a claim against the Company and
have been classified on the consolidated statements of operations and members'
equity as reorganization items.
Self-Insurance
Prior to July 1, 2006, the Company was self-insured for employee medical
insurance coverage up to an individual stop loss of $15,000. Self-insurance
liabilities are estimated based on the Company's claims experience and are
included in other accrued liabilities on the consolidated statement of financial
positions. Such amounts are immaterial at December 31, 2006. Effective July 1,
2006, the Company changed to a fully insured plan.
14
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
1. Nature of Business and Summary of Significant Accounting Policies (continued)
Preopening Costs
Preopening costs are expensed as incurred, consistent with Statement of Position
98-5, Reporting on the Costs of Start-up Activities (SOP 98-5). Expenses
incurred include payroll and payroll related expenses, marketing expenses,
rental expenses, outside services, legal and professional fees, and other
expenses related to the start-up phase of operations.
Income Taxes
As a limited liability company, the Company has elected to be treated as a
partnership for income tax purposes; accordingly, any tax related to the
Company's income is the obligation of its members and no federal or state income
tax provision has been recorded in the Company's consolidated financial
statements.
New Accounting Pronouncement
Effective January 1, 2006, the Company adopted the provision of FASB Statement
No. 123(R), Share-Based Payment, which is a revision of SFAS 123 and supersedes
APB Opinion No. 25. The effect of adopting this new standard had no effect on
the Company's accounting for its 2004 Membership Interest Appreciation Rights
Plan which allow for the receipt of an award based on the increase in value of
the Company. The plan was terminated in June 2006 and no other awards or grants
are outstanding.
2. Restricted Cash
The net proceeds from the issuance of the Notes, a portion of the equity
investment and the proceeds from the junior subordinated note were deposited
into a construction disbursement account and a tidelands lease reserve account
pursuant to the disbursement agreement of the Notes and utilized to construct
the property which was substantially completed in August 2005 and subsequently
damaged by Hurricane Katrina. The insurance proceeds related to Hurricane
Katrina totaling $160.9 million have been deposited into the restricted accounts
held by the trustee. These accounts were pledged to the trustee and disbursement
agent as security for the Company's obligations under the Notes, and could only
be released to the Company in accordance with the disbursement agreement or
approval from the Court (see Note 1).
15
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
2. Restricted Cash (continued)
The Company also has a $1.0 million certificate of deposit which is pledged as
security for the Company's obligations under the Hard Rock license agreement. In
the accompanying consolidated statement of financial position, restricted cash
is classified as noncurrent as it is primarily designated for the reconstruction
of property and purchases of equipment. Restricted cash includes the following:
Construction disbursement $ 117,047,468
Tidelands lease reserve 1,045,240
Insurance proceeds in escrow (a) 15,149,751
--------------
Cash restricted by the Notes 133,242,459
Certificate of deposit restricted by the Hard Rock license agreement 1,000,000
--------------
Total restricted cash $ 134,242,459
==============
(a) Includes $1.3 million escrowed on behalf of Peoples Bank and $13.8
million escrowed on behalf of IGT pending determination of their
rights, if any to the insurance proceeds.
3. Property and Equipment
Property and equipment held at December 31, 2006 consisted of the following:
Land $ 30,991,578
Building 50,707,794
Equipment 12,643,492
Construction in progress 40,848,974
--------------
135,191,838
Less accumulated depreciation 1,097,518
--------------
Property and equipment, net $ 134,094,320
==============
Depreciation expense totaled $771,450 in 2006. Interest capitalized totaled $0.5
million in 2006 and $16.9 million for the period from inception through December
31, 2006.
16
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
4. Other Noncurrent Assets
Other assets, net consisted of the following:
Hard Rock license fee, net of accumulated amortization of $33,334 $ 466,666
Deferred financing costs, net of accumulated amortization of $151,823 273,177
Deposit 122,795
------------
Other assets, net $ 862,638
============
Amortization expense for the Hard Rock license fee and the leasehold contract
was $25,000 in 2006. For the Hard Rock license fee, the estimated amortization
expense per year for the next five years is $25,000.
5. Long-Term Debt and Loan and Security Agreement
Long-term debt as of December 31, 2006 is as follows:
10 3/4% First Mortgage Notes due 2012 in default, net $ 160,000,000
15% Junior Subordinated Note due 2012 in default, net 14,430,810
Variable rate IGT note payable in default 12,870,932
Variable rate Senior Secured Reducing Line of Credit
Facility in default 1,250,000
Fixed rate BHR note payable in default 8,100,000
---------------
196,651,742
---------------
Less debt and loan agreements classified as liabilities
subject to compromise 174,120,932
Less notes payable current 8,100,000
---------------
Long-term debt $ 14,430,810
===============
17
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
10 3/4% First Mortgage Notes due 2012
On January 23, 2004, the Company issued $160 million of 10 3/4% First Mortgage
Notes due February 1, 2012 in a private placement offering which were
subsequently exchanged in an exchange offer registered on Form S-4. The
unamortized discount of $1.6 million, which was being amortized over the term of
the Notes was written off during the year ended December 31, 2006 as a result of
the bankruptcy filing. The Notes were senior to all existing and future senior
unsecured indebtedness, but were subordinated to $14.1 million of senior secured
indebtedness incurred to finance the acquisition and installation of furniture,
fixtures, and equipment. The Notes were secured by a pledge of the Company's
membership interests and substantially all of the existing and future assets,
except for assets securing certain other indebtedness. In addition, the trustee
and disbursement agent was named as a loss payee on behalf of the noteholders
under the Company's insurance policies.
Interest on the Notes was payable semiannually on each February 1 and August 1
through maturity. Under the governing indenture, the Notes may have been
redeemed, in whole or in part, at any time on or after February 1, 2008 at the
redemption prices (expressed as percentages of principal amount) set forth
below, plus accrued and unpaid interest, to the applicable redemption date, if
redeemed during the 12-month period beginning on February 1 of the years
indicated below:
Year Percentage
-------------------- --------------
2008 105.38%
2009 102.69%
2010 and thereafter 100.00%
In addition, up to 35% of the Notes may have been redeemed at a premium on or
prior to February 1, 2007 with the net cash proceeds of an initial public
offering. Deferred financing costs, net of accumulated amortization of $4.9
million, which were incurred in connection with the issuance were written off at
September 19, 2006 as a result of the bankruptcy filing. Prior to the write-off,
these deferred financing costs had been included in other assets and were being
amortized over the term of the related long-term debt. As a result of the
bankruptcy, the Notes are classified as liabilities subject to compromise in the
accompanying consolidated statement of financial positions. The notes were paid
in full on August 10, 2007 in accordance with the Company's confirmed plan of
reorganization (see Note 1).
18
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
15% Junior Subordinated Note due 2012
Concurrently with the issuance of the Notes, the Company borrowed $10.0 million
in the form of a junior subordinated note due August 1, 2012 from Rank America,
Inc., an affiliate of The Rank Group Plc, and owner of Hard Rock Hotel
Licensing, Inc. Interest on the junior subordinated note accrues at a rate of
15% per annum and will be paid semiannually. If the Company had opened as
planned, the first interest payment would have been due on February 1, 2006.
Accrued interest at each semi annual interest payment date prior to opening is
added to the principal balance. The Company will be required to pay a repayment
premium of 3% of the principal amount of the junior subordinated note when it is
repaid. Such premium is being accrued over the term of the junior subordinated
note. On April 25, 2006, LRE, an affiliated company, acquired the junior
subordinated note from Rank America, Inc.
IGT Note Payable
On January 5, 2005, the Company entered into a Commercial Sales and Security
Agreement (the IGT Agreement) with IGT for the financing of certain gaming
devices and systems. Pursuant to the IGT Agreement, the Company purchased
approximately 1,100 slot devices from IGT, as well as software licenses and
related equipment for the gaming system. Under the IGT Agreement, interest
accrued at the "high Wall Street Journal prime lending rate" (8.25% at December
31, 2006) and payments were based on a 60-month amortization payable in
thirty-six monthly installments of principal and accrued interest with the
balance due on the thirty-seventh month (November 2008). IGT was named as a loss
payee under the Company's insurance policies. As a result of the bankruptcy, the
amount due under the IGT Agreement is classified as liabilities subject to
compromise in the accompanying consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, $7.6 million of
principal, accrued pre-petition interest at the contract rate, and post-petition
accrued interest at the reduced rate of 5.02% was paid on August 10, 2007. The
remaining balance of principal and accrued interest was paid October 10, 2007
(see Note 1).
19
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
5. Long-Term Debt and Loan and Security Agreement (continued)
Senior Secured Reducing Line of Credit Facility
On August 26, 2005, the Company received a $1.3 million loan from The Peoples
Bank pursuant to a $10.0 million Senior Secured Reducing Line of Credit Facility
(the Credit Facility). The Credit Facility was secured by a security interest in
certain collateral purchased by the Company and the lender was named as a loss
payee under the Company's blanket insurance policies. The Credit Facility had a
term of 66 months that included an initial funding period that ended on December
31, 2005.
Interest on the Credit Facility accrued at the rate of 9.6659% at December 31,
2006, based on twelve-month LIBOR plus 4.25%. On December 31, 2005, the
outstanding balance of the Credit Facility was converted into a fully
amortizing, five-year term loan due December 31, 2010, requiring quarterly
payments of principal and interest. As a result of the bankruptcy, the amounts
due under the credit facility are classified as liabilities subject to
compromise in the accompanying consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, the credit
facility was paid in full, with post petition accrued interest at the reduced
rate of 7% per annum on August 10, 2007.
BHR Holdings, Inc. Note Payable
On May 23, 2006, the Company received an $8.0 million loan from BHR, an
affiliated company. An additional $0.1 million was received in September 2006.
The note bears interest at 12% per annum and the principal balance and all
accrued and unpaid interest is due on the earlier of May 23, 2007 or the date on
which sufficient insurance proceeds received from certain insurance carriers
become available to repay the note.
Other
On July 1, 2005, the Company obtained an Irrevocable Letter of Credit from The
Peoples Bank in favor of Hard Rock Hotel Licensing, Inc. in the amount of $1.0
million to comply with the terms and conditions of the Licensing Agreement with
Hard Rock Hotel Licensing, Inc. The Letter of Credit is secured by a certificate
of deposit in the amount of $1.0 million for a term of 90 days and will
automatically renew.
20
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
6. Related Party Transactions
Roy Anderson, III a member of GAR is the President, Chief Executive Officer and
majority stockholder of Roy Anderson Corp. (RAC), the Company's general
contractor.
Pursuant to a guaranteed maximum price construction agreement, dated December
24, 2003, (the Initial Construction Agreement), as amended, RAC had constructed
the Hard Rock Casino and Hotel facilities (the Project). Total payments for
construction of the Project for the period from the commencement of operations
on March 27, 2003 through December 31, 2006 were $89.5 million, of which $71.1
million was paid directly to RAC. Post-Katrina remedial work was performed by
RAC and payments in respect thereof through December 31, 2006 were $7.5 million;
$2.9 million was outstanding and reflected in liabilities subject to compromise
in the December 31, 2006 consolidated statement of financial position. In
accordance with the Company's confirmed plan of reorganization, this amount was
paid in full on September 30, 2007 (see Note 1). On June 16, 2006, the Initial
Contract was amended and restated (the Amended Construction Agreement) to
provide for rebuilding the casino portion of the Hard Rock Biloxi and renovating
and repairing the existing hotel tower, low-rise building, parking garage and
pool and deck area that were severely damaged by Hurricane Katrina. Pursuant to
the terms of the Amended Construction Agreement, the Company agreed to pay RAC
the cost of the work performed plus a contractor's fee, with the aggregate of
such amounts not to exceed the guaranteed maximum price of $78.3 million.
Deductive change orders were issued on October 25, 2006, May 25, 2007, and
October 10, 2007, reducing the amount of the guaranteed maximum price to $73.0
million.
At December 31, 2006, work performed by RAC under the Amended Construction
Agreement was $33.6 million, of which $26.4 million was paid to RAC and $7.2
million is outstanding and reflected in accounts payable in the December 31,
2006 consolidated statement of financial position. The Company believes that the
terms of the amendments to the Amended Construction Agreement are no less
favorable to the Company than the terms of the Initial Construction Agreement.
On June 16, 2006, the Company entered into a receivables purchase agreement with
BHR and RAC. Pursuant to the terms of the receivables purchase agreement, BHR
agreed to purchase up to $40.0 million of receivables due to RAC by the Company
under the amended construction contract if such receivables are past due for
more than ten days. At December 31, 2006, $11.3 million of the amount paid to
RAC was paid under this purchase agreement. The Company has reflected these
amounts owing to BHR as liabilities subject to compromise in the December 31,
2006 consolidated statement of financial position. In accordance with the
Company's confirmed plan of reorganization, this amount was paid in full on
October 10, 2007 (see Note 1).
In March 2006, the Company entered into an agreement with RAC to provide
additional services at the property required as a result of the damage caused by
Hurricane Katrina. The Company agreed to pay RAC the cost of the work performed
plus a contractor's fee in an amount not to exceed the guaranteed maximum price
of $1.4 million. At December 31, 2006, total amount billed and paid under this
agreement was $1.4 million.
21
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
7. 2004 Membership Interest Appreciation Rights Plan
On June 13, 2006, the Company entered into agreements with the employees who
were participants in the Company's Membership Interest Appreciation Rights Plan,
to terminate such plan. As a result of the plan termination, payments
aggregating $198,400 were made to plan participants and are included in
preopening expenses in the consolidated statement of operations and members'
equity for the year ended December 31, 2006.
8. Commitments
Operating Leases
The Company is committed under various operating lease agreements which were
assumed in the bankruptcy proceedings primarily related to property, submerged
tidelands and equipment. Generally, these leases include renewal provisions and
rental payments, which may be adjusted for taxes, insurance and maintenance
related to the property. Future minimum rental commitments under noncancelable
operating leases are as follows:
2007 $ 806,697
2008 1,291,660
2009 1,291,660
2010 1,289,440
2011 1,285,000
Thereafter 28,061,163
---------------
$ 34,025,620
===============
Total rent expense for these long-term lease obligations was $219,900 in 2006,
and $695,513 for the period from inception through December 31, 2006.
In October 2003, the Company entered into an agreement with the State of
Mississippi for the lease and use of approximately 5 acres of submerged
tidelands. The term of the lease is for a period of 30 years. For the initial
period commencing on October 27, 2003 until the opening date as defined in the
agreement, the Company was required to pay annual rent of $21,900. From the
opening date through the remainder of the lease term, the lease rate was to be
determined as fair value on that date. In conjunction with the opening of the
casino, the revised lease rate is $985,000 annually. This rate will be adjusted
annually based on the CPI change for the period.
In November 2003, the Company entered into an agreement with the City of Biloxi,
Mississippi to lease property and the related airspace for a period of 40 years.
For the initial three years of the lease beginning in October 2004, the Company
must pay monthly rent of $12,500. The rent will increase by the Consumer Price
Index beginning on the fifth anniversary date of execution of the lease and
continuing on each fifth anniversary date.
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual lease fee of $150,000 for memorabilia displayed at the Hard Rock Biloxi.
The annual lease fee is fixed for the first two years and then adjusts
thereafter by the greater of 3% or an adjustment based on the inflation index,
but in no event shall such adjustment exceed 5% annually.
22
Premier Entertainment Biloxi LLC
--------------------------------
(A Development-Stage Company)
----------------------------
Debtor-In-Possession
--------------------
Notes to Consolidated Financial Statements - Unaudited (continued)
Other Commitments
Under the Hard Rock licensing agreement, the Company is obligated to pay an
annual fee of $1.1 million which increases to $1.5 million over five years and
increases annually thereafter based on the consumer price index, plus fees based
on future non-gaming revenues. The Company will pay a "Continuing Fee" equal to
three percent (3%) of the Licensing Fee Revenues and a marketing fee equal to
one percent (1%) of the Licensing Fee Revenues during the term of the agreement.
In no event shall these fees be construed so as to allow licensor to share in
any revenue generated by the Company's gaming operations. In April 2006, the
Company agreed to accrue $150,000 per month in lieu of any other fees due under
the terms of the license agreement until such time that the operations commence.
At December 31, 2006, $2.5 million has been accrued and recorded in other
accrued liabilities in the accompanying consolidated statement of financial
position. Such amounts were subsequently paid in November 2007.
9. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practical to estimate that
value:
o Cash and cash equivalents - The carrying amounts approximate fair
value because of the short maturity of these instruments.
o Restricted cash - The carrying amounts approximate fair value because
of the short maturity of these instruments.
o Long-term debt - As a result of the bankruptcy filing, the fair value
of the Company's long-term debt as of December 31, 2006 cannot be
estimated. As a result, the fair value is presented at its carrying
value. Debt obligations with a short remaining maturity are valued at
the carrying amount.
The estimated carrying amounts and fair values of the Company's financial
instruments at December 31, 2006 are as follows:
Carrying Amount Fair Value
------------------- -------------
Financial assets:
Cash and cash equivalents $ 858,072 $ 858,072
Restricted cash 134,242,459 134,242,459
Financial liabilities:
10 3/4% First mortgage notes 160,000,000 160,000,000
15% Junior subordinated note 14,430,810 14,430,810
IGT note payable 12,870,932 12,870,932
Senior secured reducing line of credit facility 1,250,000 1,250,000
BHR note payable 8,100,000 8,100,000
23
HFH ShortPLUS FUND, L.P.
(In Liquidation)
Statement of Financial Condition
Year Ended December 31, 2008
(Unaudited)
--------------------------------------------------------------------------------
Assets
Investment in HFH ShortPLUS Master Fund, Ltd. (In Liquidation), at fair value $ 40,625,051
Cash 2,673
-------------
$ 40,627,724
=============
Liabilities and partners' capital
Liabilities
Capital withdrawals payable $ 19,969,871
Accrued expenses 134,999
-------------
Total liabilities 20,104,870
Partners' capital 20,522,854
-------------
$ 40,627,724
=============
1
See accompanying notes to financial statements
HFH ShortPLUS FUND, L.P.
(In Liquidation)
Statement of Operations
Year Ended December 31, 2008
(Unaudited)
--------------------------------------------------------------------------------
Net investment income (loss) allocated from
HFH ShortPLUS Master Fund, Ltd. (In Liquidation)
Interest income $ 2,542,190
Interest expense (864,798)
Professional fees and other (227,559)
Administrative fee (40,223)
------------------
Total net investment income (loss) allocated from
HFH ShortPLUS Master Fund, Ltd. (In Liquidation) 1,409,610
------------------
Fund income
Interest 1,912
------------------
Fund expenses
Management fee 601,176
Professional fees and other 125,733
------------------
Total Fund expenses 726,909
------------------
Net investment income 684,613
------------------
Realized and unrealized gain (loss) on investments allocated from
HFH ShortPLUS Master Fund, Ltd. (In Liquidation)
Net realized gain (loss) on securities (2,200,823)
Net realized gain (loss) on credit default swap contracts 59,941,394
Net change in unrealized appreciation or (depreciation) on securities (887,582)
Net change in unrealized appreciation or (depreciation) on credit default swap contracts (45,623,955)
Net gain (loss) from foreign exchange transactions (23,115)
------------------
Net gain (loss) on investments 11,205,919
------------------
Net income 11,890,532
Less reallocation to the General Partner 1,246,505
------------------
Net income available for distribution to all partners $ 10,644,027
==================
2
See accompanying notes to financial statements
HFH ShortPLUS FUND, L.P.
(In Liquidation)
Statement of Changes in Partners' Capital
Year Ended December 31, 2008
(Unaudited)
--------------------------------------------------------------------------------
General Limited
Partner Partners Total
------- -------- -----
Partners' capital, beginning of year $ 6,565,358 $ 83,295,107 $ 89,860,465
Early withdrawal fees 13 210,664 210,677
Capital withdrawals (7,260,220) (74,178,600) (81,438,820)
Allocation of net income
Pro rata allocation 6,126 11,884,406 11,890,532
Reallocation to General Partner 1,246,505 (1,246,505) --
-------------- ------------- --------------
1,252,631 10,637,901 11,890,532
-------------- ------------- --------------
Partners' capital, end of year $ 557,782 $ 19,965,072 $ 20,522,854
============== ============= ==============
3
See accompanying notes to financial statements
HFH ShortPLUS FUND, L.P.
(In Liquidation)
Statement of Cash Flowsl
Year Ended December 31, 2008
(Unaudited)
--------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 11,890,532
Adjustments to reconcile net income to net cash provided by
operating activities:
Net income allocated from HFH ShortPLUS Master Fund, Ltd. (In Liquidation) (12,615,529)
Changes in operating assets and liabilities:
Proceeds from the sales of shares from
HFH ShortPLUS Master Fund, Ltd. (In Liquidation) 55,914,309
Other assets 140
Accrued expenses 112,498
-----------------
Net cash provided by operating activities 55,301,950
----------------
Net cash flows used in financing activities,
Capital withdrawals, net of capital withdrawals payable and early withdrawal fees (61,258,272)
----------------
Net change in cash (5,956,322)
Cash, beginning of year 5,958,995
----------------
Cash, end of year $ 2,673
================
4
See accompanying notes to financial statements
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
(Unaudited)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
Nature of Operations
HFH ShortPLUS Fund, L.P. (the "Partnership") is a Delaware limited partnership
and commenced operations on January 2, 2007. The Partnership invests
substantially all of its investable assets through a "master-feeder" structure
in HFH ShortPLUS Master Fund, Ltd. (the "Master Fund"), a Cayman Islands
exempted company that invests and trades a short-biased portfolio of
asset-backed securities ("ABS") that the Investment Manager believes are most
likely to produce high returns during periods of adverse credit performance for
residential mortgages, and for mortgage-backed securities ("MBS") and ABS.
Returns will come from two principal sources: (i) market value changes, arising
from changes in credit spreads on the Master Fund's short positions; and (ii)
credit default payments from counterparties on credit default swaps ("CDS") or
other derivatives in credit sensitive mortgage and asset-backed securities,
consumer debt and other assets. The Partnership's investment objective is the
same as that of the Master Fund. The financial statements of the Master Fund are
included elsewhere in this report and should be read in conjunction with the
Partnership's financial statements. Highland Financial Holdings, LLC (the
"General Partner") serves as the General Partner and Highland Financial Holdings
Group, LLC ("Investment Manager") serves as the investment manager of the
Partnership.
The Master Fund is also managed by the Investment Manager. Valuation of the
investments held by the Master Fund is discussed in the notes to the financial
statements of the Master Fund included elsewhere in this report. The percentage
of the Master Fund's net assets owned by the Partnership at December 31, 2008
was approximately 21.5%.
In accordance with the Partnership's documents, the General Partner has
formalized a plan of liquidation to liquidate the Partnership in an orderly
manner, and as a result, changed its basis of accounting from the going concern
to the liquidation basis whereby assets and liabilities are stated at their
estimated settlement amounts and all costs of liquidation have been recognized.
The adoption of the liquidation basis of accounting did not have a material
effect on the carrying values of assets and liabilities as of December 31, 2008.
The residual 50% of the capital held by the remaining investors in the
Partnership will be distributed on or about March 31, 2009. The distribution
amount which dollars and shares are not currently fixed and determinable
approximate $19,970,000. In addition, a new entity, HFH ShortPLUS Master Fund
Liquidating Trust was established for purposes of receiving cash flows on
securities that were distributed in-kind.
Basis of Presentation
The financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America.
Valuation of Investment in HFH ShortPLUS Master Fund, Ltd.
The Partnership records its investment in the Master Fund at fair value based on
the net asset value of the Master Fund. Valuation of instruments held by the
Master Fund is discussed in Note 1 of the Master Fund's financial statements.
5
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Income and Expense Recognition
The Partnership records its proportionate share of the Master Fund's investment
income/loss, expenses and realized and unrealized gains and losses. The Master
Fund's income and expense recognition and allocation policies are discussed in
Note 1 of the Master Fund's financial statements.
Interest income of the Partnership's cash balance is accrued as earned. Expenses
that are directly attributable to the Partnership are recorded on the accrual
basis as incurred.
Income Taxes
The Partnership is not a taxable entity for federal, state or local income tax
purposes; such taxes are the responsibility of the individual partners.
Accordingly, no provision has been made in the accompanying financial statements
for any federal, state or local income taxes.
On December 30, 2008, the FASB issued FIN 48-3, Effective Date of FASB
Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which allows
the Partnership to defer the adoption of FIN 48 until periods beginning after
December 15, 2008. The General Partner has elected to take advantage of this
deferral. Based on its continued analysis, the General Partner has determined
that the adoption of FIN 48 will not have a material impact on the Partnership's
financial statements. However, the General Partner's conclusions regarding FIN
48 may be subject to review and adjustment at a later date based on factors
including, but not limited to, further implementation guidance and on-going
analyses of tax laws, regulations and interpretations thereof. The Partnership's
accounting policy for evaluating uncertain tax positions during financial
statement periods subject to the deferral of FIN 48 is based on the recognition
and disclosure criteria for loss contingencies under SFAS No. 5 "Accounting for
Contingencies".
FIN 48 requires the General Partner to determine whether a tax position of the
Partnership is more likely than not to be sustained upon examination by the
applicable taxing authority, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The tax
benefit to be recognized is measured as the largest amount of benefit that is
greater than fifty percent likely of being realized upon ultimate settlement
which could result in the Partnership recording a tax liability that would
reduce net assets. FIN 48 must be applied to all existing tax positions upon
initial adoption and the cumulative effect, if any, is to be reported as an
adjustment to partners' capital upon adoption.
Use of Estimates
The financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America ("U.S. GAAP"). The
preparation of financial statements in accordance with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts
and disclosures in the financial statements. Actual results could differ from
these estimates.
6
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
--------------------------------------------------------------------------------
2. Partners' capital
The minimum initial and subsequent capital contributions (each a "Capital
Contribution") in the Partnership are $5,000,000 and $1,000,000, respectively.
The Investment Manager may waive or reduce the minimum capital contributions in
its sole discretion. The General Partner admitted new Limited Partners and
permitted Limited Partners to make additional capital contributions as of the
first business day of each calendar month, or at any other time in the General
Partner's sole discretion.
Subject to the lock-up period and early withdrawal fee, Limited Partners had the
right to require the Partnership to withdraw all or any portion of their
investment by delivering written notice to the General Partner not less than 90
days prior to the end of any calendar quarter, or at such other times as the
General Partner determined in its sole discretion. The General Partner reserved
the right to waive or reduce the notice period in its sole discretion.
Notwithstanding anything to the contrary, a Limited Partner could not withdraw
each capital contribution (and any appreciation thereon) until after the 12
month period (the "Lock-up Period") following the date of such contribution,
without the prior consent of the General Partner, which may have been granted or
denied in the General Partner's sole discretion.
Limited Partners who withdraw a Capital Contribution after the Lock-up Period
with respect to such Capital Contribution but less than 24 months after
purchasing such capital contribution will be charged an early withdrawal fee
equal to 5% of the withdrawal amount. Any early withdrawal fee will be payable
to the Partnership and is subject to the incentive allocation described in Note
3. The General Partner reserves the right, in its sole discretion, to waive or
reduce the early withdrawal fee on a case-by-case basis. Subject to the
Partnership's right to establish reserves, a minimum of 95% of the withdrawals
proceeds will generally be paid to the withdrawing Limited Partner within 15
business days after the corresponding withdrawal date, with the balance payable
(without interest) within 90 days of the corresponding withdrawal date. However,
payments to withdrawing Limited Partners may be subject to further delay or may
be suspended.
In the event that withdrawal requests are received representing in the aggregate
more than 10% of the total Net Asset Value of the Partnership on any withdrawal
date, the Partnership is entitled to reduce ratably and pro rata amongst all
Limited Partners seeking to withdraw interests on the withdrawal date and to
carry out only sufficient withdrawals, which in the aggregate, amount to 10% of
the total Net Asset Value of the Partnership on such withdrawal date.
3. Allocation of net income (loss) and incentive allocation
Net investment income and gains and losses are allocated to the partners on a
monthly basis, based on the partners' proportionate share of capital in the
Partnership at the beginning of the month.
The General Partner receives an incentive allocation equal to 20% of net capital
appreciation (as defined in the limited partnership agreement) credited to the
capital account of each limited partner, less management fees. The incentive
allocation will be deducted from the capital account of such limited partner and
reallocated to the General Partner's capital account. At the discretion of the
General Partner, this rate may be reduced for certain Limited Partners. If there
is a loss for the fiscal period, such loss is carried forward to future periods
and no incentive allocations will be made to the General Partner until prior
fiscal period losses are recovered. For the year ended December 31, 2008, the
General Partner was allocated $1,246,505 in incentive allocations.
7
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
--------------------------------------------------------------------------------
4. Management fee and other related party transactions
The Investment Manager receives a quarterly management fee in arrears, equal to
0.50% (2% per annum) of each Limited Partner's capital account. At the
discretion of the General Partner, this rate may be reduced for certain Limited
Partners and affiliated fund investments. For the year ended December 31, 2008,
the Investment Manager earned a management fee of $601,176 from the Partnership.
5. Off-balance sheet risk, leverage and concentration of credit risks
Off-balance sheet risk, leverage and concentration of credit risks are discussed
in the Master Fund's financial statements.
Due to the nature of the master fund/feeder fund structure, the Partnership
could be materially affected by significant subscriptions and redemptions of the
other feeder fund. From time to time, the Partnership may have a concentration
of partners holding a significant percentage of the Partnership's partners'
capital. Investment activities of these partners could have a material impact on
the Partnership. At December 31, 2008, one partner owned 97% of the total
partners' capital of the Partnership
6. Capital withdrawals payable
In accordance with FASB Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity, as effected by
FASB Staff Position No. FAS 150-3, withdrawals are recognized as liabilities by
the Partnership, net of incentive allocations, when the amount requested in the
withdrawal notice becomes fixed. This generally occurs either at the time of the
receipt of the notice, or on the last day of a fiscal period, depending on the
nature of the request. As a result, withdrawals paid after the end of the year,
but based upon year-end capital balances are reflected as capital withdrawals
payable at December 31, 2008. Withdrawal notices received for which the dollar
amount is not fixed remains in capital until the amount is determined.
Withdrawals payable may be treated as capital for purposes of allocations of
gains/losses pursuant to the Partnership's governing documents. On December 31,
2008, the General Partner of the Partnership passed a resolution to wind-up the
operations of the Fund and a compulsorily redeem 50% of the net asset value of
the Fund (approximately $19,970,000) which is included in redemptions payable at
December 31, 2008.
7. Commitments and contingencies
In the normal course of business, the Partnership enters into contracts that
contain a variety of representations, warranties and general indemnifications.
The Partnership's maximum exposure under these arrangements, including future
claims that may be made against the Partnership that have not yet occurred, is
unknown. However, based on the experience of the General Partner, the
Partnership expects the risk of loss associated with such contracts to be
remote.
8
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
--------------------------------------------------------------------------------
8. Administrative fee
Admiral Administration, Ltd. (Cayman Islands) (the "Administrator") serves as
the Partnership's Administrator and performs certain administrative and clerical
services on behalf of the Partnership.
9. Financial highlights
Financial highlights for the year ended December 31, 2008 are as follows:
Total Return
Total return before reallocation to General Partner 16.6%
Reallocation to General Partner (1.7)
-----
Total return after reallocation to General Partner (a) 14.9%
=====
Ratio to average limited partners' capital
Expenses (including interest) (b) 3.3%
Reallocation to General Partner 2.2
-----
Expenses and reallocation to General Partner 5.5%
=====
Expenses excluding interest expense (c) 1.8%
=====
Net investment income (d) 1.2%
=====
(a) Total return is calculated for aggregate limited partners' capital,
exclusive of the General Partner, taken as a whole and adjusted for cash
flows related to capital contributions and withdrawals during the year. An
individual limited partner's return may differ depending on the timing of
contributions and withdrawals, as well as varying fee structures.
(b) The operating expense ratio is based on the expenses allocated to each
partner prior to the effects of any incentive allocation. For the purpose
of this calculation, operating expenses include expenses incurred by the
Partnership directly as well as expenses allocated from the Master Fund.
Expense ratios are calculated over average net assets. Expense ratio
excluding the effect of allocated expenses from the Master Fund would be
1.3%. The expense ratios attributable to an individual partner's account
may vary based on different management fee and incentive allocation
arrangements and the timing of capital transactions.
(c) The expenses excluding interest expense ratio is based on the expenses
allocated to each partner. For the purpose of this calculation, operating
expenses include expenses incurred by the Partnership directly as well as
expenses allocated from the Master Fund, excluding interest expense and the
reallocation to the General Partner. Expense ratios are calculated over
average net assets. The expense ratios attributable to an individual
partner's account may vary based on different management fee arrangements
and the timing of capital transactions.
(d) The net investment income ratio is based on the net investment income
allocated to a limited partner prior to the effect of an incentive
allocation and is exclusive of unrealized and realized gains and losses.
The net investment income ratio attributable to an individual partner's
account may vary based on timing of capital transactions and different
management fee arrangements.
9
HFH ShortPLUS FUND, L.P.
(IN LIQUIDATION)
Notes to Financial Statements
--------------------------------------------------------------------------------
9. Subsequent events
As of February 2, 2009, the Custodian for the Partnership changed from J.P.
Morgan to Wells Fargo Bank, N.A.
10
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Statement of Assets and Liabilities
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
Year Ended December 31, 2008
(Unaudited)
Assets
Investments in securities, at fair value
(cost $69,721,286) $ 5,812,984
Credit default swap contracts, at fair value
(upfront fee payments $9,912,500) 22,081,724
Securities purchased under agreements to resell, at fair value 32,338,000
Cash and cash equivalents 144,185,058
Margin cash paid to counterparties 11,986,130
Other assets 65,455
--------------
Total assets 216,469,351
--------------
Liabilities
Margin cash received from counterparties 12,088,168
Credit default swap contracts, at fair value
(upfront fee receipts $6,300,000) 14,685,603
Accrued expenses and other payables 441,484
Due to broker 33,439
--------------
Total liabilities 27,248,694
--------------
Net assets $ 189,220,657
==============
Net asset value per share, based on net assets of $189,220,657
and 468.89 shares outstanding $ 403,554.21
==============
1
See accompanying notes to financial statements.
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Statement of Operations
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
Year Ended December 31, 2008
(Unaudited)
Investment income
Interest $ 9,210,975
--------------
Expenses
Interest 3,071,390
Professional fees and other 890,215
Administrative fee 158,920
--------------
Total expenses 4,120,525
--------------
Net investment income (loss) 5,090,450
--------------
Realized and unrealized gain (loss) on investments
Net realized gain (loss) on securities (9,307,178)
Net realized gain (loss) on credit default swap contracts 225,379,191
Net change in unrealized appreciation or (depreciation) on securities (2,534,158)
Net change in unrealized appreciation or (depreciation) on credit default swap contracts (174,353,921)
Net gain (loss) from foreign exchange transactions (107,994)
--------------
Net gain (loss) on investments 39,075,940
--------------
Net change in net assets resulting from operations $ 44,166,390
==============
2
See accompanying notes to financial statements.
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Statement of Changes in Net Assets
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
Year Ended December 31, 2008
(Unaudited)
Operations
Net investment income (loss) $ 5,090,450
Net realized gain (loss) on securities (9,307,178)
Net realized gain (loss) on credit default swaps 225,379,191
Net change in unrealized appreciation or (depreciation) on securities (2,534,158)
Net change in unrealized appreciation or (depreciation) on credit default swap contracts (174,353,921)
Net gain (loss) from foreign exchange transactions (107,994)
--------------
Net change in net assets resulting from operations 44,166,390
--------------
Capital share transactions
Issuance of shares 304,492
Redemption of shares (176,552,945)
--------------
Net change in net assets resulting from capital share transactions (176,248,453)
--------------
Net change in net assets (132,082,063)
Net assets, beginning of year 321,302,720
--------------
Net assets, end of year $ 189,220,657
===============
3
See accompanying notes to financial statements.
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Statement of Cash Flows
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
Year Ended December 31, 2008
(Unaudited)
Cash flows from operating activities
Net change in net assets resulting from operations $ 44,166,390
Adjustments to reconcile net change in net assets resulting
from operations to net cash provided by operating activities:
Net realized gain (loss) on securities 9,307,178
Net change in unrealized appreciation or (depreciation) on securities 2,534,158
Changes in operating assets and liabilities:
Purchases of investments in securities, at fair value (41,515,670)
Proceeds from sales of investments in securities, at fair value 36,188,013
Credit default swap contracts, at fair value 210,366,456
Securities purchased under agreements to resell, at fair value 26,836,000
Margin cash paid to counterparties (10,185,886)
Dividends and interest receivable (1,811,299)
Other assets 23,679
Margin cash received from counterparties (206,559,962)
Due to broker (62,044)
Accrued expenses 207,734
-----------------
Net cash provided by operating activities 69,494,747
-----------------
Cash flows from financing activities
Proceeds from issuance of shares 304,492
Payments for redemption of shares (176,552,945)
-----------------
Net cash used in financing activities (176,248,453)
-----------------
Net change in cash and cash equivalents (106,753,706)
Cash and cash equivalents, beginning of year 250,938,764
-----------------
Cash and cash equivalents, end of year $ 144,185,058
=================
4
See accompanying notes to financial statements.
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Condensed Schedule of Investments
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
December 31, 2008
(Unaudited)
Current Face / Coupon Maturity Percentage of Fair
Notional Rates % Date Range Net Assets Value
-------- ------- ---------- ---------- -----
Asset-Backed Securities, at fair value
Fixed Rate Home Equity
TMTS 04-8HES B2 (cost $407,368) $ 446,131 8.000% 6/25/34 0.07 % $ 131,312
------- --------------
Floating Rate Home Equity
Bayview Financial TR 2004-D $ 1,893,329 2.971 8/28/44 0.10 190,220
Morgan Stanley Cap 2007-NC A2A $ 1,615,661 0.551 6/25/37 0.62 1,181,957
------- --------------
Total Floating Rate Home Equity 0.72 1,372,177
------- --------------
(cost $3,294,809)
Floating Rate Business Loans
BAYC 05-3A B3 $ 594,122 3.471 11/25/35 0.13 243,915
Bayview Coml Mtg TR 2006-SP1 $ 7,060,000 4.471 4/25/36 0.76 1,438,475
------- --------------
Total Floating Rate Business Loans
(cost $7,325,808) 0.89 1,682,390
------- --------------
Home Equity Residuals
Option One Mtg LN TR 2007-4
20370425 FL (cost $2,874,362) $ 3,090,711 0.561 4/25/37 1.39 2,627,105
------- --------------
Other (cost $55,818,939)* $46,136,708 0-8.500% 1/15/35-9/08/51 -- --
------- --------------
Total Asset-Backed Securities,
at fair value (cost $69,721,286) 3.07 % $ 5,812,984
-====== ==============
* Fifteen (15) bonds with a cost of $55,818,939 had fair values of -0- at
December 31, 2008.
5
See accompanying notes to financial statements.
HFH ShortPLUS MasterFund, Ltd.
(In Liquidation)
Condensed Schedule of Investments (Continued)
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
December 31, 2008
(Unaudited)
Notional Termination Percentage of Fair
Amount Date Net Assets Value
------ ---- ---------- -----
Swap contracts, at fair value
Credit default swap contracts
United States
JPMAC 2005-OPTI M9
(pay 3.00%) $ 5,595,354 6/25/2035 2.80 % $ 5,288,265
RFC06NC3 M9
(pay CITI 7.50%) $ 4,000,000 3/25/2036 2.10 3,921,978
SAIL 2006-4 M4
(pay CS 3.75%) $ 10,000,000 7/25/2036 5.10 9,708,523
Nevada GO CDS (pay .98%) $ 10,000,000 3/1/2017 0.50 971,094
New Jersey GO CDS (pay .87%) $ 10,000,000 7/1/2019 0.50 906,641
SHIPO 3 A2 (pay 2.60%) $ 13,971,000 1/18/2050 0.70 1,285,223
------- -------------
Total credit default swap contracts 11.70 22,081,724
------- -------------
(upfront fee payments $9,912,500)
Credit default swap contracts
United States
SAIL 2006-4 M4
(JP Morgan (Bear) pays 5.80%) $(10,000,000) 7/25/2036 (5.20) (9,819,978)
RFC06NC3 M8
(CITI pays 5.00%) $ (5,000,000) 3/25/2036 (2.60) (4,865,625)
----- -------------
Total credit default swap contracts (7.80) (14,685,603)
----- -------------
(upfront fee receipts $6,300,000)
Total swap contracts, at fair value 3.90 % $ 7,396,121
======= =============
Securities purchased under agreements to resell, at fair value
J.P. Morgan, 1.74% - 6.00%, 4/15/2032 - 6/16/2038 (cost $32,338,000) 17.10 % $ 32,338,000
======= =============
6
See accompanying notes to financial statements.
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
(Unaudited)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
Nature of Operations
HFH ShortPLUS Master Fund, Ltd. (In Liquidation) (the "Fund") is a Cayman
Islands exempted company incorporated in accordance with the Companies Law (2004
revision) which commenced operations on January 2, 2007. The Fund's strategy is
to assemble a short-biased portfolio of asset-backed securities ("ABS") that the
Investment Manager believes are most likely to produce high returns during
periods of adverse credit performance for residential mortgages, and for
mortgage-backed securities ("MBS") and ABS. Returns will come from two principal
sources: (i) market value changes arising from changes in credit spreads on the
Fund's short positions; and (ii) credit default payments from counterparties on
credit default swaps ("CDS") or other derivatives.
In accordance with the Fund's documents, the board of directors have formalized
a plan of liquidation to liquidate the Fund in an orderly manner, and as a
result, changed its basis of accounting from the going concern to the
liquidation basis whereby assets and liabilities are stated at their estimated
settlement amounts and all costs of liquidation have been recognized. The
adoption of the liquidation basis of accounting did not have a material effect
on the carrying values of assets and liabilities as of December 31, 2008. The
shares held by the remaining investors will be distributed on March 31, 2009. In
addition, a new entity called HFH ShortPLUS Master Fund Liquidating Trust was
established for purposes of receiving cash flows on securities that were
distributed in-kind.
Highland Financial Holdings Group, LLC ("Investment Manager") serves as the
investment manager of the Fund. The Investment Manager manages and invests the
Fund's assets and effects all security transactions on behalf of the Fund. The
Fund operates under a "master fund/feeder fund" structure. HFH ShortPLUS, Ltd.
and HFH ShortPLUS Fund, L.P. (collectively, the "Feeder Funds") invest
substantially all of their investable assets in the Fund.
Basis of Presentation
The financial statements are expressed in United States dollars and have been
prepared in conformity with accounting principles generally accepted in the
United States of America.
Cash and Cash Equivalents
Cash and cash equivalents consist principally of cash, margin cash received from
counterparties, and short term investments (treasury bills), which are readily
convertible into cash and have original maturities of three months or less.
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
The Fund adopted the provisions of SFAS No. 157, "Fair Value Measurements"
("SFAS No. 157"), effective January 1, 2008. Under SFAS No. 157, fair value is
defined as the price that would be received to sell an asset or paid to transfer
a liability (i.e., the "exit price") in an orderly transaction between market
participants at the measurement date.
7
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
In determining fair value, the Fund uses various valuation approaches. SFAS No.
157 establishes a fair value hierarchy for inputs used in measuring fair value
that maximizes the use of observable inputs and minimizes the use of
unobservable inputs by requiring that the most observable inputs be used when
available. Observable inputs are those that market participants would use in
pricing the asset or liability based on market data obtained from sources
independent of the Fund. Unobservable inputs reflect the Fund's assumptions
about the inputs market participants would use in pricing the asset or liability
developed based on the best information available in the circumstances. The fair
value hierarchy is categorized into three levels based on the inputs as follows:
Level 1 - Valuations based on unadjusted quoted prices in active markets
for identical assets or liabilities that the Fund has the ability to
access. Valuation adjustments and block discounts are not applied to Level
1 securities. Since valuations are based on quoted prices that are readily
and regularly available in an active market, valuation of these securities
does not entail a significant degree of judgment.
Level 2 - Valuations based on quoted prices in markets that are not active
or for which all significant inputs are observable, either directly or
indirectly.
Level 3 - Valuations based on inputs that are unobservable and significant
to the overall fair value measurement.
The availability of valuation techniques and observable inputs can vary from
security to security and is affected by a wide variety of factors including, the
type of security, whether the security is new and not yet established in the
marketplace, and other characteristics particular to the transaction. To the
extent that valuation is based on models or inputs that are less observable or
unobservable in the market, the determination of fair value requires more
judgment. Those estimated values do not necessarily represent the amounts that
may be ultimately realized due to the occurrence of future circumstances that
cannot be reasonably determined. Because of the inherent uncertainty of
valuation, those estimated values may be materially higher or lower than the
values that would have been used had a ready market for the securities existed.
Accordingly, the degree of judgment exercised by the Fund in determining fair
value is greatest for securities categorized in Level 3. In certain cases, the
inputs used to measure fair value may fall into different levels of the fair
value hierarchy. In such cases, for disclosure purposes, the level in the fair
value hierarchy within which the fair value measurement in its entirety falls,
is determined based on the lowest level input that is significant to the fair
value measurement.
Fair value is a market-based measure considered from the perspective of a market
participant rather than an entity-specific measure. Therefore, even when market
assumptions are not readily available, the Fund's own assumptions are set to
reflect those that market participants would use in pricing the asset or
liability at the measurement date. The Fund uses prices and inputs that are
current as of the measurement date, including periods of market dislocation. In
periods of market dislocation, the observability of prices and inputs may be
reduced for many securities. This condition could cause a security to be
reclassified to a lower level within the fair value hierarchy.
8
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
Valuation Techniques
The Investment Manager will use its reasonable discretion to value each
investment by using, as a guide, a combination of (i) independent, third-party
pricing sources; (ii) indications from one or more financial institutions
engaged in trading the investments or securities similar to the investments
being valued; (iii) transactions in the market of the same or similar
securities; and (iv) in-house models the Investment Manager maintains (the
"Highland Model"). In cases where the number of indications is limited, the
Investment Manager will review other factors such as the previous month's value,
whether such indication is from the same counterparty, the delta between the
current value and the previous month value, relevant market data or news, the
value of similar securities, recent trading information and any other
information which may be deemed relevant at the discretion of the Investment
Manager. With respect to credit default swaps ("CDS"), the Investment Manager
may use, if considered representative of the value of CDS positions, margin
marks from the actual counterparty with whom the security was traded, or from
counterparties of a similar CDS position to estimate the valuation. However, if
the Investment Manager believes the exit price will be either greater or less
than the current margin mark, the Investment Manager has the discretion to
revise the value accordingly.
Fair value determinations based on indications from financial institutions or
margin marks from counterparties may be based on as few as a single
indication/margin mark, or may be calculated as the average of more than one
such indication/margin mark, which average may include recent transactions in
the market or ignore outlying indications/margin marks based on the Investment
Manager's discretion. The Investment Manager may use observable transactions in
the market in determining the fair value of investments if, at the discretion of
the Investment Manager, prioritization of such transactions is considered more
relevant given market conditions or other factors.
The Highland Model is a proprietary system that is used to generate a
price/yield based on key inputs. Cash flows for the Fund's securities that are
projected through the Highland Model, incorporate assumptions regarding
potential future rates of delinquency, prepayments, defaults, collateral losses,
and interest rates. On a monthly basis, each security's actual cash flows are
compared to the previously projected cash flows. Assumptions can be modified
based on significant deviations between actual cash flows and cash flows from
previous projections. Discount rates may be changed based on market observations
for prices and discount rates of similar securities trading in the secondary
market. The following outlines the key inputs that are reevaluated on a monthly
basis:
i. Constant Default Rate (CDR) - an annualized rate of default on a group
of mortgages within a collateralized product (i.e. MBS). It represents
the percentage of outstanding principal balances in the pool that are
in default, which typically equates to the home being past 60-day and
90-day notices and in the foreclosure process.
ii. Constant Prepayment Rate (CPR) - A loan prepayment rate that is equal
to the proportion of the principal of a pool of loans that is assumed
to be paid off prematurely in each period. The calculation of this
estimate is based on a number of factors such as historical prepayment
rates for previous loans that are similar to ones in the pool and on
the future economic outlook.
iii. Loss Severity - costs (expressed as a %) to foreclose and liquidate a
home securing a defaulted mortgage, as well as any decline in property
value.
9
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
Valuation Techniques (continued)
iv. Delinquency - monthly mortgage payments that are 30, 60, or more than
60 days past due.
v. Yield - the yield is obtained from the "Matrix" which is updated on a
monthly basis. The Matrix associates yields based on various groups of
securities and market conditions.
The Fund will also determine fair value for MBS and ABS securities that are not
based on the Highland Model price. The following represent additional price
sources:
Transaction based - Represents a recent transaction utilized as the
price source if the transaction occurred within 30 days of the
valuation date.
Trader based - Represents a price determined by a portfolio manager.
The portfolio manager will determine the proper valuation for a
particular security utilizing a combination of observable and
unobservable inputs. In determining the valuation the portfolio
manager will rely upon third party broker quotes, pricing services,
recent transactions of the security or similar securities, inquiries
with marker-makers and industry expertise. The Fund will use this
valuation technique if the responsible portfolio manager determines
that the Highland Model does not accurately reflect certain
idiosyncratic factors for a specific security.
Third party quotes - Represents a valuation that is received
externally from either a pricing service or dealer price. The Fund
will utilize this price if the responsible portfolio manager
determines that this price accurately reflects fair value and for
various reasons the Highland Model price (e.g. model inadequacies,
non-current data, etc.) is less accurate than the third party price.
The following table summarizes the pricing sources used to determine fair value
of the securities owned by the Fund at December 31, 2008:
Pricing Source % of Portfolio Priced
Third party quotes 39.8%
Trader based 32.9%
Transaction based 14.1%
Highland Model 13.2%
ABS and MBS and Credit Default Swaps on ABS and MBS securities are generally
categorized in Level 3 of the fair value hierarchy.
Derivative Instruments and Hedging Activities
---------------------------------------------
The Fund recognizes the value of all derivative instruments as either assets or
liabilities in the Statement of Assets and Liabilities and measures those
instruments at fair value.
10
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
Valuation Techniques (continued)
Interest Rate and Index Swaps
-----------------------------
The Fund may enter into interest rate and index swaps as part of its investment
strategies. Swaps involve the exchange by the Fund with another party of
respective commitments to pay or receive interest, effective return, or total
return throughout the lives of the agreements. The Fund may be required to
deliver or receive cash or securities as collateral upon entering into swap
transactions. Movements in the relative value of the swap transactions may
require the Fund or the counterparty to post additional collateral. Interest
rate swaps change in value with movements in interest rates. During the term of
the swap contracts, changes in value and accrued interest payments are
recognized as unrealized gains or losses by marking the contracts to the market.
These unrealized gains and losses are reported as an asset or liability,
respectively, on the Statement of Assets and Liabilities. When contracts are
terminated, the Fund will realize a gain or loss equal to the difference between
the proceeds from (or cost of) the closing transaction and the Fund's basis in
the contract, if any.
Credit Default Swaps
--------------------
The Fund adopted FASB Staff Position FAS 133-1 and FIN 45-4, Disclosures about
Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No.
133 and FASB Interpretation No. 45, as of December 31, 2008, which requires
additional disclosures about credit derivatives.
The Fund enters into credit default swaps to simulate long and short bond
positions that are either unavailable or considered to be less attractively
priced in the bond market. The Fund uses these swaps to attempt to reduce risk
where the Fund has exposure to the issuer, or to take an active long or short
position with respect to the likelihood of the issuer's default. There is no
certainty that the objectives of holding credit default swaps will be achieved.
The buyer of a credit default swap is obligated to pay the seller a periodic
stream of payments over the term of the contract in return for a contingent
payment upon the occurrence of a credit event, with respect to an underlying
reference obligation. Generally, a credit event means bankruptcy, failure to
pay, obligation accelerated or modified restructuring. If a credit event occurs,
the seller typically must pay the contingent payment to the buyer, which is
typically the par value (full notional value) of the reference obligation. The
contingent payment may be a cash settlement or by a physical delivery of the
reference obligation in return for payment of the face amount of the obligation.
If the Fund is a buyer and no credit event occurs, the Fund may lose its
investment and recover nothing. However, if a credit event occurs, the buyer
typically receives full notional value and interest for a reference obligation
that may have little or no value. As a seller, the Fund receives a fixed rate of
income throughout the term of the contract, provided that no credit event
occurs. If a credit event occurs, the seller may pay the buyer the full notional
value and interest of the reference obligation. Upfront payments made and/or
received by the Fund are recorded as an asset and/or liability on the Statement
of Assets and Liabilities and are recorded as a realized gain or loss on the
termination date.
As of December 31, 2008, the Fund has eight open credit default swaps. The Fund
is the buyer on six of these swaps ("receiving protection" on a total notional
amount of approximately $53.6 million) and is the seller on the remaining two
("providing protection" on a total notional amount of $15 million).
11
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
Credit Default Swaps (continued)
--------------------------------
Credit default swaps involve greater risks than if the Fund had invested in the
reference obligations directly. In addition to general market risks, credit
default swaps are subject to liquidity risk and counterparty credit risk. A
buyer also may lose its investment and recover nothing should a credit event not
occur. If a credit event did occur, the value of the reference obligation
received by the seller, coupled with the periodic payments previously received,
may be less than the full notional value it pays to the buyer, resulting in a
loss of value.
At December 31, 2008, the two credit default swaps sold held by the Fund were
referenced to mortgage-backed securities. Both credit default swaps sold expire
in 2036.
The current status of the performance risk of both credit default swaps sold are
classified by the external Standard & Poor's credit ratings of the reference
obligations as CC.
In the event that certain specified credit events occur, the maximum potential
amount of future undiscounted payments that the Fund would be required to pay
under the credit default swaps sold would be approximately $15,000,000. However,
if the Fund was required to make payments under the credit default swaps sold,
it would be entitled to certain assets owned by the reference entities that
collateralize the reference obligations. The Fund is unable to estimate the
approximate extent of which the proceeds from liquidation can be applied towards
the maximum potential amount of future payments under the credit default swaps
sold.
The fair value of open swaps reported in the statement of assets and liabilities
may differ from that which would be realized in the event the Fund terminated
its position in the contract. Risks may arise as a result of the failure of the
counterparty to the swap contract to comply with the terms of the swap contract.
The loss incurred by the failure of a counterparty is generally limited to the
aggregate of the unrealized gain on the swap contracts in an unrealized gain
position as well as any collateral posted with the counterparty. Therefore, the
Fund considers the creditworthiness of each counterparty to a swap contract in
evaluating potential credit risk. Additionally, risks may arise from
unanticipated movements in the fair value of the underlying securities and the
lack of market liquidity to unwind the positions at current fair values.
The Fund's credit default swap contracts are subject to International Swaps and
Derivatives Association (ISDA) Master Agreements which contain certain covenants
and other provisions. During the year ended December 31, 2008, the decline of
the Fund's net asset value resulted in an additional termination event as
defined in two of these agreements. As a result, the Fund's counterparties have
the right to terminate these agreements and the related derivative contracts.
The Fund closed one of the contracts subsequent to year end. The swap contract
had a fair value of approximately $1,285,000 at December 31, 2008. The Fund is
in the process of closing the remaining swap in connection with the liquidation
of the Fund. As of December 31, 2008, the value of this swap was approximately
$9,846,000 and the Fund held collateral from the counterparty in the amount of
approximately $3,488,000. In January 2009, the counterparty posted an additional
$6,360,000 of collateral with the Fund. The Fund has not received any notice
from its counterparty to terminate this agreement.
The fair values of the credit default swaps sold referenced to mortgage-backed
securities were approximately $14,686,000 as of December 31, 2008.
12
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities at Fair Value - Definition and Hierarchy
(continued)
Futures
-------
A futures contract is an agreement between two parties to buy or sell a
financial instrument for a set price on a future date. Initial margin deposits
are made upon entering into futures contracts and can be either cash or
securities. During the period the futures contract is open, changes in the value
of the contract are recognized as unrealized gains or losses by marking to
market on a daily basis to reflect the fair value of the contract at the end of
each day's trading. When the contract is closed, the Fund records a realized
gain or loss equal to the difference between the proceeds of the closing
transaction and the Fund's basis in the contract.
Purchased Options
-----------------
The Fund may purchase put or call options. When the Fund purchases an option, an
amount equal to the premium paid is recorded as an asset and is subsequently
marked-to-market. Premiums paid for purchasing options that expire unexercised
are recognized on the expiration date as realized losses. If an option is
exercised, the premium paid is subtracted from the proceeds of the sale or added
to the cost of the purchase to determine whether the Fund has realized a gain or
loss on the related investment transaction. When the Fund enters into a closing
transaction, the Fund will realize a gain or loss depending upon whether the
amount from the closing transaction is greater or less than the premium paid.
Written Options
---------------
The Fund may write put or call options. When the Fund writes an option, an
amount equal to the premium received is recorded as a liability and is
subsequently marked-to-market. Premiums received for writing options that expire
unexercised are recognized on the expiration date as realized gains. If an
option is exercised, the premium received is subtracted from the cost of the
purchase or added to the proceeds of the sale to determine whether the account
has realized a gain or loss on the related investment transaction. When the Fund
enters into a closing transaction, the Fund will realize a gain or loss
depending upon whether the amount from the closing transaction is less or
greater than the premium received.
Short Sales
-----------
When the Fund sells short, it may borrow the security sold short and deliver it
to the broker-dealer through which it sold short as collateral for its
obligation to deliver the security upon conclusion of the sale. Additionally,
the Fund generally is required to deliver cash or securities as collateral for
the Fund's obligation to return the borrowed security. The Fund may have to pay
a fee to borrow the particular securities and may be obligated to pay over any
payments received on such borrowed securities. A gain, limited to the price at
which the Fund sold the security short, or a loss, unlimited as to dollar
amount, will be recognized upon the termination of a short sale if the exit
price is less or greater than the proceeds originally received.
13
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Valuation of Investments in Securities and Securities Sold Short at Fair Value -
Definition and Hierarchy (continued)
Financing Transactions
----------------------
The Fund enters into repurchase agreements as a borrower (securities sold under
agreements to repurchase) and as a lender (securities purchased under agreements
to resell). All repurchase agreements are carried at their contractual amounts
on the Statement of Assets and Liabilities, and the accrued income (expense) is
recorded separately. Securities sold under agreements to repurchase include
sell-buy financing transactions while securities purchased under agreements to
resell include buy-sell financing transaction.
Securities Sold Under Agreements to Repurchase
----------------------------------------------
The Fund monitors collateral fair values relative to the amounts due under the
agreements, including accrued interest, throughout the lives of the agreements,
and when necessary, requires transfer of cash or securities in order to manage
exposure and liquidity. In connection with such agreements, if the counterparty
defaults or enters an insolvency proceeding, realization or return of the
collateral to the Fund may be delayed or limited.
At December 31, 2008, the Fund had no securities sold under agreements to
repurchase.
Securities Purchased Under Agreements to Resell
-----------------------------------------------
Transactions involving purchases of securities under agreements to resell are
treated as collateralized financial transactions and are recorded at their
contracted resell amounts. Securities purchased under agreements to resell are
generally collateralized principally by U.S. government and agency securities.
The Fund takes possession of such underlying collateral, monitors its fair value
relative to the amounts due under the agreements, including accrued interest,
throughout the lives of the agreements, and when necessary, may require a
transfer of additional cash or securities in order to manage exposure and
liquidity. In connection with such agreements, if the counterparty defaults or
enters an insolvency proceeding, realization or return of the funds to the Fund
may be delayed or limited.
At December 31, 2008, the Fund had securities purchased under agreements to
resell totaling $32,338,000. The Fund received collateral in the form of various
FNMA MBS pools under a held in custody agreement with an interest rate of 0.035%
and a maturity of two days. The value of the securities, including accrued
interest, received as collateral by the Fund that it was permitted to sell or
repledge was approximately $33,294,000.
Translation of Foreign Currency
Assets and liabilities denominated in foreign currencies are translated into
United States dollar amounts at the year-end exchange rates. Transactions
denominated in foreign currencies, including purchases and sales of investments,
and income and expenses, are translated into United States dollar amounts on the
transaction date. Adjustments arising from foreign currency transactions are
reflected in the statement of operations.
The Fund does not isolate that portion of the results of operations arising from
the effect of changes in foreign exchange rates on investments from fluctuations
arising from changes in market prices of investments held. Such fluctuations are
included in net gain (loss) on investments in the statement of operations.
14
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Investment Transactions and Related Investment Income
Investment transactions are accounted for on a trade-date basis. Interest is
recognized on the accrual basis.
Offsetting of Amounts Related to Certain Contracts
The Fund has elected not to offset fair value amounts recognized for cash
collateral receivables and payables against fair value amounts recognized for
net derivative positions executed with the same counterparty under the same
master netting arrangement. At December 31, 2008, the Fund had no cash
collateral receivables and payables with derivative counterparties covered under
the same master netting arrangement.
Income Taxes
The Fund is a Cayman Islands exempted company. Under the current laws of the
Cayman Islands, there are no income, estate, transfer, sale or other taxes
payable by the Fund. The Fund is taxed as a partnership for U.S. Federal income
tax purposes, and as such, is not subject to income taxes; each investor may be
individually liable for income taxes, if any, on its share of the Fund's net
taxable income. The Fund trades securities for its own account and, as such,
investors are generally not subject to U.S. tax on such earnings (other than
certain withholding taxes indicated below). The Investment Manager intends to
conduct the business of the Fund to the maximum extent practicable so that the
Fund's activities do not constitute a U.S. trade or business. Interest and other
income received by the Fund from sources within the United States may be subject
to, and reflected net of, United States withholding tax at the rate of 30%.
Interest, dividend and other income realized by the Fund from non-U.S. sources
and capital gains realized on the sale of securities of non-U.S. issuers may be
subject to withholding and other taxes levied by the jurisdiction in which the
income is sourced.
The Fund has adopted FASB Staff Position No. FIN 48-3, which allows certain
nonpublic entities to defer the effective date of FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes" ("FIN 48"), until the annual
financial statements for fiscal years beginning after December 15, 2008. The
Investment Manager has elected to take advantage of this deferral. Based on its
continued analysis, the Investment Manager has determined that the adoption of
FIN 48 will not have a material impact to the Fund's financial statements.
However, the Investment Manager's conclusions regarding FIN 48 may be subject to
review and adjustment at a later date based on factors including, but not
limited to, further implementation guidance, and on-going analyses of tax laws,
regulations and interpretations thereof. The Fund's accounting policy for
evaluating uncertain tax positions during financial statement periods subject to
the deferral of FIN 48 is based on the recognition and disclosure criteria for
loss contingencies under SFAS No. 5 "Accounting for Contingencies".
FIN 48 requires the Investment Manager to determine whether a tax position of
the Fund is more likely than not to be sustained upon examination by the
applicable taxing authority, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The tax
benefit to be recognized is measured as the largest amount of benefit that is
greater than fifty percent likely of being realized upon ultimate settlement
which could result in the Fund recording a tax liability that would reduce net
assets. FIN 48 must be applied to all existing tax positions upon initial
adoption and the cumulative effect, if any, is to be reported as an adjustment
to net assets upon adoption.
15
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
1. Nature of operations and summary of significant accounting policies
(continued)
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the Fund's
management to make estimates and assumptions that affect the amounts disclosed
in the financial statements. Actual results could differ from those estimates.
2. Fair value measurements
The Fund's assets and liabilities recorded at fair value have been categorized
based upon a fair value hierarchy in accordance with SFAS No. 157. See Note 1
for a discussion of the Fund's policies.
The following table presents information about the Fund's assets and liabilities
measured at fair value as of December 31, 2008 (in thousands):
Quoted Prices Significant
in Active Other Significant Balance
Markets for Observable Unobservable as if
Identical Assets Inputs Inputs December 31
(Level 1) (Level 2) (Level 3) 2008
---------------- ----------- ------------ -----------
Assets
Investments in securities,
at fair value $ -- $ -- $ 5,813 $ 5,813
Credit default swap
contracts, at fair value -- -- 22,082 22,082
---------- ---------- --------- ---------
$ -- $ -- $ 27,895 $ 27,895
========== ========== ========= =========
Liabilities
Credit default swap
contracts, at fair value $ -- $ -- $ 14,686 $ 14,686
========== ========== ========= =========
16
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
2. Fair value measurements (continued)
The following table presents additional information about Level 3 assets and
liabilities measured at fair value. Both observable and unobservable inputs may
be used to determine the fair value of positions that the Fund has classified
within the Level 3 category. As a result, the unrealized gains and losses for
assets and liabilities within the Level 3 category may include changes in fair
value that were attributable to both observable (e.g., changes in market
interest rates) and unobservable (e.g., changes in unobservable long-dated
volatilities) inputs.
Changes in Level 3 assets and liabilities measured at fair value for the year
ended December 31, 2008 (in thousands) are as follows:
Level 3
-------------------------------------------------------------------------------------------
Change in
Unrealized
Gains (Losses)
Beginning Realized & Purchases Net Ending for Investments
Balance Unrealized Sales Transfers Balance still held at
January 1 Gains and In and/or December 31, December 31,
2008 (Losses) Settlements (Out) of 2008 2008
---------- ------------- ----------- ----------- ----------- -------------
Assets
Investments in securities, at
fair value $ 12,297 $ (10,658) $ 4,174 $ -- $ 5,813 $ (2,737)
Credit default swap contracts,
at fair value 271,422 66,112 (315,452) -- 22,082 5,271
--------- ---------- ---------- -------- -------- ---------
$ 283,719 $ 55,454 $ (311,278) $ -- $ 27,895 $ 2,534
========= ========== ========== ======== ======== =========
Liabilities
Credit default swap contracts,
at fair value 54,613 8,658 (48,585) -- 14,686 (4,430)
--------- ---------- ---------- -------- -------- ---------
$ 54,613 $ 8,658 $ (48,585) $ -- $ 14,686 $ (4,430)
========= ========== ========== ======== ======== =========
Realized and unrealized gains and losses are included in net gain (loss) on
securities in the statement of operations. The change in unrealized gains
(losses) for the year ended December 31, 2008 for investments still held at
December 31, 2008 of ($2,737) and ($841) are reflected in unrealized
appreciation or depreciation of securities and unrealized appreciation or
depreciation on credit default swap contracts, respectively, in the statement of
operations.
17
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
3. Due to broker
Amounts due to broker represent margin borrowings that are collateralized by
certain securities.
In the normal course of business, substantially all of the Fund's securities
transactions, money balances and security positions are transacted with a
broker. The Fund is subject to credit risk to the extent any broker with which
it conducts business is unable to fulfill contractual obligations on its behalf.
The Fund's management monitors the financial condition of such brokers and does
not anticipate any losses from these counterparties.
Throughout 2008, the Fund primarily transacted with the following brokers J.P.
Morgan, Goldman Sachs, Deutsche Bank, Citibank, Credit Suisse and Merrill Lynch.
4. Financial instruments with off-balance sheet risk and other risks
The Fund invests on a leveraged basis in various financial instruments and is
exposed to market risks resulting from changes in the fair value of the
instruments. The Statement of Assets and Liabilities may include the fair value
of contractual commitments involving forward settlements, futures contracts and
swap transactions as well as investments in securities sold short. These
instruments involve elements of market risk in excess of amounts reflected on
the Statement of Assets and Liabilities. Derivative financial statements are
used by the Fund to help manage such market risk and to take an active long or
short position in the market. Should interest rates move unexpectedly, the Fund
may not achieve the anticipated benefits of the hedging instruments and may
realize a loss. Further, the use of such derivative instruments involves the
risk of imperfect correlation in movements in the price of the instruments,
interest rates and the underlying hedged assets.
The investment characteristics of mortgage-backed and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that the underlying residential or commercial mortgage loans or other assets
generally may be prepaid at any time. Maturities on mortgage-backed and
asset-backed securities represent stated maturity dates. Actual maturity dates
may differ based on prepayment dates.
The Fund is exposed to credit-related losses in the event of nonperformance by
counterparties to financial instruments. The maximum credit exposure related to
the derivative financial instruments of the Fund is equal to the fair value of
the contracts with positive fair values as of December 31, 2008. It is the
policy of the Fund to transact the majority of its securities and contractual
commitment activity with broker-dealers, banks and regulated exchanges that the
Investment Manager considers to be well established.
The Fund's short-biased strategy depends in large measure upon the ability of
the Investment Manager to identify ABS that experience future credit losses
arising from the defaults by obligors on the related mortgage loans. This is the
opposite approach from that employed in traditional long-bias credit investment
strategies that generally seek to avoid credit losses on investments purchased
on the basis of fundamental credit analysis, or on other bases.
18
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
4. Financial instruments with off-balance sheet risk and other risks
(continued)
There can be no assurance that the Investment Manager's assessments of the
likelihood of default and losses on specific ABS transactions will be accurate
or that the predictive strengths of the Investment Manager's models and
practices will not decline in the future. Even if ABS default and loss rates
increase generally in the future relative to the rates observed in the past, the
Fund's return objectives will not be met if the Fund has bought credit
protection or otherwise shorted securities that do not experience such higher
default and loss rates.
The Fund's strategy also includes long investments that are intended to generate
positive income during the first several years of the Fund, in order to
partially offset the negative carry of the short positions. Losses on these long
positions could produce losses for the Fund and could result in the failure of
the Fund to achieve the intended purpose of offsetting the CDS premium costs.
An investment in the Fund entails risk. There can be no assurance that the Fund
will achieve its investment objective or that the Fund's strategies will be
successful. There exists a possibility that an investor could suffer a
substantial loss as a result of an investment in the Fund.
The success of any investment activity is influenced by general economic
conditions that may affect the level and volatility of equity prices, credit
spreads, interest rates and the extent and timing of investor participation in
the markets for both equity and interest-rate-sensitive securities. Unexpected
volatility or illiquidity in the markets in which the Fund directly or
indirectly holds positions could impair the Fund's ability to carry out its
business and could cause the Fund to incur losses.
Depending on market conditions, reliable pricing information will not always be
available from any source. Prices quoted by different sources are subject to
material variation.
Credit-sensitive tranches of ABS are exposed to credit risk arising from
possible defaults of the underlying loans and recovery rates on those liquidated
loans. The default rates of loans backing these securities is dependent on a
number of factors including the quality and characteristics of the loans,
national and regional economic growth, real estate values, the level of interest
rates, changes in the availability of mortgage financing and other factors.
Recovery values following a default will be dependent largely on regional and
national real estate values among other things; although real estate values may
depend on other economic variables.
The rate of prepayments on the loans collateralizing a subordinate ABS tranche
will generally have a significant effect on the amount of obligor defaults such
a tranche can face before suffering losses of interest or principal. The
Investment Manager believes it is impossible to accurately predict prepayment
rates because prepayment rates are heavily influenced by equally unpredictable
interest rates. Consequently, while the Investment Manager seeks to explore the
potential effects of a wide range of possible prepayment rates for securities or
CDS it purchases or sells, there can be no assurance that this analysis will
exhaust the possible paths prepayments could take, or that the effects of any
particular prepayment rate scenario will be evaluated correctly in respect of a
specific ABS tranche or CDS.
19
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
4. Financial instruments with off-balance sheet risk and other risks
(continued)
A decline in the fair value of the Fund's portfolio of assets may limit the
Investment Manager's ability to borrow, or may result in lenders initiating
margin calls (i.e., requiring a pledge of cash or additional assets to
re-establish the ratio of the amount of the borrowing to the value of the
collateral). The Investment Manager could be required to sell assets at
distressed prices under adverse market conditions in order to satisfy the
requirements of the lenders. A default by the Fund under its collateralized
borrowings could also result in a liquidation of the collateral by the lender,
including any cross-collateralized assets, and a resulting loss of the
difference between the value of the collateral and the amount borrowed.
As discussed in Note 1, the Fund's investors are two Feeder Funds managed by the
Investment Manager. The Fund could be materially affected by significant
subscriptions and redemptions from the underlying investors of these Feeder
Funds.
5. Capital share transactions
The authorized share capital of the Fund consists of 5,000,000 shares having a
par value of $0.01 (U.S.) per share. At December 31, 2008, 468.89 shares were
issued and outstanding.
Common shares are offered at an offering price equal to the net asset value per
common share as of the close of business on the immediately preceding business
day.
Any holder of common shares has the right, in accordance with and subject to the
applicable provisions of the memorandum of association of the Fund and the laws
of the Cayman Islands, to have all or a portion of their shares redeemed on a
date determined by the Directors.
At December 31, 2008, all outstanding shares are held by the Feeder Funds.
The following table reconciles share transactions for the year ended December
31, 2008:
Shares
------
Shares outstanding, beginning of year 931.50
Shares issues 0.88
Shares redeemed (463.49)
-------
Shares outstanding, end of year 468.89
=======
Shareholders have redemption rights which contain certain restrictions with
respect to rights of redemption of shares as specified in the offering
memorandum.
20
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
6. Director fee
The following persons are independent non-executive Directors of the Fund:
o David Bree
o Peter Burnim
All members of the Board of Directors are reimbursed for their out-of-pocket
expenses incurred in connection with the performance of their duties and each
receives an annual fee of approximately $5,000. No Directors have a shareholder
interest in the Fund or have an interest, direct or indirect, in any transaction
affecting the Fund during the year ended December 31, 2008, which is unusual in
nature or significant to the business of the Fund. No Director has any contracts
of significance with the Fund.
7. Administrative fee
Admiral Administration, Ltd. (Cayman Islands) (the "Administrator") serves as
the Fund's Administrator and performs certain administrative and clerical
services on behalf of the Fund.
8. Financial highlights
Financial highlights for the year ended December 31, 2008 are as follows:
Shares
------------
Per share operating performance
Net asset value, beginning of year $344,929.53
-----------
Income (loss) from investment operations:
Net invesmtent income (loss) 8,875.78
Net gain (loss) on investments 49,748.90
-----------
Total from investment operations 58,624.68
-----------
Net asset value,e nd of year $403,554.21
===========
Total return 17.0%
===========
Ratio to averate net assets
Total operating expenses 1.8%
===========
Total operating expenses excluding interest expense 0.5%
===========
Net investment income (loss) 2.3%
===========
21
HFH ShortPLUS MASTER FUND, LTD.
(In Liquidation)
Notes to Financial Statements
(Expressed in United States Dollars)
--------------------------------------------------------------------------------
8. Financial highlights (continued)
Financial highlights are calculated for common shares. An individual investor's
return and ratios may vary based on participation in new issues, private
investments, and the timing of capital share transactions.
9. Subsequent events
As of February 2, 2009, the Custodian for the Fund's securities changed from
J.P. Morgan to Wells Fargo Bank, N.A.
22
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
FINANCIAL STATEMENTS
DECEMBER 31, 2007
A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS
HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION
PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY
POOL OPERATOR OF HFH SHORTPLUS FUND, L.P.
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
INDEX
DECEMBER 31, 2007
--------------------------------------------------------------------------------
11
PAGE(S)
REPORT OF INDEPENDENT AUDITORS.............................................1
FINANCIAL STATEMENTS
Statement of Assets, Liabilities and Partners' Capital.....................2
Statement of Operations and Special Allocation.............................3
Statement of Changes in Partners' Capital..................................4
Statement of Cash Flows....................................................5
Financial Highlights.......................................................6
Notes to Financial Statements...........................................7-10
Affirmation of the Commodity Pool Operator................................11
REPORT OF INDEPENDENT AUDITORS
To the General Partner and Limited Partners of
HFH ShortPLUS Fund, L.P.
In our opinion, the accompanying statement of assets, liabilities, and partners'
capital and the related statements of operations and special allocation, of
changes in partners' capital, of cash flows and financial highlights present
fairly, in all material respects, the financial position of HFH ShortPLUS Fund,
L.P. (the "Partnership") at December 31, 2007, and the results of its
operations, the changes in its partners' capital, its cash flows and the
financial highlights for the year then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereinafter referred to as the "financial
statements") are the responsibility of the General Partner. Our responsibility
is to express an opinion on these financial statements based on our audit. We
conducted our audit of these financial statements in accordance with auditing
standards generally accepted in the United States of America. Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by the General Partner, and evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
March 17, 2008
1
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF ASSETS, LIABILITIES AND PARTNERS' CAPITAL
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
ASSETS
Investment in HFH ShortPLUS Master Fund, Ltd. $83,923,831
Cash and cash equivalents 5,958,995
Other assets 140
-----------
Total assets $89,882,966
===========
LIABILITIES
Accrued expenses and other liabilities $ 22,501
-----------
Total liabilities 22,501
-----------
PARTNERS' CAPITAL 89,860,465
-----------
Total liabilities and partners' capital $89,882,966
===========
The accompanying notes are an integral part of these financial statements.
2
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF OPERATIONS AND SPECIAL ALLOCATION
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NET INVESTMENT INCOME ALLOCATED FROM HFH SHORTPLUS MASTER FUND, LTD.
Income $ 3,798,885
Expense (1,523,828)
------------
2,275,057
------------
PARTNERSHIP INVESTMENT INCOME
Interest 10,538
------------
Total income 2,285,595
PARTNERSHIP EXPENSES
Management fee 416,360
Professional fees 30,000
------------
Total expenses 446,360
------------
Net investment income 1,839,235
------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS ALLOCATED FROM HFH SHORTPLUS
MASTER FUND, LTD.
Net realized gains on investments and derivatives 26,147,378
Net change in unrealized appreciation on investments and derivatives 38,016,188
------------
Net realized and unrealized gains on investments and derivatives 64,163,566
------------
Net increase in partners' capital resulting from operations 66,002,801
Profit Reallocation to General Partner 6,561,910
------------
Net income available for pro-rata distribution to all partners $ 59,440,891
============
The accompanying notes are an integral part of these financial statements.
3
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
GENERAL LIMITED
PARTNER PARTNERS TOTAL
------------ ------------ ------------
Balance, January 2, 2007 $ -- $ -- $ --
Capital contributions 1,000 39,965,569 39,966,569
Capital withdrawals -- (16,108,905) (16,108,905)
Increase in partners' capital resulting from operations
Pro rata allocation 2,448 66,000,353 66,002,801
Incentive allocation 6,561,910 (6,561,910) --
------------ ------------ ------------
BALANCE, DECEMBER 31, 2007 $ 6,565,358 $ 83,295,107 $ 89,860,465
============ ============ ============
The accompanying notes are an integral part of these financial statements.
4
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
Net increase in partners' capital resulting from operations $ 66,002,801
Adjustments to reconcile net increase in partners' capital resulting
from operations to net cash used in operating activities
Investment in HFH ShortPLUS Master Fund, Ltd. (39,961,486)
Withdrawal from HFH ShortPLUS Master Fund, Ltd. 22,476,276
Income from Master Fund (66,438,621)
Increase in other assets (140)
Increase in accrued expenses and other liabilities 22,501
------------
Net cash used in operating activities (17,898,669)
------------
Cash provided from financing activities
Partners' capital contributions 39,966,569
Partners' capital withdrawals (16,108,905)
------------
Net cash provided by financing activities 23,857,664
Net increase in cash and cash equivalents 5,958,995
Cash
Beginning of year --
------------
End of year $ 5,958,995
============
The accompanying notes are an integral part of these financial statements.
5
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
The financial highlights table represents the Partnership's financial
performance for the year ended December 31, 2007 as follows:
LIMITED PARTNERS
Total return before incentive allocation 242.28%
Incentive allocation (34.15)
----------
Total return after incentive allocation(a) 208.13%
==========
Net investment income ratio(b) 3.51%
Operating expense ratio(c) (3.77)%
Incentive allocation (12.54)
----------
Total expenses and incentive allocation (16.31)%
==========
Operating expense ratio excluding interest expense(d) (1.20)%
==========
(a) Total return is calculated for aggregate limited partners' capital,
exclusive of the General Partner, taken as a whole and adjusted for
cash flows related to capital contributions and withdrawals during
the year. An individual limited partner's return may differ
depending on the timing of contributions and withdrawals, as well
as varying fee structures.
(b) The net investment income ratio is based on the net investment
income allocated to a limited partner prior to the effect of an
incentive allocation and is exclusive of unrealized and realized
gains and losses. The net investment income ratio attributable to
an individual partner's account may vary based on timing of capital
transactions.
(c) The operating expense ratio is based on the expenses allocated to
each partner prior to the effects of any incentive allocation. For
the purpose of this calculation, operating expenses include
expenses incurred by the Partnership directly as well as expenses
allocated from the Master Fund. Expense ratios are calculated over
average net assets. Expense ratio excluding the effect of allocated
expenses from the Master Fund would be (0.85%). The expense ratios
attributable to an individual partner's account may vary based on
different management fee and incentive allocation arrangements and
the timing of capital transactions.
(d) The operating expense ratio is based on the expenses allocated to
each partner. For the purpose of this calculation, operating
expenses include expenses incurred by the Partnership directly as
well as expenses allocated from the Master Fund, excluding interest
expense. Expense ratios are calculated over average net assets. The
expense ratios attributable to an individual partner's account may
vary based on different fee arrangements and the timing of capital
transactions.
The accompanying notes are an integral part of these financial statements.
6
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
1. ORGANIZATION
Highland ShortPLUS Fund, L.P. (the "Partnership") is a Delaware limited
partnership and commenced operations on January 2, 2007. The Partnership
invests substantially all of its investable assets through a
"master-feeder" structure in HFH ShortPLUS Master Fund, Ltd. ("Master
Fund"), a Cayman Islands exempted company that invests and trades a
short-biased portfolio of asset-backed securities ("ABS") that the
Investment Manager believes are most likely to produce high returns
during periods of adverse credit performance for residential mortgages,
and for mortgage-backed securities ("MBS") and ABS. Returns will come
from two principal sources: (i) market value changes, arising from
changes in credit spreads on the Master Fund's short positions; and (ii)
credit default payments from counterparties on credit default swaps
("CDS") or other derivatives in credit sensitive mortgage and
asset-backed securities, consumer debt and other assets. The
Partnership's investment objective is the same as that of the Master
Fund. The financial statements of the Master Fund are included elsewhere
in this report and should be read in conjunction with the Partnership's
financial statements. Highland Financial Holdings, LLC (the "General
Partner") serves as the general partner and Highland Financial Holdings
Group, LLC ("Investment Manager") serves as the investment manager of
the Partnership.
The Master Fund is also managed by the Investment Manager. Valuation of
the investments held by the Master Fund is discussed in the notes to the
financial statements included elsewhere in this report. The percentage
of the Master Fund's net assets owned by the Partnership at December 31,
2007 was approximately 26.1%.
2. SUMMARY OF SELECTED SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S.
GAAP"). The preparation of financial statements in accordance with U.S.
GAAP requires management to make estimates and assumptions that affect
the reported amounts and disclosures in the financial statements. Actual
results could differ from these estimates.
BASIS OF ACCOUNTING
The Fund records security and contractual transactions, if any, on a
trade/contractual date basis.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist principally of cash and short term
investments (overnight bank investments), which are readily convertible
into cash and have original maturities of three months or less.
VALUATION
The Partnership records its investment in the Master Fund at fair value
based on the net asset value of the Master Fund. Valuation of financial
instruments by the Master Fund is discussed in Note 2 of the Master
Fund's Notes.
INCOME AND EXPENSE RECOGNITION
The Partnership records its proportionate share of the Master Fund's
investment income/loss, expenses and realized and unrealized gains and
losses. The Master Fund's income and expense recognition and allocations
policies are discussed in Note 2 of the Master Fund's Notes.
7
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
Interest income of the Partnership's cash balance is accrued as earned.
Expenses that are directly attributable to the Partnership are recorded
on the accrual basis as incurred.
INCOME TAXES
The Partnership is not a taxable entity for federal, state or local
income tax purposes; such taxes are the responsibility of individual
partners. Accordingly, no provision has been made in the accompanying
financial statements for any federal, state or local income taxes.
On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB
Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which
allows the Partnership to defer the adoption of FIN 48 until periods
beginning after December 15, 2007. The General Partner has elected to
take advantage of this deferral. Based on its analysis, the General
Partner has determined that the adoption of FIN 48 will not have a
material impact to the Partnership's financial statements. However, the
General Partner's conclusions regarding FIN 48 may be subject to review
and adjustment at a later date based on factors including, but not
limited to, further implementation guidance, and on-going analyses of
tax laws, regulations and interpretations thereof.
FIN 48 requires the General Partner to determine whether a tax position
of the Partnership is more likely than not to be sustained upon
examination by the applicable taxing authority, including resolution of
any related appeals or litigation processes, based on the technical
merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely
of being realized upon ultimate settlement which could result in the
Partnership recording a tax liability that would reduce partners'
capital. FIN 48 must be applied to all existing tax positions upon
initial adoption and the cumulative effect, if any, is to be reported as
an adjustment to partners' capital upon adoption.
3. CONTRIBUTIONS AND WITHDRAWALS
The minimum initial and subsequent capital contributions (each a
"Capital Contribution") in the Partnership are $5,000,000 and
$1,000,000, respectively. The Investment Manager may waive or reduce the
minimum Capital Contributions in its sole discretion. The General
Partner may admit new Limited Partners and permit Limited Partners to
make additional Capital Contributions as of the first business day of
each calendar month, or at any other time in the General Partner's sole
discretion.
Subject to the lock-up period and early withdrawal fee, Limited Partners
shall have the right to require the Partnership to withdraw all or any
portion of their investment by delivering written notice to the General
Partner not less than 90 days prior to the end of any calendar quarter,
or at such other times as the General Partner determines in its sole
discretion. The General Partner reserves the right to waive or reduce
the notice period in its sole discretion. Notwithstanding anything to
the contrary, a Limited Partner may not withdraw each Capital
Contribution (and any appreciation thereon) until after the 12 month
period (the "Lock-up Period") following the date of such contribution,
without the prior consent of the General Partner, which may be granted
or denied in the General Partner's sole discretion.
Limited Partners who withdraw a Capital Contribution after the Lock-up
Period with respect to such Capital Contribution but less than 24 months
after purchasing such Capital Contribution will be charged an early
withdrawal fee equal to 5% of the withdrawal amount. Any early
withdrawal fee will be payable to the Partnership. The General Partner
reserves the right, in its sole discretion, to waive or reduce the early
withdrawal fee on a case-by-case basis. Subject to the Partnership's
8
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
right to establish reserves, a minimum of 95% of the withdrawals
proceeds will generally be paid to the withdrawing Limited Partner
within 15 business days after the corresponding withdrawal date, with
the balance payable (without interest) within 90 days of the
corresponding withdrawal date. The General Partner, at its discretion,
reserves the right to suspend or limit redemptions.
In the event that withdrawal requests are received representing in the
aggregate more than 10% of the total Net Asset Value of the Partnership
on any withdrawal date, the Partnership is entitled to reduce ratably
and pro rata amongst all Limited Partners seeking to withdraw interests
on the withdrawal date and to carry out only sufficient withdrawals,
which in the aggregate, amount to 10% of the total Net Asset Value of
the Partnership on such withdrawal date.
4. ALLOCATION OF NET INCOME (LOSS) AND INCENTIVE ALLOCATION
Net investment income and gains and losses are allocated to the partners
on a monthly basis, based on the partners' proportionate share of
capital in the Partnership at the beginning of the month.
The General Partner receives an incentive allocation equal to 20% of
such net income (includes net realized and unrealized gains and losses)
which will be deducted from the capital account of such limited partner
and reallocated to the General Partner's capital account. Such incentive
allocation is earned at December 31 of each year or when withdrawals
occur. At the discretion of the General Partner, this rate may be
reduced for certain Limited Partners. If there is a loss for the fiscal
period, such loss is carried forward to future periods and no
allocations will be made to the General Partner until prior fiscal
period losses are recovered. For the year ended December 31, 2007, the
General Partner was allocated $6,561,910 in incentive allocations.
5. MANAGEMENT FEE AND OTHER RELATED PARTY TRANSACTIONS
The Investment Manager receives a quarterly management fee
prospectively, equal to 0.50% (2% per annum) of each Limited Partner's
capital account. At the discretion of the General Partner, this rate may
be reduced for certain Limited Partners and affiliated fund investments.
For the year ended December 31, 2007, the Investment Manager earned a
management fee of $416,360 from the Partnership.
For the year ended December 31, 2007, an affiliated party contributed
$13,365,569 of capital and made $16,108,905 of withdrawals. At December
31, 2007, the principal officers and employees of the Investment
Manager, either directly or through family members and affiliated
entities, had $296,785 invested in the Partnership.
6. OFF-BALANCE SHEET RISK, LEVERAGE AND CONCENTRATION OF CREDIT RISKS
Off-balance sheet risk, leverage and concentration of credit risks are
discussed in the Master Fund's Notes.
Due to the nature of the master fund/feeder fund structure, the
Partnership could be materially affected by significant subscriptions
and redemptions of the other feeder fund. From time to time, the
Partnership may have a concentration of partners holding a significant
percentage of the Partnership's partners' capital. Investment activities
of these partners could have a material impact on the Partnership. At
December 31, 2007, one partner individually owned approximately 95% of
the total partners' capital.
9
HFH SHORTPLUS FUND, L.P.
(A DELAWARE LIMITED PARTNERSHIP)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
7. WITHDRAWALS PAYABLE
In accordance with FASB Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and
Equity, as effected by FASB Staff Position No. FAS 150-3, withdrawals
are recognized as liabilities by the Partnership, net of incentive
allocations, when the amount requested in the withdrawal notice becomes
fixed. This generally occurs either at the time of the receipt of the
notice, or on the last day of a fiscal period, depending on the nature
of the request. As a result, withdrawals paid after the end of the year,
but based upon year-end capital balances are reflected as withdrawals
payable at December 31, 2007. Withdrawal notices received for which the
dollar amount is not fixed remains in capital until the amount is
determined. Withdrawals payable may be treated as capital for purposes
of allocations of gains/losses pursuant to the Partnership's governing
documents.
The Partnership has received withdrawal notices for which the dollar
amounts are not fixed as of December 31, 2007. As such, associated
amounts have remained in capital and are not reflected as withdrawals
payable. There is no capital subject to withdrawal notices for amounts
that are fixed and determinable as of December 31, 2007.
8. CONTINGENCIES AND COMMITMENTS
In the normal course of business, the Partnership enters into contracts
that contain a variety of representations, warranties and general
indemnifications. The Partnership's maximum exposure under these
arrangements, including future claims that may be made against the
Partnership that have not yet occurred, is unknown. However, based on
experience of the General Partner, the Partnership expects the risk of
loss associated with such contracts to be remote.
9. SUBSEQUENT EVENTS
As of December 31, 2007 and through March 1, 2008, the Partnership
received requests for withdrawals, including amounts which are not
currently fixed and determinable, amounting to approximately $4,000,938.
All these withdrawal requests will be recorded subsequent to March 1,
2008, in accordance with the Partnership's withdrawal notice
requirements.
In September 2006, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 157, Fair Value
Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. SFAS 157 applies to reporting periods beginning
after November 15, 2007. The adoption of SFAS 157 is not expected to
have a material impact on the Fund's financial statements.
10
AFFIRMATION OF COMMODITY POOL OPERATOR
To the best of my knowledge and belief the information contained herein
pertaining to HFH ShortPLUS Fund, L.P. is accurate and complete.
Highland Financial Holdings, LLC
Commodity Pool Operator
/s/ Paul Ullman
-------------------------------------------
By Paul Ullman
President of Highland Financial
Holdings, LLC, General Partner of HFH
ShortPLUS Fund, L.P.
11
HFH SHORTPLUS MASTER
FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
FINANCIAL STATEMENTS
DECEMBER 31, 2007
A CLAIM OF EXEMPTION FROM CERTAIN REGULATORY REQUIREMENTS
HAS BEEN MADE TO THE COMMODITY FUTURES TRADING COMMISSION
PURSUANT TO COMMISSION REGULATION 4.7 BY THE COMMODITY POOL
OPERATOR OF HFH SHORTPLUS MASTER FUND, LTD.
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
INDEX
DECEMBER 31, 2007
--------------------------------------------------------------------------------
PAGE(S)
REPORT OF INDEPENDENT AUDITORS..............................................1
FINANCIAL STATEMENTS
Statement of Assets and Liabilities.........................................2
Schedule of Investments...................................................3-7
Statement of Operations.....................................................8
Statement of Changes in Net Assets..........................................9
Statement of Cash Flows....................................................10
Financial Highlights.......................................................11
Notes to Financial Statements...........................................12-20
Affirmation of the Commodity Pool Operator.................................21
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
HFH ShortPLUS Master Fund, Ltd.
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations, of
changes in net assets, of cash flows and financial highlights present fairly, in
all material respects, the financial position of HFH ShortPLUS Master Fund, Ltd.
(the "Fund") at December 31, 2007, and the results of its operations, the
changes in its net assets, its cash flows and the financial highlights for the
year then ended, in conformity with accounting principles generally accepted in
the United States of America. These financial statements and financial
highlights (hereinafter referred to as the "financial statements") are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these financial statements in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers
March 17, 2008
1
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
ASSETS
Investments, at value $ 12,296,717
------------
Total investments, at value (cost $ 73,670,861) 12,296,717
Cash and cash equivalents 250,938,764
Margin cash paid to counterparties 1,800,244
Securities purchased under agreements to resell 59,174,000
Credit default swap contracts, at value (upfront fee payments $79,349,003) 271,421,697
Interest receivable 126,085
Other assets 89,134
------------
Total assets $595,846,641
------------
LIABILITIES
Margin cash received from counterparties $218,648,130
Credit default swap contracts, at value (upfront fee receipts $39,723,958) 54,612,639
Due to brokers (Note 3) 95,483
Interest payable on margin cash 953,919
Accrued expenses and other liabilities 233,750
------------
Total liabilities 274,543,921
------------
Net assets (5,000,000 common shares authorized, $0.01 par value;
931.50 shares issued and outstanding) $321,302,720
============
Net asset value per share disclosures are made in the financial highlights.
The accompanying notes are an integral part of these financial statements.
2
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CURRENT FACE / COUPON
NOTIONAL DESCRIPTION RATE MATURITY VALUE
Asset Backed Securities -
Fixed Rate Home Equity (0.27%)
$ 707,099 TMTS 04-8HES B2 8.000% 6/25/2034 $ 595,872
1,990,000 MASD 07-1 B1 5.250% 1/25/2037 104,475
3,482,000 MASD 07-1 B2 5.250% 1/25/2037 182,805
-----------
Total Asset Backed Securities -
Fixed Rate Home Equity
(cost $ 5,306,332) 883,152
-----------
ASSET BACKED SECURITIES -
FLOATING RATE HOME EQUITY (0.21%)
1,977,237 BAYVIEW FINANCIAL TR 2004-D 8.355% 8/28/2044 284,426
1,893,631 QUEST 2006-X1 M5 7.365% 3/25/2036 94,682
2,476,000 QUEST 2006-X2 M9 7.365% 8/25/2036 173,320
2,539,341 QUEST 2006-X2 M10 7.365% 8/25/2036 126,967
-----------
Total Asset Backed Securities -
Floating Rate Home Equity
(cost $ 8,263,205) 679,395
-----------
ASSET BACKED SECURITIES -
FIXED RATE HOME EQUITY NIM (0.40%)
2,218,243 CWALN 2006-0C8 N 7.750% 2/25/2037 420,539
6,171,417 GSAMP 07 FM1N N1 6.000% 12/25/2036 433,323
4,950,000 HASCN 06-OPT1 B 8.000% 12/26/2035 80,437
5,740,685 NHELN 07-2 N1 NIM 7.385% 1/25/2037 287,034
5,900,000 SBFT 05-HE3 N2 144A * 6.500% 9/25/2035 77,466
-----------
Total Asset Backed Securities -
Fixed Rate Home Equity NIM
(cost $ 23,132,410) 1,298,799
-----------
ASSET BACKED SECURITIES - FLOATING
RATE BUSINESS LOANS (2.41%)
738,720 BAYC 05-3A B3 7.865% 11/25/2035 470,587
7,060,000 BAYVIEW COML MTG TR 2006-SP1 8.865% 4/25/2036 3,591,775
4,178,000 LBSBN 2007-1 N2 8.500% 3/27/2037 3,676,640
-----------
Total Asset Backed Securities -
Floating Rate Business Loans
(cost $ 11,414,997) 7,739,002
-----------
PREFERRED ASSET BACKED SECURITIES - FLOATING
SHARES RATE CDO (0.03%)
2,000,000 BUCKINGHAM CDO III LTD 2007-3 0.000% 9/5/2051 20,000
8,000 CITATION HGH GRD ABS CDO I LTD PFD
3C7 144A *# 6.000% 1/15/2035 80,000
-----------
Total Asset Backed Securities -
Floating Rate CDO (cost $ 6,981,641) 100,000
-----------
The accompanying notes are an integral part of these financial statements.
3
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NOTIONAL/
PREFERRED COUPON
SHARES DESCRIPTION RATE MATURITY VALUE
ASSET BACKED SECURITIES -
HOME EQUITY RESIDUALS (0.50%)
$ 2,351,781 CMLTI 2006-HE1 CE 0.000% 1/25/2036 $ 250,000
18 CMLTI 2006-HE1 P 0.000% 1/25/2036 275,000
24,000 GSAMP 2006 RES - PREFERRED 0.000% N/A 999,999
2,469,540 MANM 07-1 1N2 5.873% 1/25/2047 71,370
5,514,200 MANM 07-1 1N3 7.373% 1/25/2047 -
------------
Total Asset Backed Securities -
Home Equity Residuals
(cost $ 18,572,276) 1,596,369
------------
Total Investments
(cost $ 73,670,861) $ 12,296,717
------------
* 144A securities are exempt from registration under Rule 144A of
the Securities Act of 1933. These securities may only be resold
to qualified institutional buyers.
# Citation is an entity that is advised by Highland Financial
Holdings Group, LLC, the Fund's Investment Manager, and
accordingly is considered an affiliate.
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (-17.00%) DATE AT VALUE
$(10,000,000) SAIL 2006-4 M4 (BEAR pays 5.80%) 6/25/2036 $ (6,851,192)
(10,000,000) RAMP 2005-EFC6 M9 (BEAR pays 5.85%) 11/25/2035 (6,576,706)
(7,500,000) BNC07001 M8 (UBS pays 5.75%) 3/25/2037 (5,232,031)
(6,000,000) HASC 2006 -OPT1 M9 (DB pays 7.45%) 12/25/2035 (4,291,400)
(5,000,000) RFC06NC3 M8 (CITI pays 5.00%) 3/25/2036 (3,759,223)
(5,000,000) SAST 06-1 B3 (GS pays 6.55%) 3/25/2036 (3,086,684)
(5,000,000) RFC05KS9 M8 (UBS pays 5.60%) 10/25/2035 (2,772,204)
(5,000,000) WLT05WC1 M9 (GS pays 7.30%) 10/25/2035 (2,762,035)
(5,000,000) SABR 2005-FR2 B2 (LEH pays 3.20%) 3/25/2035 (2,815,630)
(5,000,000) LBML0502 M8 (GS pays 4.90%) 4/25/2035 (2,589,105)
(5,000,000) CWL 2006 -15 (CS pays 6.25%) 8/25/2042 (2,879,129)
(5,000,000) RFC06KS2 M8 (GS pays 5.75%) 3/25/2036 (3,661,476)
(5,000,000) CMLTI 2006-HE1 M8 (DB pays 2.11%) 1/25/2036 (3,807,247)
(5,000,000) WMLT 2005-WMC1 M9 (CS pays 7.30%) 10/25/2035 (2,778,257)
(2,000,000) FFML 2005-FF2 B3 (GS pays 3.75%) 3/25/2035 (750,320)
------------
Credit Default Swap Contracts, at Value -
(upfront fee receipts: $ 39,723,958) $(54,612,639)
The accompanying notes are an integral part of these financial statements.
4
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE
$ 2,000,000 FFML 2005-FF2 B3 (Pay GS 1.70%) 3/25/2035 $ 751,087
3,350,000 JPMAC 2005-FRE1 MP (Pay DB 7.00%) 10/25/2035 1,978,175
4,000,000 FFML 2004-FF8 B3 (Pay CS 2.00%) 10/25/2034 596,458
4,000,000 RFC06NC3 M9 (Pay CITI 7.50%) 3/25/2036 2,604,830
4,000,000 RFC06KS8 M5 (Pay GS 1.10%) 10/25/2036 2,739,291
4,000,000 FFML06F5 M9 (Pay CITI 3.35%) 4/25/2036 3,309,590
5,000,000 SAMI 2006-AR1 B6 (Pay CS 3.00%) 2/25/2036 3,035,000
5,000,000 CWE0626 M7 (Pay UBS 2.30%) 5/25/2037 2,877,000
5,000,000 HEAT0607 B1 (Pay CS 5.35%) 1/25/2037 3,820,443
5,000,000 FFML 2006 - FF12 M9 (Pay CITI 3.00%) 9/25/2036 4,161,633
5,000,000 ARS06W01 M9 (Pay GS 2.42%) 3/25/2036 3,924,809
5,000,000 RFC06NC2 M9 (Pay GS 2.42%) 2/25/2036 4,137,900
5,000,000 NFHE0603 M6 (Pay GS 0.98%) 10/25/2036 3,505,230
5,000,000 NFHE0603 M8 (Pay UBS 2.23%) 10/25/2036 3,739,510
5,000,000 RASC 2006-KS3 M9 (Pay GS 2.42%) 4/25/2036 4,074,810
5,000,000 NCHET 2005-D M8 (Pay GS 1.70%) 2/25/2036 2,991,500
5,000,000 ACE 06-OP1 M8 (Pay GS 2.25%) 3/25/2036 4,076,989
5,000,000 MSAC 2006-HE2 B3 (Pay GS 2.42%) 3/25/2036 4,331,125
5,000,000 BSABS 2006-EC2 M9 (Pay GS 3.50%) 2/25/2036 3,987,429
5,000,000 MAB06AM2 M9 (Pay CS 4.50%) 6/25/2036 4,210,759
5,000,000 MLMI 2005-HE1 B3 (Pay GS 1.24%) 3/25/2037 4,015,848
5,000,000 SABR 2005-FR2 B2 (Pay UBS 1.92%) 3/25/2035 2,822,047
5,000,000 LBML0502 M8 (Pay CITI 2.40%) 4/25/2035 2,601,605
5,000,000 CMLTI 2006-HE1 M8 (Pay GS 2.11%) 1/25/2036 3,820,448
5,000,000 RFC05KS9 M8 (Pay UBS 3.50%) 10/25/2035 2,782,715
5,000,000 CWHE0615 B (Pay ML 4.75%) 10/25/2046 2,886,629
5,000,000 CHEC06A M9 (Pay CITI 2.87%) 6/25/2036 3,097,201
5,000,000 SAST 06-1 B3 (Pay UBS 4.30%) 3/25/2036 3,097,934
5,000,000 RFC06EM8 M5 (Pay GS 1.50%) 10/25/2036 3,173,000
5,000,000 ACCT0601 M9 (Pay GS 2.17%) 4/25/2036 3,217,315
5,000,000 ACCT0601 M9 (Pay CS 3.72%) 4/25/2036 3,209,565
5,000,000 CWHE0614 M8 (Pay CITI 6.90%) 2/25/2037 3,315,500
5,000,000 CWHE0610 MV9 (Pay CITI 8.50%) 9/25/2046 3,440,023
5,000,000 SVHE06E1 M9 (Pay CITI 5.75%) 10/25/2036 3,511,748
5,000,000 FFM07FF1 B1 (Pay CITI 3.10%) 1/25/2038 3,627,912
5,000,000 RFC06KS2 M8 (Pay CITI 2.50%) 3/25/2036 3,677,726
5,000,000 RASC 2007-KS2 M8 (Pay GS 2.80%) 2/25/2037 3,740,497
5,000,000 BSABS 2007-HE2 2M8 (Pay GS 3.25%) 3/25/2037 3,873,094
5,000,000 GSA06HE7 M9 (Pay CITI 5.50%) 10/25/2036 3,888,971
5,000,000 FFML 06-FF6 M6 (Pay GS 2.65%) 4/25/2036 3,934,604
5,000,000 RASC 2007-KS2 M8 (Pay GS 3.25%) 2/25/2037 3,950,383
5,000,000 ACE06OP1 M9 (Pay DB 3.25%) 4/25/2036 4,109,693
5,000,000 GSA06HE7 M9 (Pay GS 5.80%) 10/25/2036 4,120,351
The accompanying notes are an integral part of these financial statements.
5
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
CREDIT
DEFAULT SWAP
NOTIONAL TERMINATION CONTRACTS,
AMOUNT CREDIT DEFAULT SWAP CONTRACTS, AT VALUE (84.48%) DATE AT VALUE
$ 5,000,000 CWHE0619 M9 (Pay CITI 3.35%) 3/25/2037 $ 4,216,615
6,000,000 CWL 2006-26 M9 (Pay CS 4.79%) 6/25/2037 4,762,222
6,000,000 HSA06OP1 M9 (Pay GS 3.80%) 12/25/2035 4,323,348
6,250,000 RFC06EF1 M8 (Pay UBS 2.45%) 4/25/2036 4,047,188
7,500,000 CWL 2006 - 22 M8 (Pay CS 5.00%) 5/25/2037 5,876,598
7,500,000 CWABS INC 2006-26 (Pay GS 2.75%) 8/25/2037 5,697,813
7,500,000 OOMLT0503 M9 (Pay GS 10.25%) 8/25/2035 4,562,982
7,500,000 BNC07001 M8 (Pay UBS 3.53%) 3/25/2037 5,223,525
7,500,000 FFM07FF1 B2 (Pay UBS 5.25%) 1/25/2038 5,255,116
7,500,000 FFM06F17 M8 (Pay UBS 5.53%) 12/25/2036 6,018,409
7,500,000 FFM06F15 M8 (Pay CITI 5.43%) 11/25/2036 6,261,120
10,000,000 FFM07FF1 B2 (Pay UBS 3.10%) 1/25/2038 5,429,476
10,000,000 NOVASTAR MTG FDG TR 2006-5 (Pay UBS 3.14%) 11/25/2036 7,167,728
10,000,000 SAIL 2006-4 M4 (Pay CS 3.75%) 7/25/2036 6,849,220
10,000,000 WLT05WC1 M9 (Pay BEAR 5.05%) 10/25/2035 5,546,570
10,000,000 RFC05EF6 M9 (Pay CITI 3.80%) 11/25/2035 6,537,957
10,000,000 CWHE0610 MV9 (Pay BEAR 8.25%) 9/25/2046 6,951,296
10,000,000 OOMLT0603 M8 (Pay UBS 4.78%) 2/25/2037 7,741,132
10,000,000 SAS06EQ1 M8 (Pay UBS 1.60%) 7/25/2036 7,834,000
10,000,000 FFM06F17 M8 (Pay DB 2.90%) 12/25/2036 8,187,489
10,000,000 FFM06F12 M8 (Pay UBS 5.42%) 9/25/2036 8,163,516
------------
Credit Default Swap Contracts, at Value -
(upfront fee payments: $ 79,349,003) $271,421,697
------------
Total Net Credit Default Swap Contracts, at Value $216,809,058
------------
The accompanying notes are an integral part of these financial statements.
6
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
SCHEDULE OF INVESTMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL
DAYS TO REPURCHASE
COUNTERPARTY RATE MATURITY AGREEMENT TOTAL
Bear Stearns 4.60% 2 $ 59,174,000
-------------
Total $ 59,174,000
-------------
The accompanying notes are an integral part of these financial statements.
7
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
INVESTMENT INCOME
Interest (includes interest from an affiliated investment of $427,870) $ 11,304,208
Dividends 1,257,011
-------------
Total investment income 12,561,219
INVESTMENT EXPENSE
Interest 4,935,004
-------------
OTHER EXPENSES
Custody fees 62,530
Professional fees 308,250
Administration fees 141,333
Director fees 17,160
Other expenses 6,352
-------------
Total other expenses 535,625
-------------
Total expenses 5,470,629
-------------
Net investment income 7,090,590
-------------
NET REALIZED AND UNREALIZED GAIN (LOSS)
Net realized gain (loss) on
Investments (8,247,891)
Swap contracts 107,929,188
-------------
Net realized gain 99,681,297
-------------
Net change in unrealized appreciation/(depreciation) on
Investments (includes depreciation from an affiliated investment of $5,160,391) (61,374,144)
Swap contracts 178,219,519
-------------
Net change in unrealized appreciation 116,845,375
-------------
Net realized and unrealized gain 216,526,672
-------------
Net increase in net assets resulting from operations $ 223,617,262
=============
The accompanying notes are an integral part of these financial statements.
8
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF CHANGES IN NET ASSETS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
FROM OPERATIONS
Net investment income $ 7,090,590
Net realized gain 99,681,297
Net change in unrealized appreciation 116,845,375
-------------
Net increase in net assets resulting from operations 223,617,262
-------------
FROM CAPITAL SHARE TRANSACTIONS
Subscriptions 135,380,623
Redemptions (37,695,165)
-------------
Net increase in net assets resulting from capital share transactions 97,685,458
-------------
Total increase in net assets 321,302,720
NET ASSETS
Beginning of year --
-------------
End of year $ 321,302,720
-------------
The accompanying notes are an integral part of these financial statements.
9
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 223,617,262
Adjustments to reconcile net increase in net assets resulting from
operations to net cash provided from operating activities
Purchase of investment securities (111,312,492)
Purchase of credit default swaps (87,793,098)
Proceeds from dispositions of investment securities
(including paydowns) 29,393,740
Proceeds from dispositions of credit default swaps 156,097,241
Net realized (gain)/loss on investments 8,247,891
Net realized (gain)/loss on swap contracts (107,929,188)
Net change in unrealized depreciation on investments 61,374,144
Change in net value of swap contracts (177,184,013)
Change in margin cash received from counterparties 218,648,130
Change in margin cash paid to counterparties (1,800,244)
Change in securities purchased under agreements to resell (59,174,000)
Change in interest receivable (126,085)
Change in interest payable on margin cash 953,919
Change in accrued expenses and other liabilities 233,750
Change in due to brokers 95,483
Change in other assets (89,134)
-------------
Net cash provided from operating activities 153,253,306
-------------
CASH PROVIDED FROM FINANCING ACTIVITIES
Capital subscriptions 135,380,623
Capital redemptions (37,695,165)
-------------
Net cash provided from financing activities 97,685,458
-------------
Net change in cash and cash equivalents 250,938,764
CASH AND CASH EQUIVALENTS
Beginning of year --
-------------
End of year $ 250,938,764
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 3,981,085
=============
The accompanying notes are an integral part of these financial statements.
10
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31, 2007
--------------------------------------------------------------------------------
(expressed in U.S. dollars)
Results of operations for a share outstanding for the year ended December 31,
2007 are as follows:
Per share operating performance(a)
NET ASSET VALUE PER SHARE, BEGINNING OF YEAR $ 100,000.00
Net investment income 7,873.42
Net realized and unrealized gain 237,056.11
--------------
NET ASSET VALUE PER SHARE, END OF YEAR $ 344,929.53
==============
Total return(b) 244.93%
RATIOS TO AVERAGE NET ASSETS
Operating expense(c) (3.34)%
Operating expense excluding interest expense(c) (0.33)%
Net investment income(c) 4.33%
(a) Per share operating performance is computed based upon the monthly
outstanding shares.
(b) Total return is calculated for a share outstanding the entire year. An
individual shareholder's return may differ depending on the timing of
subscriptions and redemptions.
(c) The operating expense and net investment income ratios are calculated for
the Fund taken as a whole. An individual shareholder's ratio may vary from
these ratios based on the timing of capital transactions.
The accompanying notes are an integral part of these financial statements.
11
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
1. ORGANIZATION AND INVESTMENT OBJECTIVE
HFH ShortPLUS Master Fund, Ltd. (the "Fund") is a Cayman Islands
exempted company incorporated in accordance with the Companies Law (2004
revision) which commenced operations on January 2, 2007. The Fund's
strategy is to assemble a short-biased portfolio of asset-backed
securities ("ABS") that the Investment Manager believes are most likely
to produce high returns during periods of adverse credit performance for
residential mortgages, and for mortgage-backed securities ("MBS") and
ABS. Returns will come from two principal sources: (i) market value
changes arising from changes in credit spreads on the Fund's short
positions; and (ii) credit default payments from counterparties on
credit default swaps ("CDS") or other derivatives.
Highland Financial Holdings Group, LLC ("Investment Manager") serves as
the investment manager of the Fund. The Investment Manager manages and
invests the Fund's assets and effects all security transactions on
behalf of the Fund.
The Fund operates under a "master fund/feeder fund" structure. HFH
ShortPLUS Fund, Ltd. and HFH ShortPLUS Fund, L.P. (collectively, the
"Feeder Funds") invest substantially all of their investable assets in
the Fund. The following Feeder Funds were invested in the Fund at
December 31, 2007:
HFH ShortPLUS Fund, Ltd. $237,378,889
HFH ShortPLUS Fund, L.P. 83,923,831
------------
Total Feeder Funds' investment in the Fund $321,302,720
------------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America ("U.S.
GAAP"). The preparation of financial statements in accordance with U.S.
GAAP requires management to make estimates and assumptions, including
estimates of fair value investments and CDS, that affect the reported
amounts and disclosures in the financial statements. Actual results
could differ from these estimates and those differences could be
material to the financial statements.
BASIS OF ACCOUNTING
Transactions in securities are recorded on a trade date basis. Realized
and unrealized gains/losses are calculated based on a FIFO cost basis.
Interest income is recorded on an accrual basis when earned. Operating
expenses, including interest on securities sold short, margin deposits,
and reverse repurchase agreements, are recorded on the accrual basis as
incurred.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist principally of cash, margin cash
received from counterparties, and short term investments (treasury
bills), which are readily convertible into cash and have original
maturities of three months or less.
12
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
VALUATION
Investments in securities held by the Fund are carried at value. Value
for such investments is estimated by the Investment Manager. The
Investment Manager will use its reasonable discretion to value each
investment by using, as a guide, a combination of (i) independent,
third-party pricing sources; (ii) indications from one or more financial
institutions engaged in trading the investments or securities similar to
the investments being valued; (iii) transactions in the market of the
same or similar securities; and (iv) in-house models the Investment
Manager maintains. In cases where the number of indications is limited,
the Investment Manager will review other factors such as the previous
month's value, whether such indication is from the same counterparty,
the delta between the current value and the previous month value,
relevant market data or news, the value of similar securities, recent
trading information and any other information which may be deemed
relevant at the discretion of the Investment Manager. With respect to
CDS, the Investment Manager may use, if considered representative of the
value of CDS positions, margin marks from the actual counterparty with
whom the security was traded, or from counterparties of a similar CDS
position to estimate the valuation. However, if the Investment Manager
believes the exit price will be either greater or less than the current
margin mark, the Investment Manager has the discretion to revise the
value accordingly.
Fair value determinations based on indications from financial
institutions or margin marks from counterparties may be based on as few
as a single indication/margin mark, or may be calculated as the average
of more than one such indication/margin mark, which average may include
recent transactions in the market or ignore outlying indications/margin
marks based on the Investment Manager's discretion. The Investment
Manager may use observable transactions in the market in determining the
fair value of investments if, at the discretion of the Investment
Manager, prioritization of such transactions is considered more relevant
given market conditions or other factors. Securities for which no
indications are available are to be valued at such value as the
Investment Manager may reasonably determine.
The Investment Manager defines investments that are fair valued as those
investments for which an investment is valued solely based on an
in-house maintained model. As of December 31, 2007, these financial
statements include investments fair valued by such in-house model
totaling $4,705,836 (1.5% of net assets). In addition, the Investment
Manager has determined that conditions in the 2007 asset backed
securities market have impacted the extent of relevant data points that
are available to estimate fair value of the Fund's investments. These
market conditions include reduced liquidity, increased risk premiums for
issuers, reduced investor demand for asset-backed securities,
particularly those securities backed by sub-prime collateral, general
financial stress and rating agency downgrades, and a general tightening
of available credit. At December 31, 2007, the values for approximately
$7,507,552 (2.3% of net assets) of investments, $176,174,662 (54.8% of
net assets) of CDS "receiving" protection, and -$3,759,223 (-1.2% of net
assets) of CDS "providing" protection were primarily estimated using one
indication/margin mark obtained from an external source. Given market
conditions described above, the indication/margin mark provided by
financial institutions may differ from the bid or ask that market
participants would be willing to transact. As a result, the range of
fair value of investments and CDS positions can be significant and the
values reflected in these financial statements may differ from the
values that would have been realized had such investments been
liquidated.
Options that are listed on or admitted to trading on one or more
exchanges are valued at the last sale price, if such price is equal to
or is between, the "bid" and the "ask" prices (otherwise, the mean
between the "bid" and "ask" prices is used). If options are not listed
or admitted to trading on one or more exchanges, the fair value of such
options is obtained from external parties which may include the contract
13
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
counterparty. Future contracts traded on a national exchange or market
are valued at the last reported sales price on the valuation date.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Fund recognizes the market value of all derivative instruments as
either assets or liabilities in the Statement of Assets and Liabilities
and measures those instruments at fair value.
INTEREST RATE AND INDEX SWAPS
The Fund may enter into interest rate and index swaps as part of its
investment strategies. Swaps involve the exchange by the Fund with
another party of respective commitments to pay or receive interest,
effective return, or total return throughout the lives of the
agreements. The Fund may be required to deliver or receive cash or
securities as collateral upon entering into swap transactions. Movements
in the relative value of the swap transactions may require the Fund or
the counterparty to post additional collateral. Swaps change in value
with movements in interest rates. During the term of the swap contracts,
changes in value and accrued interest payments are recognized as
unrealized gains or losses by marking the contracts to the market. These
unrealized gains and losses are reported as an asset or liability,
respectively, on the Statement of Assets and Liabilities. When contracts
are terminated, the Fund will realize a gain or loss equal to the
difference between the proceeds from (or cost of) the closing
transaction and the Fund's basis in the contract, if any.
CREDIT DEFAULT SWAPS
The Fund enters into credit default swaps to simulate long and short
bond positions that are either unavailable or considered to be less
attractively priced in the bond market. The Fund uses these swaps to
attempt to reduce risk where the Fund has exposure to the issuer, or to
take an active long or short position with respect to the likelihood of
the issuer's default. There is no certainty that the objectives of
holding credit default swaps will be achieved.
The buyer of a credit default swap is obligated to pay the seller a
periodic stream of payments over the term of the contract in return for
a contingent payment upon the occurrence of a credit event, with respect
to an underlying reference obligation. Generally, a credit event means
bankruptcy, failure to pay, obligation accelerated or modified
restructuring. If a credit event occurs, the seller typically must pay
the contingent payment to the buyer, which is typically the par value
(full notional value) of the reference obligation. The contingent
payment may be a cash settlement or by a physical delivery of the
reference obligation in return for payment of the face amount of the
obligation. If the Fund is a buyer and no credit event occurs, the Fund
may lose its investment and recover nothing. However, if a credit event
occurs, the buyer typically receives full notional value and interest
for a reference obligation that may have little or no value. As a
seller, the Fund receives a fixed rate of income throughout the term of
the contract, provided that no credit event occurs. If a credit event
occurs, the seller may pay the buyer the full notional value and
interest of the reference obligation. Upfront payments made and/or
received by the Fund are recorded as an asset and/or liability on the
Statement of Assets and Liabilities and are recorded as a realized gain
or loss on the termination date.
As of December 31, 2007, the Fund has 79 open credit default swaps. The
Fund is the buyer on 64 of these swaps ("receiving protection" on a
total notional amount of $382.1 million) and is the seller on the
remaining 15 ("providing protection" on a total notional amount of $85.5
million).
Credit default swaps involve greater risks than if the Fund had invested
in the reference obligations directly. In addition to general market
risks, credit default swaps are subject to liquidity risk and
counterparty credit risk. A buyer also may lose its investment and
recover nothing should a credit event not occur. If a credit event did
14
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
occur, the value of the reference obligation received by the seller,
coupled with the periodic payments previously received, may be less than
the full notional value it pays to the buyer, resulting in a loss of
value.
The notional amounts of the swaps are not recorded in the financial
statements. The swaps are carried at their estimated fair value, as
determined in good faith by the Investment Manager. The change in value
is recorded within unrealized appreciation (depreciation) until the
occurrence of a credit event or the termination of the swap, at which
time a realized gain (loss) is recorded.
FUTURES
A futures contract is an agreement between two parties to buy or sell a
financial instrument for a set price on a future date. Initial margin
deposits are made upon entering into futures contracts and can be either
cash or securities. During the period the futures contract is open,
changes in the value of the contract are recognized as unrealized gains
or losses by marking to market on a daily basis to reflect the market
value of the contract at the end of each day's trading. When the
contract is closed, the Fund records a realized gain or loss equal to
the difference between the proceeds of the closing transaction and the
Fund's basis in the contract.
PURCHASED OPTIONS
The Fund may purchase put or call options. When the Fund purchases an
option, an amount equal to the premium paid is recorded as an asset and
is subsequently marked-to-market. Premiums paid for purchasing options
that expire unexercised are recognized on the expiration date as
realized losses. If an option is exercised, the premium paid is
subtracted from the proceeds of the sale or added to the cost of the
purchase to determine whether the Fund has realized a gain or loss on
the related investment transaction. When the Fund enters into a closing
transaction, the Fund will realize a gain or loss depending upon whether
the amount from the closing transaction is greater or less than the
premium paid.
WRITTEN OPTIONS
The Fund may write put or call options. When the Fund writes an option,
an amount equal to the premium received is recorded as a liability and
is subsequently marked-to-market. Premiums received for writing options
that expire unexercised are recognized on the expiration date as
realized gains. If an option is exercised, the premium received is
subtracted from the cost of the purchase or added to the proceeds of the
sale to determine whether the account has realized a gain or loss on the
related investment transaction. When the Fund enters into a closing
transaction, the Fund will realize a gain or loss depending upon whether
the amount from the closing transaction is less or greater than the
premium received.
SHORT SALES
When the Fund sells short, it may borrow the security sold short and
deliver it to the broker-dealer through which it sold short as
collateral for its obligation to deliver the security upon conclusion of
the sale. Additionally, the Fund generally is required to deliver cash
or securities as collateral for the Fund's obligation to return the
borrowed security. The Fund may have to pay a fee to borrow the
particular securities and may be obligated to pay over any payments
received on such borrowed securities. A gain, limited to the price at
which the Fund sold the security short, or a loss, unlimited as to
dollar amount, will be recognized upon the termination of a short sale
if the market price is less or greater than the proceeds originally
received.
15
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
FINANCING TRANSACTIONS
The Fund enters into repurchase agreements as a borrower (securities
sold under agreement to repurchase) and as a lender (securities
purchased under agreement to resell). All repurchase agreements are
carried at their contractual amounts on the Statement of Assets and
Liabilities, and the accrued income (expense) is recorded separately.
Securities sold under agreements to repurchase include buy-sell
financing transactions.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
("REVERSE REPURCHASE AGREEMENTS")
The Fund monitors collateral market values relative to the amounts due
under the agreements, including accrued interest, throughout the lives
of the agreements, and when necessary, requires transfer of cash or
securities in order to manage exposure and liquidity. In connection with
such agreements, if the counterparty defaults or enters an insolvency
proceeding, realization or return of the collateral to the Fund may be
delayed or limited.
At December 31, 2007, the Fund had no securities sold under agreements
to repurchase.
SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL ("REPURCHASE
AGREEMENTS")
Securities purchased under agreements to resell are generally
collateralized principally by U.S. government and agency securities. The
Fund takes possession of such underlying collateral, monitors its market
value relative to the amounts due under the agreements, including
accrued interest, throughout the lives of the agreements, and when
necessary, may require a transfer of additional cash or securities in
order to manage exposure and liquidity. In connection with such
agreements, if the counterparty defaults or enters an insolvency
proceeding, realization or return of the funds to the Fund may be
delayed or limited.
At December 31, 2007, the Fund had securities purchased under agreements
to resell totaling $59,174,000. The Fund received collateral in the form
of various FNMA MBS pools under a held in custody agreement with an
interest rate of 4.6% and a maturity of two days. The value of the
securities, including accrued interest, received as collateral by the
Fund that it was permitted to sell or repledge was $59,189,122.
INCOME TAXES
The Fund is a Cayman Islands exempted company. Under the current laws of
the Cayman Islands, there are no income, estate, transfer, sale or other
taxes payable by the Fund. The Fund is taxed as a partnership for U.S.
Federal income tax purposes, and as such, is not subject to income
taxes; each investor may be individually liable for income taxes, if
any, on its share of the Fund's net taxable income. The Fund trades
securities for its own account and, as such, investors are generally not
subject to U.S. tax on such earnings (other than certain withholding
taxes indicated below). The Investment Manager intends to conduct the
business of the Fund to the maximum extent practicable so that the
Fund's activities do not constitute a U.S. trade or business. Interest
and other income received by the Fund from sources within the United
States may be subject to, and reflected net of, United States
withholding tax at the rate of 30%. Interest, dividend and other income
realized by the Fund from non-U.S. sources and capital gains realized on
the sale of securities of non-U.S. issuers may be subject to withholding
and other taxes levied by the jurisdiction in which the income is
sourced.
On February 1, 2008, FASB issued FIN 48-2, Effective Date of FASB
Interpretation No. 48 for Certain Nonpublic Enterprises ("FSP"), which
allows the Fund to defer the adoption of FIN 48 until periods beginning
after December 15, 2007. The Investment Manager has elected to take
advantage of this deferral. Based on its analysis, the Investment
Manager has determined that the adoption of FIN 48 will not have a
16
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
material impact to the Fund's financial statements. However, the
Investment Manager's conclusions regarding FIN 48 may be subject to
review and adjustment at a later date based on factors including, but
not limited to, further implementation guidance, and on-going analyses
of tax laws, regulations and interpretations thereof.
FIN 48 requires the Investment Manager to determine whether a tax
position of the Fund is more likely than not to be sustained upon
examination by the applicable taxing authority, including resolution of
any related appeals or litigation processes, based on the technical
merits of the position. The tax benefit to be recognized is measured as
the largest amount of benefit that is greater than fifty percent likely
of being realized upon ultimate settlement which could result in the
Fund recording a tax liability that would reduce net assets. FIN 48 must
be applied to all existing tax positions upon initial adoption and the
cumulative effect, if any, is to be reported as an adjustment to net
assets upon adoption.
3. DUE TO/FROM BROKERS
The Fund has brokerage agreements with various brokerage firms to carry
its account as a customer. The brokers have custody of the Fund's
securities and, from time to time, cash balances may be due to/from
these brokers.
These securities and/or cash positions serve as collateral for any
amounts due to brokers or as collateral for securities sold, not yet
purchased or investment securities purchased on margin. The securities
and/or cash positions also serve as collateral for potential defaults of
the Fund.
The Fund is subject to credit risk if the brokers are unable to repay
balances due or deliver securities in their custody.
4. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND OTHER RISKS
The Fund may invest on a leveraged basis in various financial
instruments and is exposed to market risks resulting from changes in the
fair value of the instruments. The Statement of Assets and Liabilities
may include the market or fair value of contractual commitments
involving forward settlements, futures contracts and swap transactions
as well as investments in securities sold short. These instruments
involve elements of market risk in excess of amounts reflected on the
Statement of Assets and Liabilities. Derivative financial statements are
used by the Fund to help manage such market risk and to take an active
long or short position in the market. Should interest rates move
unexpectedly, the Fund may not achieve the anticipated benefits of the
hedging instruments and may realize a loss. Further, the use of such
derivative instruments involves the risk of imperfect correlation in
movements in the price of the instruments, interest rates and the
underlying hedged assets.
The investment characteristics of mortgage-backed and asset-backed
securities differ from traditional debt securities. Among the major
differences are that interest and principal payments are made more
frequently, usually monthly, and that principal may be prepaid at any
time because the underlying residential or commercial mortgage loans or
other assets generally may be prepaid at any time. Maturities on
mortgage-backed and asset-backed securities represent stated maturity
dates. Actual maturity dates may differ based on prepayment rates.
The Fund is exposed to credit-related losses in the event of
nonperformance by counterparties to financial instruments. The maximum
credit exposure related to the derivative financial instruments of the
17
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
Fund is equal to the fair value of the contracts with positive fair
values as of December 31, 2007. It is the policy of the Fund to transact
the majority of its securities and contractual commitment activity with
broker-dealers, banks and regulated exchanges that the Investment
Manager considers to be well established.
The Fund's short-biased strategy depends in large measure upon the
ability of the Investment Manager to identify ABS that experience future
credit losses arising from the defaults by obligors on the related
mortgage loans. This is the opposite approach from that employed in
traditional long-bias credit investment strategies that generally seek
to avoid credit losses on investments purchased on the basis of
fundamental credit analysis, or on other bases.
There can be no assurance that the Investment Manager's assessments of
the likelihood of default and losses on specific ABS transactions will
be accurate or that the predictive strengths of the Investment Manager's
models and practices will not decline. Even if ABS default and loss
rates increase generally in the future relative to the rates observed in
the past, the Fund's return objectives will not be met if the Fund has
bought credit protection or otherwise shorted securities that do not
experience such higher default and loss rates.
The Fund's strategy also includes long investments that are intended to
generate positive income during the first several years of the Fund, in
order to partially offset the negative carry of the short positions.
Losses on these long positions could produce losses for the Fund and
could result in the failure of the Fund to achieve the intended purpose
of offsetting the CDS premium costs.
The Fund is a new enterprise with limited operating history.
Accordingly, an investment in the Fund entails risk. There can be no
assurance that the Fund will achieve its investment objective or that
the Fund's strategies will be successful. There exists a possibility
that an investor could suffer a substantial loss as a result of an
investment in the Fund.
The success of any investment activity is influenced by general economic
conditions that may affect the level and volatility of equity prices,
credit spreads, interest rates and the extent and timing of investor
participation in the markets for both equity and interest-rate-sensitive
securities. Unexpected volatility or illiquidity in the markets in which
the Fund directly or indirectly holds positions could impair the Fund's
ability to carry out its business and could cause the Fund to incur
losses.
Depending on market conditions, reliable pricing information will not
always be available from any source. Prices quoted by different sources
are subject to material variation.
Credit-sensitive tranches of ABS are exposed to credit risk arising from
possible defaults of the underlying loans and recovery rates on those
liquidated loans. The default rates of loans backing these securities is
dependent on a number of factors including the quality and
characteristics of the loans, national and regional economic growth,
real estate values, the level of interest rates, changes in the
availability of mortgage financing and other factors. Recovery values
following a default will be dependent largely on regional and national
real estate values among other things; although real estate values may
depend on other economic variables.
The rate of prepayments on the loans collateralizing a subordinate ABS
tranche will generally have a significant effect on the amount of
obligor defaults a tranche can face before suffering losses of interest
or principal. The Investment Manager believes it is impossible to
accurately predict prepayment rates because prepayment rates are heavily
influenced by equally unpredictable interest rates. Consequently, while
18
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
the Investment Manager seeks to explore the potential effects of a wide
range of possible prepayment rates for securities or CDS it purchases or
sells, there can be no assurance that this analysis will exhaust the
possible paths prepayments could take, or that the effects of any
particular prepayment rate scenario will be evaluated correctly in
respect of a specific ABS tranche or CDS.
A decline in the market value of the Fund's portfolio of assets may
limit the Investment Manager's ability to borrow, or may result in
lenders initiating margin calls (i.e., requiring a pledge of cash or
additional assets to re-establish the ratio of the amount of the
borrowing to the value of the collateral). The Investment Manager could
be required to sell assets at distressed prices under adverse market
conditions in order to satisfy the requirements of the lenders. A
default by the Fund under its collateralized borrowings could also
result in a liquidation of the collateral by the lender, including any
cross-collateralized assets, and a resulting loss of the difference
between the value of the collateral and the amount borrowed.
As discussed in Note 1, the Fund's investors are two Feeder Funds
managed by the Investment Manager. The Fund could be materially affected
by significant subscriptions and redemptions from the underlying
investors of these Feeder Funds.
5. SHARE CAPITAL
The authorized share capital of the Fund consists of 5,000,000 shares
having a par value of $0.01 (U.S.) per share. At December 31, 2007,
931.50 shares were issued and outstanding.
Common shares are offered at an offering price equal to the net asset
value per common share as of the close of business on the immediately
preceding business day.
Any holder of common shares has the right, in accordance with and
subject to the applicable provisions of the memorandum of association of
the Fund and the laws of the Cayman Islands, to have all or a portion of
their shares redeemed on a date determined by the Directors.
At December 31, 2007, all outstanding shares are held by the Feeder
Funds.
The following table reconciles share transactions for the year ended
December 31, 2007:
SHARES
Balance, January 2, 2007 --
Shares issued 1,150.86
Shares redeemed (219.36)
-----------
BALANCE, DECEMBER 31, 2007 931.50
===========
The Directors of the Fund have the sole discretion to authorize
distribution of dividends.
6. DIRECTORS AND FEES
The following persons are independent non-executive Directors of the
Fund:
o David Bree
19
HFH SHORTPLUS MASTER FUND, LTD.
(A CAYMAN ISLANDS EXEMPTED COMPANY)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2007
--------------------------------------------------------------------------------
o Peter Burnim
All members of the Board of Directors are reimbursed for their
out-of-pocket expenses incurred in connection with the performance of
their duties and each receives an annual fee of approximately $5,000. No
Directors have a shareholder interest in the Fund or have an interest,
direct or indirect, in any transaction affecting the Fund during the
year ended December 31, 2007, which is unusual in nature or significant
to the business of the Fund. No Director has any contracts of
significance with the Fund.
7. CONTINGENCIES AND COMMITMENTS
In the normal course of business, the Fund enters into contracts that
contain a variety of representations, warranties and general
indemnifications. The Fund's maximum exposure under these arrangements,
including future claims that may be made against the Fund that have not
yet occurred, is unknown. However, based on experience of the Investment
Manager, the Fund expects the risk of loss associated with such
contracts to be remote.
8. RELATED PARTY TRANSACTIONS
The Investment Manager provides discretionary services to other funds
that follow an investment program similar to that which was followed by
the Fund. Investments may be allocated between the Fund and other funds.
Also, the Fund may purchase securities from and sell securities to such
other funds. No additional transaction costs are incurred by the Fund as
a result of such transactions. The Investment Manager allocates certain
expenses to the Fund for the day-to-day accounting and administrative
services performed by its employees on behalf of the Fund. For the
year-ended December 31, 2007, these costs amounted to $163,588. These
costs are included in the Fund's "professional expenses" on the
statement of operations.
9. SUBSEQUENT EVENTS
From January 1 through March 1, 2008, the Fund had redemptions of
$33,617,455.
In September 2006, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 157, Fair Value
Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. SFAS 157 applies to reporting periods beginning
after November 15, 2007. The adoption of SFAS 157 is not expected to
have a material impact on the Fund's financial statements.
20
AFFIRMATION OF COMMODITY POOL OPERATOR
To the best of my knowledge and belief the information contained herein
pertaining to HFH ShortPLUS Master Fund, Ltd. is accurate and complete.
Highland Financial Holdings Group, LLC
Commodity Pool Operator
/s/ Paul Ullman
------------------------------------------
By Paul Ullman
President of Highland Financial Holdings
Group, LLC The Investment Manager of
Highland ShortPLUS Master Fund, Ltd.
21