SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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
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(State or Other Jurisdiction of (I.R.S.
Incorporation or Organization) Employer 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
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Common Shares, par value $1 per share New York Stock Exchange
7-3/4% Senior Notes due August 15, 2013 New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [x] No [ ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
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:
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Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2009 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
1
PART I
Item 1. Business.
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The Company
The Company is a diversified holding company engaged in a variety of
businesses, including manufacturing, telecommunications, property management and
services, gaming entertainment, real estate activities, medical product
development and winery operations. The Company also has significant investments
in the common stock of two public companies that are accounted for at fair
value, one of which is a full service investment bank and the other an
independent auto finance company. The Company also owns equity interests in
operating businesses and investment partnerships which are accounted for under
the equity method of accounting, including a broker-dealer engaged in making
markets and trading of high yield and special situation securities, land based
contract oil and gas drilling, real estate activities and development of a
copper mine in Spain. The Company concentrates on return on investment and cash
flow to maximize long-term shareholder value. Additionally, the Company
continuously evaluates the retention and disposition of its existing operations
and investigates possible acquisitions of new businesses. In identifying
possible acquisitions, the Company tends to seek assets and companies that are
out of favor or troubled and, as a result, are selling substantially below the
values the Company believes to be present.
The worldwide recession, turmoil in public securities markets and lack of
liquidity in the credit markets have put a strain on many businesses and caused
great uncertainty about asset values in nearly all industry sectors. If these
economic and market conditions continue for some time, the Company expects that
some extraordinary investment opportunities will be available. However, it also
expects that financing these investment opportunities may be difficult. The
Company has available liquidity on its balance sheet (as discussed below) and
could dispose of existing businesses or investments if additional internal
liquidity is needed to take advantage of any investment opportunities. Although
no assurance can be given that the Company will be successful in acquiring new
businesses, making new investments or in raising sufficient capital for any such
opportunities, the Company does intend to pursue those opportunities that it
considers to be the most compelling.
Shareholders' equity has grown from a deficit of $7,700,000 at December
31, 1978 (prior to the acquisition of a controlling interest in the Company by
the Company's Chairman and President), to a positive shareholders' equity of
$2,676,800,000 at December 31, 2008, equal to a book value per common share of
the Company (a "common share") of negative $.04 at December 31, 1978 and $11.22
at December 31, 2008. Shareholders' equity and book value per share amounts have
been reduced by the $811,900,000 special cash dividend paid in 1999.
The Company's manufacturing operations are conducted through Idaho
Timber, LLC ("Idaho Timber") and Conwed Plastics, LLC ("Conwed Plastics").
Acquired in May 2005, Idaho Timber is headquartered in Boise, Idaho and
primarily remanufactures dimension lumber and remanufactures, packages and/or
produces other specialized wood products. Conwed Plastics manufactures and
markets lightweight plastic netting used for a variety of purposes including,
among other things, building and construction, erosion control, packaging,
agricultural, carpet padding, filtration and consumer products.
As of December 31, 2008, the Company had acquired approximately 25% of
the outstanding common shares of AmeriCredit Corp. ("ACF"), a company listed on
the New York Stock Exchange, Inc. ("NYSE") (Symbol: ACF) for aggregate cash
consideration of $405,300,000. ACF is an independent auto finance company that
is in the business of purchasing and servicing automobile sales finance
contracts, historically for consumers who are typically unable to obtain
financing from other sources. The Company accounts for its investment in ACF at
fair value, which was $249,900,000 at December 31, 2008 market prices;
unrealized gains or losses are reflected in the Company's consolidated
statements of operations.
2
During 2008, the Company acquired approximately 30% of the outstanding
common shares of Jefferies Group, Inc. ("Jefferies"), a company listed on NYSE
(Symbol: JEF) for cash and newly issued common shares of the Company aggregating
$794,400,000. Jefferies is a full-service global investment bank and
institutional securities firm serving companies and their investors. The Company
accounts for its investment in Jefferies at fair value, which was $683,100,000
at December 31, 2008 market prices; unrealized gains or losses are reflected in
the Company's consolidated statements of operations.
The Company's telecommunications operations are conducted through its 75%
owned subsidiary, STi Prepaid, LLC ("STi Prepaid"), which acquired the assets of
Telco Group, Inc. and its affiliates ("Telco") in March 2007. STi Prepaid is a
provider of international prepaid phone cards and other telecommunications
services in the U.S.
The Company's property management and services operations are conducted
through ResortQuest International, Inc. ("ResortQuest"). Acquired in June 2007,
ResortQuest is engaged in offering property management and other services to
vacation properties in beach and mountain resort locations in the continental
U.S.
The Company's gaming entertainment operations are conducted through its
controlling interest in Premier Entertainment Biloxi, LLC ("Premier"), which is
the owner of the Hard Rock Hotel & Casino Biloxi ("Hard Rock Biloxi"), located
in Biloxi, Mississippi. The Hard Rock Biloxi was severely damaged by Hurricane
Katrina on August 29, 2005, just prior to its originally scheduled opening; upon
completion of reconstruction the Hard Rock Biloxi opened for business on June
30, 2007.
The Company's domestic real estate operations include a mixture of
commercial properties, residential land development projects and other
unimproved land, all in various stages of development.
The Company's medical product development operation is conducted through
Sangart, Inc. ("Sangart"), which became a majority-owned subsidiary in 2005.
Sangart is developing a product called Hemospan(R), which is a solution of
cell-free hemoglobin that is designed for intravenous administration to treat a
wide variety of medical conditions, including use as an alternative to red blood
cell transfusions.
The Company's winery operations consist of Pine Ridge Winery in Napa
Valley, California, Archery Summit in the Willamette Valley of Oregon, Chamisal
Vineyards in the Edna Valley of California and a vineyard development project in
the Columbia Valley of Washington. The wineries primarily produce and sell wines
in the ultra premium and luxury segments of the premium table wine market.
In 2007, the Company and Jefferies expanded and restructured the
Company's equity investment in Jefferies Partners Opportunity Fund II, LLC
("JPOF II") and formed Jefferies High Yield Holdings, LLC ("JHYH"). Through its
wholly-owned subsidiary, JHYH makes markets in high yield and special situation
securities and provides research coverage on these types of securities.
The Company's land based contract oil and gas drilling investment is
conducted by Goober Drilling, LLC ("Goober Drilling"), in which the Company has
a 50% voting and equity interest at December 31, 2008. The Company has also made
secured loans to Goober Drilling aggregating $144,400,000, at various interest
rates, to finance new equipment purchases and construction costs, repay existing
debt and finance working capital needs.
The Company owns 30% of Cobre Las Cruces, S.A. ("CLC"), a former
subsidiary of the Company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. During 2005, the Company
sold a 70% interest in CLC to Inmet Mining Corporation ("Inmet"), a
Canadian-based global mining company, in exchange for 5,600,000 newly issued
Inmet common shares, representing approximately 11.6% of Inmet's current
outstanding common shares. CLC expects to begin commercial production at the
mine in the first half of 2009.
In August 2006, pursuant to a subscription agreement with Fortescue
Metals Group Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd
("FMG"), the Company invested in Fortescue's Pilbara iron ore and infrastructure
project in Western Australia. The Company owns 277,986,000 common shares of
Fortescue (approximately 9.9% of the outstanding shares); Fortescue is a
publicly traded company on the Australian Stock Exchange (Symbol: FMG). The
Company also owns a $100,000,000 note of FMG that matures in August 2019;
interest on the note is calculated as 4% of the revenue, net of government
royalties, invoiced from the iron ore produced from two specified project areas.
The ultimate value of the note will depend on the volume of iron ore shipped and
iron ore prices over the remaining term of the note, which can fluctuate widely.
The Company's total cash investment in Fortescue's common shares and the FMG
note aggregates $452,200,000; the market value of the Fortescue common shares
owned by the Company was $377,000,000 at December 31, 2008.
3
The Company and certain of its subsidiaries have substantial federal net
operating loss carryforwards ("NOLs") of approximately $5,745,600,000 at
December 31, 2008. During 2008, the Company concluded that a valuation allowance
was required against substantially all of its net deferred tax asset (which
includes the NOLs), and increased its valuation allowance by $1,672,100,000 with
a corresponding charge to income tax expense. For more information, see Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included elsewhere herein.
As used herein, the term "Company" refers to Leucadia National
Corporation, a New York corporation organized in 1968, and its subsidiaries,
except as the context otherwise may require.
Investor Information
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the Company
files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 100 F Street, N.E., Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov)
that contains reports, proxy and information statements and other information
regarding the Company and other issuers that file electronically. Material filed
by the Company can also be inspected at the offices of the NYSE, 20 Broad
Street, New York, NY 10005, on which the Company's common shares are listed. The
Company has submitted to the NYSE a certificate of the Chief Executive Officer
of the Company, dated May 13, 2008, certifying that he is not aware of any
violations by the Company of NYSE corporate governance listing standards.
The Company's website address is www.leucadia.com. The Company makes
available, without charge through its website, copies of its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act, as soon as reasonably practicable after such reports
are filed with or furnished to the SEC.
Financial Information about Segments
The Company's reportable segments consist of the operating units
identified above, which offer different products and services and are managed
separately. At acquisition, the Company's investment in Premier was reported as
a consolidated subsidiary in the other operations segment; however, it was
deconsolidated and classified as an investment in an associated company upon the
filing of voluntary petitions for reorganization under chapter 11 of title 11 of
the United States Bankruptcy Code in September 2006. While in bankruptcy,
Premier was classified as an investment in an associated company and its
operating results were not reported in the gaming entertainment segment. Upon
its emergence from bankruptcy in August 2007, Premier was once again
consolidated by the Company and has been reported as an operating segment since
that date. Other operations primarily consist of the Company's wineries and
energy projects.
Associated companies include equity interests in other entities that the
Company accounts for on the equity method of accounting. Investments in
associated companies that are accounted for under the equity method of
accounting include HomeFed Corporation ("HomeFed"), a corporation engaged in
real estate activities, JHYH, Goober Drilling and CLC. The Company also has made
non-controlling investments in entities that are engaged in investing and/or
securities transactions activities that are accounted for on the equity method
of accounting including Pershing Square IV, L.P. ("Pershing Square"), Highland
Opportunity Fund, L.P. ("Highland Opportunity"), HFH ShortPLUS Fund, L.P.
("Shortplus"), RCG Ambrose, L.P., ("Ambrose"), EagleRock Capital Partners (QP),
LP ("EagleRock"), Safe Harbor Domestic Partners L.P. ("Safe Harbor") and
Wintergreen Partners Fund, L.P. ("Wintergreen"). Associated companies also
include the Company's investments in ACF and Jefferies, which are accounted for
at fair value rather than the equity method of accounting.
Corporate assets primarily consist of investments and cash and cash
equivalents and corporate revenues primarily consist of investment and other
income and securities gains and losses. Corporate assets include the Company's
investment in Fortescue. Corporate assets, revenues, overhead expenses and
interest expense are not allocated to the operating units.
4
Conwed Plastics has manufacturing facilities located in Belgium and
Mexico and STi Prepaid has a customer care unit located in the Dominican
Republic. These are the only foreign operations with non-U.S. revenue or assets
that the Company consolidates, and are not material. Unconsolidated non-U.S.
based investments include 38% of Light and Power Holdings Ltd., the parent
company of the principal electric utility in Barbados, a small Caribbean-based
telecommunications provider, the 30% ownership of CLC and the investments in
Fortescue and Inmet. From time to time the Company invests in the securities of
non-U.S. entities or in investment partnerships that invest in non-U.S.
securities.
Certain information concerning the Company's segments is presented in
the following table. Consolidated subsidiaries are reflected as of the date of
acquisition, which was June 2007 for ResortQuest and March 2007 for STi Prepaid.
As discussed above, Premier is reflected as a consolidated subsidiary from May
2006 until it was deconsolidated in September 2006; Premier once again became a
consolidated subsidiary in August 2007. Associated Companies are only reflected
in the table below under identifiable assets employed.
5
2008 2007 2006
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(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 235.3 $ 292.2 $ 345.7
Conwed Plastics 106.0 105.4 106.4
Telecommunications 452.4 363.2 --
Property Management and Services 142.0 81.5 --
Gaming Entertainment 119.1 38.5 --
Domestic Real Estate 15.1 13.4 86.7
Medical Product Development .7 2.1 .7
Other Operations (b) 53.4 53.6 42.8
Corporate (c) (43.3) 205.0 280.4
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Total consolidated revenues and other income $ 1,080.7 $ 1,154.9 $ 862.7
========= ========= =========
Income (loss) from continuing operations before income taxes and income (losses)
related to associated companies:
Manufacturing:
Idaho Timber $ .8 $ 9.1 $ 12.0
Conwed Plastics 14.0 17.4 17.9
Telecommunications 11.9 18.4 --
Property Management and Services (1.9) (6.5) --
Gaming Entertainment 1.0 (9.3) --
Domestic Real Estate (14.4) (8.2) 44.0
Medical Product Development (32.3) (31.5) (21.1)
Other Operations (b) (41.6) (17.2) (14.4)
Corporate (c) (304.1) (29.3) 95.4
--------- --------- ---------
Total consolidated income (loss) from continuing operations before income
taxes and income (losses) related to associated companies $ (366.6) $ (57.1) $ 133.8
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 118.3 $ 129.5 $ 132.3
Conwed Plastics 78.5 88.8 83.6
Telecommunications 107.7 81.9 --
Property Management and Services 55.2 62.8 --
Gaming Entertainment 281.6 300.6 --
Domestic Real Estate 409.7 306.3 198.1
Medical Product Development 21.2 36.5 12.2
Other Operations 290.1 255.5 257.8
Investments in Associated Companies 2,006.6 1,362.9 773.0
Corporate (d) 1,829.6 5,501.8 3,846.8
--------- --------- ---------
Total consolidated assets $ 5,198.5 $ 8,126.6 $ 5,303.8
========= ========= =========
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains (losses) in the
Company's consolidated statements of operations.
(b) Other operations include pre-tax losses of $33,600,000, $12,500,000 and
$8,300,000 for the years ended December 31, 2008, 2007 and 2006,
respectively, for investigation and evaluation of various energy related
projects. There were no material operating revenues or identifiable assets
associated with these activities in any period; however, other income
includes $8,500,000 in 2007 related to the termination of a joint
development agreement with another party.
6
(c) Net securities gains (losses) for Corporate aggregated $(144,500,000),
$92,700,000 and $116,600,000 during 2008, 2007 and 2006, respectively.
Corporate net securities gains (losses) are net of impairment charges of
$143,400,000, $36,800,000 and $12,900,000 during 2008, 2007 and 2006,
respectively. The impaired securities include the Company's investment in
various debt and equity securities and reflect the significant decline in
value of worldwide securities markets during 2008. The impairment charges
in 2008 result from declines in fair values of securities believed to be
other than temporary, principally for securities classified as available
for sale securities. In 2007, security gains include a gain of $37,800,000
from the sale of Eastman Chemical Company ("Eastman"). In 2006, security
gains include a gain of $37,400,000 from the sale of 115,000,000 common
shares of Level 3 Communications, Inc. ("Level 3"), which were received in
December 2005 in connection with Level 3's purchase of WilTel
Communications Group, LLC ("WilTel").
(d) During the year ended December 31, 2008, the Company increased its deferred
tax valuation allowance by $1,672,100,000 to reserve for substantially all
of the net deferred tax asset. See Item 7, Management's Discussion and
Analysis of Financial Position and Results of Operations included elsewhere
herein for more information.
(e) For the years ended December 31, 2008, 2007 and 2006, income (loss) from
continuing operations reflects depreciation and amortization expenses of
$77,300,000, $54,200,000 and $39,500,000, respectively; such amounts are
primarily comprised of Corporate ($20,400,000, $12,700,000 and $11,600,000,
respectively), manufacturing ($17,300,000, $18,000,000 and $17,500,000,
respectively), gaming entertainment ($17,000,000, $6,300,000 and $900,000,
respectively), domestic real estate ($7,600,000, $3,800,000 and $3,300,000,
respectively), property management and services ($4,600,000 and $3,100,000
in 2008 and 2007, respectively) and other operations ($8,300,000,
$9,000,000 and $5,600,000, respectively). Depreciation and amortization
expenses for other segments are not material.
(f) For the years ended December 31, 2008, 2007 and 2006, income (loss) from
continuing operations reflects interest expense of $145,500,000,
$111,500,000 and $79,400,000, respectively; such amounts are primarily
comprised of Corporate ($140,000,000, $110,800,000 and $70,900,000,
respectively), domestic real estate ($4,400,000 in 2008) and gaming
entertainment ($900,000, $500,000 and $8,000,000, respectively).
At December 31, 2008, the Company and its consolidated subsidiaries had
3,584 full-time employees.
Manufacturing
Idaho Timber
Business Description
Idaho Timber, which was acquired in May 2005, is headquartered in Boise,
Idaho and is engaged in the manufacture and/or distribution of various wood
products. Idaho Timber's principal product lines include remanufacturing
dimension lumber; remanufacturing, bundling and bar coding of home center boards
for large retailers; and production of 5/4" radius-edge, pine decking. Idaho
Timber also manufactures and/or distributes a number of other specialty wood
products. Idaho Timber has over 25 years of operating experience in its
industry. The Company's investment in Idaho Timber was $108,600,000 at December
31, 2008.
Remanufactured dimension lumber is Idaho Timber's largest product line.
Dimension lumber is used for general construction and home improvement,
remodeling and repair projects, the demand for which is normally a function of
housing starts and home size. All dimension lumber is assigned a quality grade,
based on the imperfections in the wood, and higher-grade lumber is sold at a
higher price than lower-grade lumber. Idaho Timber purchases low-grade dimension
lumber from sawmills located in North America and Europe and upgrades it into
higher-grade dimension lumber products. The remanufacturing process includes
ripping, trimming and planing lumber to reduce imperfections and produce a
variety of lumber sizes. These products are produced at plants located in
Florida, North Carolina, Texas, Kansas, Idaho and New Mexico. Each plant
distributes its product primarily by truck to lumber yards and contractors
within a 300 mile shipping radius from the plant site.
7
Idaho Timber's next largest product line is home center board products,
which are principally sold to large home improvement retailers. Idaho Timber
purchases high-grade boards from sawmills in the western United States, South
America and New Zealand (primarily pine but other wood species are also used),
performs minor re-work on those boards to upgrade the quality, and then packages
and bar codes those boards according to customer specifications. Production
takes place in owned plants in Idaho and Montana. Idaho Timber also operates a
sawmill in Arkansas to produce its 5/4" radius-edge, pine decking products.
Idaho Timber performs traditional sawmill processes (cutting, drying and
planing) to manufacture these products.
Idaho Timber's profitability is dependent upon its ability to manage
manufacturing costs and process efficiency, minimize capital expenditures
through the purchase and cost-effective maintenance of used, lower-cost
equipment, and effective management of the spread between what it pays for
dimension lumber and boards and the selling prices of the remanufactured
products. Selling prices for remanufactured products may rise quicker than
supplier prices in strong markets creating greater spreads; however, during
periods of declining product demand and reduced selling prices, supply price
declines may lag behind, resulting in lower spreads.
Idaho Timber owns nine plants, one sawmill that principally produces
decking products and one sawmill that produces split-rail fencing. These eleven
facilities in the aggregate have approximately 941,000 square feet of
manufacturing and office space, covering approximately 230 acres. Two plants are
principally dedicated to home center board products and the remaining plants
principally produce remanufactured dimension lumber products. All plant
locations can produce and distribute specialty wood products. Idaho Timber has
the capacity to ship approximately 70 million board feet per month; during 2008
actual shipments averaged approximately 45 million board feet per month.
Sales and Marketing
Idaho Timber primarily markets to local, regional and national lumber
retailers for its dimension lumber products, home improvement centers for its
home center board products and decking treaters for its sawmill product, and
other resellers of home construction materials. Its success in attracting and
retaining customers depends in large part on its ability to provide quicker
delivery of specified customer products than its competitors. For dimension
lumber products, sales are primarily generated at each of the plants, with a
dedicated sales force located in the same geographic region as the customers the
plant serves. Board and decking products are sold and managed centrally. Sales
of home center board product were heavily dependent on national home center
chains which accounted for approximately 90% of product revenues and 19% of
Idaho Timber's total revenue for the year ended December 31, 2008. One of our
national home center customers discontinued purchasing pine boards through its
vendor managed inventory program effective July 1, 2008. Revenues from this
customer pursuant to the program were $8,000,000 for the six months ended June
30, 2008.
The customer base for the dimension lumber business is much less
concentrated; no customer accounts for more than 10% of revenue. Idaho Timber's
sales are somewhat concentrated in regions where its facilities are located,
with the largest being Florida, 21%; North Carolina, 16%; and Texas, 11%.
Competition
Idaho Timber sells commodity products, and operates in an industry that
is currently oversupplied and very competitive. Idaho Timber competes against
domestic and foreign sawmills and intermediate distributors for its dimension
lumber and decking products. In some cases, Idaho Timber competes on a limited
basis with the same sawmills that are a source of supply of low-grade dimension
lumber. Foreign suppliers have been active in the U.S. market, particularly
European competitors, which has added to the current oversupply condition in the
industry and may continue to do so. The home center board business has many
competitors, and suppliers to large home centers are always under pressure to
reduce prices.
8
Idaho Timber also competes for raw material purchases needed for its
remanufactured dimension lumber and home center board products, and in the past
the availability and pricing of certain raw materials has been adversely
affected by export charges (tariffs) imposed on Canadian exports, the largest
source of these supplies. A decades old trade dispute between the U.S. and
Canada resurfaced with the expiration of the Softwood Lumber Agreement in 2001.
In October 2006, the trade dispute was resolved and a new Softwood Lumber
Agreement between Canada and the U.S. became effective. The agreement has a
seven year term and may be extended for an additional two years. Currently,
restrictions on Canadian exports are not significantly adversely affecting Idaho
Timber's operations; however, if tariffs continue beyond the current term of the
Softwood Lumber Agreement or further import limitations are imposed in the
future, it is possible that raw material costs could increase or supplies could
be constrained. During 2008, the export charge was at the maximum level for the
entire year. Idaho Timber is examining alternative sources of supply to increase
its raw material purchasing flexibility.
Government Regulation
Lumber and decking are identified at Idaho Timber facilities with a grade
stamp that shows the grade, moisture content, mill number, species and grading
agency. All lumber is graded in compliance with the National Grading Rule for
Dimension Lumber, which is published by the U.S. Department of Commerce. Idaho
Timber facilities are subject to regular inspection by agencies approved by the
American Lumber Standards Committee. Idaho Timber believes that its procedure
for grading lumber is highly accurate; however, Idaho Timber could be exposed to
product liability claims if it can be demonstrated its products are
inappropriately rated.
Since Idaho Timber's sawmills do not treat its wood with chemicals, and
since timber deeds purchased from private land owners do not impose a
re-planting obligation, Idaho Timber does not have any unusual environmental
compliance issues.
Plastics Manufacturing
Business Description
Through Conwed Plastics, which was acquired in March 1985, the Company
manufactures and markets lightweight plastic netting used for a variety of
purposes including, among other things, building and construction, erosion
control, packaging, agricultural, carpet padding, filtration and consumer
products. These products are primarily used for containment purposes,
reinforcement of other products, packaging for produce and meats, various types
of filtration and erosion prevention. Conwed Plastics believes it is a market
leader in netting products used in carpet cushion, turf reinforcement, erosion
control and packaging. Agricultural, erosion control and building and
construction markets tend to be seasonal, with peak periods in the second and
third quarters of the calendar year. Packaging is seasonal with the second
quarter being the slowest period in this market. Carpet padding, filtration and
consumer product markets are not usually subject to seasonal fluctuations
resulting in sales that tend to be evenly spread throughout the year. The
Company's investment in Conwed Plastics was $67,100,000 at December 31, 2008.
Certain products of Conwed Plastics are proprietary, protected by patents
and/or trade secrets. The Company holds patents on certain improvements to the
basic manufacturing processes it uses and on applications thereof. The Company
believes that the expiration of these patents, individually or in the aggregate,
is unlikely to have a material effect on its operations.
Sales and Marketing
Conwed Plastics' manufacturing revenues and other income were
$106,000,000, $105,400,000 and $106,400,000 for the years ended December 31,
2008, 2007 and 2006, respectively. Products are marketed both domestically and
internationally, with approximately 21.4% of 2008 revenues generated by
customers from Europe, Latin America, Japan and Australia. Products are sold
primarily through an employee sales force, located in the U.S. and Europe.
Conwed Plastics emphasizes development of new products and new applications of
existing products to grow its revenues. New product development focuses on
market niches where proprietary technology and expertise can lead to sustainable
competitive economic advantages. In addition, revenues have grown as a result of
acquisitions that provide synergies with existing customers, manufacturing
capacity, an expanded customer base and/or product lines. Conwed Plastics has
completed eight acquisitions since 2004 and continues to look for additional
acquisition opportunities.
9
Approximately half of Conwed Plastics' revenues are generated on a make
to order basis. The remainder of Conwed Plastics' sales requires a more
substantial investment in inventory that is stored at various locations to
service customers with short lead time requirements. In the aggregate, inventory
is turned over between 6 and 8 times per year. The top 10 customers with
multiple locations typically represent approximately 30% - 37% of total sales.
The largest single customer typically represents 5% - 8% of total sales; for the
year ended December 31, 2008, the largest single customer represented 5% of
total sales. Order backlog generally ranges from 6% - 12% of annual sales
throughout the year.
Competition
Conwed Plastics is subject to domestic and international competition,
generally on the basis of price, service and quality. Conwed Plastics has 3 to 5
competitors in most of its market segments but the size and type of its
competition varies by market segment. Additionally, certain products are
dependent on cyclical industries, including the construction industry. The cost
of the principal raw material used in its products, polypropylene, has increased
by approximately 130% from 2002. Conwed Plastics has been able to raise prices
to its customers during this period to offset some of the increase in raw
material costs. The increasing volatility of oil and natural gas prices along
with current general economic conditions worldwide make it difficult to predict
future raw material costs. Historically, declining oil and natural gas prices
combined with reduced demand have usually resulted in reduced raw material
costs.
Telecommunications
Business Description
STi Prepaid purchased 75% of the assets of Telco in March 2007; the
remaining Telco assets were contributed to STi Prepaid by the former owner in
exchange for a 25% interest in STi Prepaid. At December 31, 2008, STi Prepaid's
consolidated liabilities exceeded its consolidated assets; as a result, the
Company has a negative net investment in STi Prepaid of $20,200,000.
STi Prepaid, headquartered in New York, New York, is a facilities-based
provider of long-distance wireline and wireless telecommunications services. STi
Prepaid's principal product line is prepaid international long distance calling
cards; STi Prepaid also generates revenues by providing carrier wholesale
services and selling prepaid wireless products and related services.
Prepaid international calling cards represent STi Prepaid's largest
telecommunication service. For the year ended December 31, 2008, calling card
sales accounted for approximately 80% of STi Prepaid's revenues. Consumers
located in the U.S. who make international phone calls often use calling cards
because they provide lower rates than those offered by traditional long distance
providers. Through its portfolio of calling cards, STi Prepaid provides
international service to over 200 destinations. STi Prepaid currently offers
over 250 different calling cards in various denominations that are sold through
a wide variety of retail stores and on the Internet, targeted to appeal to a
wide variety of consumers. STi Prepaid's calling cards are primarily marketed to
ethnic communities in urban areas.
To activate a card and initiate a call, a card customer will dial either
a local access or toll-free telephone number that accesses STi Prepaid's
interactive voice response unit on its network. Once a card is activated, calls
are routed to one of STi Prepaid's termination vendors, then ultimately to the
consumer's dialed party. STi Prepaid's switching network currently handles over
55 million outbound calls and over 600 million minutes per month. STi Prepaid
operates a customer care center in the Dominican Republic with over 100
operators to support its prepaid business.
STi Prepaid's next largest telecommunication service is carrier
wholesale, which is a business-to-business service. The carrier wholesale
division accounted for approximately 18% of the Company's revenues in 2008. STi
Prepaid enters into wholesale service agreements with other telecommunication
service providers pursuant to which STi Prepaid becomes the terminating vendor
for international calls. Services provided to other carriers are highly
automated and do not require much support labor since calls simply pass through
the Company's switches and utilize excess capacity.
10
STi Prepaid operates its prepaid mobile business as a Mobile Virtual
Network Operator ("MVNO"). MVNOs are entities that do not own their own wireless
network; rather they enter into agreements to resell minutes from an established
facilities based wireless carrier such as Sprint or Verizon Wireless. However,
unlike wireless resellers that simply earn commissions for selling the products
of large facilities based wireless companies, MVNO operators have their own
brand name and directly maintain customer relationships including activities
related to rate plans, billing, and general customer service. STi Prepaid's
brand name for this product is STi Mobile.
STi Prepaid acquired three small prepaid card companies during 2008, and
continues to look for additional acquisition opportunities. The acquisitions
have provided greater distribution capacity in certain geographic locations,
sales synergies and additional distribution channels, equipment, technology
and/or licenses.
Sales and Marketing
STi Prepaid distributes its prepaid calling cards primarily through
distributors who resell the cards to retailers throughout the U.S. A significant
portion of the calling cards are marketed to ethnic communities that shop at
small retailers or smaller chains that do not receive attention from large
telecommunication providers. STi Prepaid's relationships with its distributors
are critical to serving these market segments and maintaining and growing
prepaid calling card market share. On October 1, 2008, STi Prepaid completed the
acquisition of Sprint's prepaid card division, providing it with a distribution
channel into retail stores nationwide. The company also sells prepaid calling
cards through its websites, www.stiprepaid.com and www.stiphonecard.com. The
websites allow customers to search for calling cards by state of origination and
call destination.
The carrier wholesale business sales group focuses on establishing
relationships with leading telecommunication carriers. STi Prepaid markets its
STi Mobile wireless products and services through national, regional and local
retail outlets in the U.S., internet resellers and the division's website,
www.stimobile.com. STi Mobile provides prepaid wireless services to consumers
who may not have the credit rating required to qualify for a post-paid plan,
prefer to pay as they go in order to control expenses or do not use sufficient
minutes to justify the cost of a post-paid plan.
Competition
Prepaid calling cards are marketed by a wide range of telecommunication
providers from large national inter-exchange carriers to small local and
regional resellers. STi Prepaid's calling card products compete in markets where
consumers' decisions are primarily based on price and service quality. The
emergence and growth of wholesale carriers using voice over internet protocol,
privatization and deregulation has contributed to a decline in international
call pricing which is likely to continue. STi Prepaid will need to rely on its
network operation expertise and quality of service to continue to effectively
compete in the markets it serves.
Government Regulation
STi Prepaid is subject to significant federal, state and local laws,
regulations and orders that affect the rates, terms and conditions of certain of
its service offerings, its costs and other aspects of its operations. Regulation
of the telecommunications industry varies from state to state and it changes
regularly in response to technological developments, competition, government
policies and judicial proceedings. The Company cannot predict the impact, nor
give any assurances about the materiality of any potential impact, that any
adverse changes may have on STi Prepaid's business or results of operations, nor
can it be sure that regulatory authorities will not take action against STi
Prepaid regarding its compliance with applicable laws and regulations.
The Federal Communications Commission ("FCC") has jurisdiction over STi
Prepaid's facilities and services to the extent those facilities are used in the
provision of interstate telecommunications services (services that originate and
terminate in different states). State regulatory commissions generally have
jurisdiction over facilities and services to the extent the facilities are used
in intrastate telecommunications services.
The Communications Act of 1934. The Communications Act of 1934, as
amended (the "Communications Act") grants the FCC authority to regulate
interstate and foreign communications by wire or radio. The Telecommunications
Act of 1996 (the "1996 Act") establishes a framework for fostering competition
in the provision of local and long distance telecommunications services. STi
Prepaid is regulated by the FCC as a non-dominant interstate and international
telecommunication provider and is therefore subject to less comprehensive
regulation than dominant carriers under the Communications Act. The FCC reviews
its rules and regulations from time to time, and STi Prepaid may be subject to
those new or changed rules.
11
STi Prepaid has registered with the FCC as a provider of domestic
interstate long distance services. STi Prepaid believes that it is in material
compliance with applicable federal laws and regulations, but cannot be sure that
the FCC or third parties will not raise issues regarding its compliance with
applicable laws or regulations.
Universal Service. Pursuant to the 1996 Act, in 1997 the FCC established
a significantly expanded universal service regime to subsidize the cost of
telecommunications services to high-cost areas, to low income customers, and to
qualifying schools, libraries and rural health care providers. Providers of
interstate and international telecommunications services, and certain other
entities, must pay for these programs by contributing to a Universal Service
Fund (the "Fund"). The rules concerning which services are considered when
determining how much an entity is obligated to contribute to the Fund are
complex; however, many of the services sold by STi Prepaid are included in the
calculation. Current rules require contributors to make quarterly and annual
filings reporting their revenues, and the Universal Service Administrative
Company issues monthly bills for the required contribution amounts, based on a
quarterly contribution factor approved by the FCC. STi Prepaid also contributes
to other funds mandated by the FCC including Interstate Telecommunication
Service Provider Regulatory Fees, Telecommunication Relay Service and Local
Number Portability. STi Prepaid and other contributors to the Fund may recover
their contribution costs through their end-user rates or a billing line item.
Customer Propriety Network Information ("CPNI"). CPNI is defined as
information that relates to the quantity, technical configuration, type,
destination, location, and amount of use of a telecommunications service
subscribed to by any customer of a telecommunications carrier, and that is made
available to the carrier by the customer solely by virtue of the
carrier-customer relationship. Section 222 of the 1996 Act requires
telecommunications carriers to take specific steps to ensure that CPNI is
adequately protected from unauthorized disclosure. In 2007, the FCC issued its
Report and Order and Further Notice of Proposed Rulemaking strengthening these
privacy rules by adopting additional safeguards to protect customers' CPNI. The
Company believes that it has developed policies that meet the FCC's requirements
to protect CPNI.
State Regulation of Telecommunications Services. STi Prepaid is certified
to provide telecommunication services in 49 states. State public utility
commissions ("PUC's") are permitted to regulate the Company's telecommunication
services to the extent that such services originate and terminate within the
same state. The PUC's may also impose tariff and filing requirements, consumer
protection measures and obligations to contribute to state universal service and
other funds.
For a description of certain litigation involving STi Prepaid, see Item
3, Legal Proceedings in this Report.
Property Management and Services
Business Description
ResortQuest, which was acquired in June 2007, is headquartered in Fort
Walton Beach, Florida and provides vacation rental management services to
vacation properties in beach and mountain resort locations, homeowner
association management to resort communities and real estate brokerage services
for the residential property market in resort locations. The Company's
investment in the property management and services segment was $16,000,000 at
December 31, 2008.
Vacation rental management service for homeowners is ResortQuest's
largest service offering representing 94% of ResortQuest's 2008 revenue.
ResortQuest contracts with each property owner to market and manage the rental
of their vacation property, generally for a percentage of the rent and/or fees
collected. Services provided include marketing to potential guests, performing
routine maintenance, providing housekeeping services and providing guests access
to additional activities such as golf, watersports, tennis or skiing.
ResortQuest provides services in Northwest and Southwest Florida, Delaware,
North and South Carolina, Colorado, Idaho and Utah. ResortQuest's rental
management services are somewhat geographically concentrated in the Northwest
Florida market, which accounts for 35% of its rental management services
revenue.
ResortQuest's primary means of attracting new guests is via the Internet,
through referrals and advertising in publications. ResortQuest's business is
seasonal with beach areas reaching their peak in the summer months and ski areas
reaching their peak in the winter months. Since ResortQuest's properties are in
markets that guests must travel to get to, high fuel prices, airline flight
availability, less disposable income and poor weather conditions can have an
unfavorable impact on its business.
12
ResortQuest's real estate brokerage services are concentrated in the
Northwest Florida market, which accounted for 74% of the aggregate real estate
brokerage revenue earned by ResortQuest during 2008. ResortQuest provides real
estate brokerage services to resort developers on new construction projects, and
also represents other sellers and buyers in the resort and residential resale
market. ResortQuest's revenues from these activities tend to be cyclical, and
experience the same volatility that residential real estate and new construction
markets experience. Since acquisition, the residential real estate market in
Northwest Florida and elsewhere in the U.S. has suffered from oversupply and
declining prices that have adversely affected ResortQuest's business.
ResortQuest is in the services business with minimal working capital
needs, minimal investment in property, plant and equipment and relatively little
expenditures required for technology. The vast majority of ResortQuest's
expenses relates to employees' compensation and benefits, or to service
providers when ResortQuest chooses to outsource to a vendor. As of December 31,
2008, ResortQuest had approximately 1,200 full-time employees.
Sales and Marketing
ResortQuest serves five types of customers: owners of individual vacation
rental homes, guests staying in those homes, owners selling their homes, clients
buying homes and homeowner association boards. ResortQuest markets homeowner
properties via the internet, direct mail and publications. Marketing includes
promoting ResortQuest as a provider of quality management services and promoting
the homeowners' properties as attractive places to vacation. Marketing to rental
property guests and potential home buyers occurs at local, regional and national
levels depending on the location. Community presence and reputation are also an
important part of ResortQuest's marketing programs.
Competition
ResortQuest's competition is fragmented and varies by service and
location. Vacation rental management competitors include other homeowner
vacation rental management companies similar to ResortQuest, developers that
manage their own resort properties and homeowners that market their property
directly to the consumer. When residential real estate market conditions change,
the composition of ResortQuest's competition can also change. In some locations
developers have opted out of the vacation rental business, providing greater
opportunities for ResortQuest. In other locations, market conditions have
encouraged new competitors to enter the market, including the direct homeowner
rental management business, which allows homeowners to market their own homes on
websites. These types of websites provide a low cost of entry to market rental
properties and relative ease in handling a potential guest. Real estate
brokerage service competitors are national, regional and local real estate
brokerage companies and developers that market their own projects.
Gaming Entertainment
Acquisition
Acquired during 2006, the Company owns approximately 61% of Premier's
common units and all of Premier's preferred units, which accrue an annual
preferred return of 17%. The Company also acquired Premier's junior subordinated
note due August 2012 during 2006, and during 2007 provided Premier with a
$180,000,000 senior secured credit facility to partially fund Premier's
bankruptcy plan of reorganization (discussed below). At December 31, 2008, the
Company's aggregate investment in Premier was $249,600,000. At acquisition, the
Company consolidated Premier as a result of its controlling voting interest;
during the pendency of bankruptcy proceedings Premier was deconsolidated and
accounted for under the equity method.
Plan of Reorganization
Premier owns the Hard Rock Hotel & Casino Biloxi, located in Biloxi,
Mississippi, which opened to the public on June 30, 2007. The Hard Rock Biloxi
was scheduled to open to the public on August 31, 2005; however, two days prior
to opening, Hurricane Katrina hit the Mississippi Gulf Coast and severely
damaged the hotel and related structures and completely destroyed the casino. On
September 19, 2006, Premier and its subsidiary filed voluntary petitions for
reorganization under chapter 11 of title 11 of the United States Bankruptcy Code
before the United States Bankruptcy Court for the Southern District of
Mississippi, Southern Division. Premier filed its petitions in order to seek the
court's assistance in gaining access to Hurricane Katrina-related insurance
proceeds (an aggregate of $161,200,000) which had been denied to Premier by its
pre-petition secured bondholders.
13
Premier filed an amended disclosure statement and plan of reorganization
on February 22, 2007 which provided for the payment in full of all of Premier's
creditors, including payment of principal and accrued interest due to the
holders of Premier's 10 3/4% senior secured notes at par (the "Premier Notes").
On July 30, 2007, the court entered an order confirming the plan, subject to a
modification which Premier filed on August 1, 2007; Premier emerged from
bankruptcy and once again became a consolidated subsidiary of the Company on
August 10, 2007. The plan was funded in part with the $180,000,000 senior
secured credit facility provided by a subsidiary of the Company. The credit
facility matures on February 1, 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 governing the Premier Notes.
The former holders of the Premier Notes argued that they were entitled to
liquidated damages under the indenture governing the Premier Notes, and as such
are entitled to more than the principal amount of the notes plus accrued
interest that was paid to them at emergence. Although the Company does not agree
with the position taken by the Premier noteholders, in order to have the plan
confirmed so that Premier could complete reconstruction of its property and open
its business without further delay, the Company agreed to fund an escrow account
to cover the Premier noteholders' claim for additional damages in the amount of
$13,700,000, and a second escrow account for the trustee's reasonable legal fees
and expenses in the amount of $1,000,000. Entitlement to the escrowed funds has
yet to be determined by the bankruptcy court, as an appeal to the plan
confirmation was filed by certain of the Premier noteholders. A hearing on the
appeal was held on February 2, 2009 before the United States Court of Appeals
for the Fifth Circuit; a decision on the appeal may be made within 60 days. The
Company believes it is probable that the court will approve payment of legal
fees and expenses and has fully reserved for that contingency. The Company
believes it is reasonably possible that the bankruptcy court will find in favor
of the Premier noteholders with respect to the additional damages escrow;
however, any potential loss can not be reasonably estimated. Accordingly, the
Company has not accrued a loss for the additional damages contingency.
Business Description
The Hard Rock Hotel & Casino is located on an 8.5 acre site on the
Mississippi Gulf Coast and has approximately 1,300 slot machines, 56 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. At December 31, 2008, Premier had approximately 700 full-time
employees.
Premier's marketing strategy is to position the resort as a full service
gaming, boutique hotel and entertainment resort catering to the Mississippi Gulf
Coast marketplace and the southern region of the U.S. The Mississippi Gulf Coast
region is located along the Interstate 10 corridor and is within a ninety minute
drive from the New Orleans metropolitan area, Mobile, Alabama and the Florida
panhandle. Premier's primary means of marketing utilizes its database of
customers for direct mail campaigns and promotional giveaways designed to reward
customers and generate loyalty and repeat visits. In addition, Premier benefits
from the "Hard Rock" brand name which appeals to a broad range of customers and
from its superior location, which is within walking distance of the Beau Rivage,
an MGM Mirage property and the largest hotel and casino in the Mississippi Gulf
Coast market.
Premier's current insurance policy provides up to $253,000,000 in
coverage for damage to real and personal property including business
interruption coverage. The coverage is led by Lloyds of London and is comprised
of a $50,000,000 primary layer and five excess layers. The coverage is
syndicated through several insurance carriers, each with an A.M. Best Rating of
A- (Excellent) or better. Although the insurance policy is an all risk policy,
any loss resulting from a weather catastrophe occurrence, which is defined to
include damage caused by a named storm, is sublimited to $100,000,000 with a
deductible of $5,000,000.
Competition
Premier faces significant competition primarily from nine other gaming
operations in the Mississippi Gulf Coast gaming market and secondarily from
gaming operations in Baton Rouge and New Orleans, Louisiana. Other competition
comes from gaming operations in Lake Charles, Bossier City and Shreveport,
Louisiana; Tunica and Philadelphia, Mississippi; Tampa and Hollywood, Florida
and other states.
The Hard Rock Biloxi was the last gaming operation to open in Biloxi
following Hurricane Katrina. The Hard Rock Biloxi has made progress establishing
its customer database and instituting customer loyalty programs resulting in
growth in market share of the local gaming market. Current unfavorable economic
conditions are likely to have a negative impact on the local gaming market in
2009, which could cause competition among gaming operations in Biloxi to
escalate. Since its competitors in the Mississippi Gulf Coast gaming market have
been in operation longer than Premier they have more established gaming
operations and customer databases. Many are larger and have greater financial
resources than Premier.
14
Government Regulation
The gaming industry in Mississippi is highly regulated. Premier, its
ownership and management are subject 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 Premier to hold various
licenses, registrations and permits and to obtain various approvals for a
variety of matters. In order to continue operating, Premier 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 Premier's
business. Premier believes it is currently in compliance with all governmental
rules and regulations.
Domestic Real Estate
At December 31, 2008, the Company's aggregate net investment in all
domestic real estate projects was $286,400,000. The real estate operations
include a mixture of commercial properties, residential land development
projects and other unimproved land, all in various stages of development.
Certain of the Company's real estate investments and their respective
book values as of December 31, 2008 include: approximately 104 acres of land
located in Myrtle Beach, South Carolina, a large scale mixed-use development
project with various residential, retail and commercial space ($165,900,000);
approximately 76 acres of land located on the island of Islesboro, Maine
(currently under review for approval of 13 residential waterfront lots) and 46
fully developed residential lots on approximately 120 acres of land located in
Rockport, Maine on Penobscot Bay, ($42,300,000 in the aggregate); a 15 acre,
unentitled air rights parcel above the train tracks behind Union Station in
Washington, D.C. ($11,000,000); an operating shopping center on Long Island, New
York that has 71,000 square feet of retail space ($13,300,000); and an
approximate 540 acre parcel located in San Miguel County, Colorado that the
Company is attempting to have re-zoned into a mixture of estate lots, cabins and
a lodge site ($5,700,000). The 540 acre parcel is located near Mountain Village,
Colorado, a ski resort bordering Telluride, Colorado. As of December 31, 2008,
non-recourse indebtedness secured by the company's real estate projects was
$90,200,000, all of which was incurred in connection with the Myrtle Beach
project. Phase I of the Myrtle Beach project included all retail and commercial
space which is fully constructed and leased; the Phase II residential section of
the project is currently under development.
Residential property sales volume, prices and new building starts have
declined significantly in many U.S. markets, including markets in which the
Company has real estate projects in various stages of development. The slowdown
in residential sales has been exacerbated by the turmoil in the mortgage lending
and credit markets during the past two years, which has resulted in stricter
lending standards and reduced liquidity for prospective home buyers. The Company
is not actively soliciting bids for developed and undeveloped lots in Maine, and
has deferred its development plans for certain other projects as well. The
Company intends to wait for market conditions to improve before marketing
certain of its projects for sale.
In October 2007, the Company entered into an agreement with the Panama
City-Bay County Airport and Industrial District of Panama City, Florida to
purchase approximately 708 acres of land which currently houses the Panama
City-Bay County International Airport. The Company has placed $56,500,000 into
escrow; the transaction will close and title to the land will pass only after
the city completes construction of a new airport and moves the airport
operations to its new location. Prior to closing, all interest earned on the
escrow account is for the benefit of the Company and may be withdrawn at any
time. If construction on the new airport has not begun by October 2009, or if
construction is not completed by April 2012, the Company has the right to
terminate the agreement and receive a full refund of the escrowed funds. If the
transaction closes, the Company intends to develop the property into a mixed use
community with residential, retail, commercial, educational and office sites.
The Company owns approximately 31.4% of the outstanding common stock of
HomeFed. In addition, as a result of a 1998 distribution to all of the Company's
shareholders, approximately 7.7% and 9.4% of HomeFed is owned by the Company's
Chairman and President, respectively. HomeFed is currently engaged, directly and
through subsidiaries, in the investment in and development of residential real
estate projects in the State of California. Its current development projects
consist of two master-planned communities located in San Diego County,
California: San Elijo Hills and a portion of the larger Otay Ranch planning
area. The Company accounts for its investment in HomeFed under the equity method
of accounting. At December 31, 2008, its investment had a carrying value of
$44,100,000, which is included in investments in associated companies. HomeFed
is a public company traded on the NASD OTC Bulletin Board (Symbol: HOFD).
15
The real estate development industry is subject to substantial
environmental, building, construction, zoning and real estate regulations that
are imposed by various federal, state and local authorities. In order to develop
its properties, the Company must obtain the approval of numerous governmental
agencies regarding such matters as permitted land uses, density, the
installation of utility services (such as water, sewer, gas, electric, telephone
and cable television) and the dedication of acreage for various community
purposes. Furthermore, changes in prevailing local circumstances or applicable
laws may require additional approvals or modifications of approvals previously
obtained. Delays in obtaining required approvals and authorizations could
adversely affect the profitability of the Company's projects.
Medical Product Development
Business
At December 31, 2008, the Company owned approximately 89% of Sangart, a
biopharmaceutical company principally engaged in developing an oxygen transport
agent for various medical uses. From 2003 through December 31, 2008, the Company
invested an aggregate of $117,700,000 in Sangart, principally to help fund
Sangart's ongoing product development activities (as a development stage
company, Sangart does not have any revenues from product sales). Since
inception, the Company has recorded Sangart losses of $106,200,000, resulting
from product development expenses and Sangart's overhead costs. In the first
quarter of 2009, the Company invested an additional $28,500,000 in Sangart upon
the exercise of its remaining warrants, which increased its ownership interest
to approximately 92%. Sangart became a consolidated subsidiary of the Company in
2005; the book value of the Company's investment in Sangart was $12,600,000 at
December 31, 2008.
In 2002, Sangart commenced human clinical trials of its current product
candidate, Hemospan(R), a solution of cell-free hemoglobin administered
intravenously to treat a variety of medical conditions, including use as an
alternative to red blood cell transfusions. A principal function of human blood
is to transport oxygen throughout the body, the absence of which can cause organ
dysfunction or death. The basis for Sangart's technology is the result of more
than 20 years of research in the understanding of how hemoglobin (the oxygen
carrier in red blood cells) functions outside of red blood cells in a cell-free
environment. Hemospan offers universal compatibility with all blood types and,
as compared to red blood cell transfusions, reduced risk of infectious disease
transmission and a longer storage life. Hemospan is made from purified human
hemoglobin that is extracted from outdated human blood obtained from accredited
blood centers, which is then bound to polyethylene glycol molecules using
Sangart's proprietary processes. Sangart's manufacturing process is able to
generate approximately four units of Hemospan using a single unit of blood,
which serves to expand the supply of donated blood. Sangart owns or exclusively
licenses thirteen U.S. patents and has more than thirty applications pending
worldwide covering product composition, manufacturing or methods of use. Patents
applicable to Hemospan do not begin to expire prior to 2017.
Sangart has previously completed five Phase I and Phase II human clinical
studies designed to assess product safety and gather preliminary indications of
the product's effectiveness. In 2007 and 2008 Sangart conducted two Phase III
clinical trials that were designed to demonstrate Hemospan's safety and
effectiveness in preventing and treating low blood pressure during orthopedic
hip replacement surgeries and in reducing the incidence of operative and
postoperative complications. The Phase III studies were conducted in six
countries in Europe and enrolled a total of 850 patients, including patients in
control groups treated with a different product.
Data from the Phase III clinical trials have been analyzed internally. No
major clinically important safety concerns were identified, though in the Phase
III prevention study there was a slightly higher incidence of adverse events in
the Hemospan-treated patients than in the control group. However, because these
Phase III trials were conducted in a patient population having a relatively low
incidence of medical complications, these studies were unable to demonstrate a
clinical benefit of better outcomes than the control group. Sangart has decided
not to pursue marketing approval to use Hemospan for these purposes at this
time, but plans to conduct additional clinical trials of Hemospan in a different
therapeutic area that may better demonstrate its clinical benefit and strengthen
the likelihood of regulatory approval. Sangart is currently in the process of
identifying relevant patient populations and planning additional clinical
trials, which will take several years to complete at substantial cost. Until
these additional Phase II and Phase III studies are successfully completed,
Sangart will not be able to request marketing approval and generate revenues
from Hemospan sales.
16
Substantially all of the funding needed for Hemospan development has come
from sales of Sangart's equity securities. The additional investment the Company
made in 2009, along with Sangart's existing cash resources is expected to
provide Sangart with sufficient capital to fund activities into 2010.
Thereafter, significant additional funding will be needed for product
development and clinical trial activities prior to regulatory approval and
commercial launch; the source of such funding has not as yet been determined.
Competitive Environment
Hemospan is intended to be used as a therapeutic oxygen transport agent
in clinical and trauma situations where tissues are at risk of inadequate blood
flow and oxygenation. Hemospan may provide an alternative to red cell
transfusion or act as a temporary oxygenation bridge until red cells become
available. Currently there are no similar products approved for sale in the U.S.
or the European Union; however, other companies are developing products that
could potentially compete with Hemospan.
Any successful commercialization of Hemospan will depend on an adequate
supply of raw materials, principally human red blood cells and polyethylene
glycol, at an acceptable quality, quantity and price. Sangart has contracted for
commercial launch quantities of human red blood cells, though commitments for
commercial-scale quantities of polyethylene glycol have not yet been secured.
Sangart leases a 56,700 square foot combination office and manufacturing
facility that currently produces Hemospan for its clinical trials. Sangart
believes that its current manufacturing facility would have adequate capacity to
support a commercial launch, but significant capital improvements and
engineering designs would be required or an alternative manufacturing site would
need to be acquired for commercial production. In addition to obtaining
requisite regulatory approvals and increasing manufacturing capacity for the
manufacture and sale of Hemospan, Sangart would have to create sales, marketing
and distribution capabilities prior to any commercial launch of this product,
either directly or in partnership with a service provider.
Government Regulation
As a product intended for medical use, clinical trials, marketing
approval, manufacturing and distribution of Hemospan is highly regulated. An
application for marketing approval may only be made after the safety and
effectiveness of the product has been demonstrated, including through human
clinical trial data. In the U.S., the U.S. Food and Drug Administration
regulates medical products, including the category known as "biologics", which
includes Hemospan. The Federal Food, Drug and Cosmetic Act and the Public Health
Service Act govern the testing, manufacture, safety, effectiveness, labeling,
storage, record keeping, approval, advertising and promotion of Hemospan.
In Europe, each country has its own agency that regulates clinical
trials. However, the Committee for Medicinal Products for Human Use ("CHMP"),
which is administered by the European Agency for the Evaluation of Medicinal
Products, is an EU-wide regulatory body. Following completion of clinical
trials, marketing approval can be granted either by a centralized application
through CHMP, or on a decentralized basis by one or more selected countries.
Other Operations
Wineries
The Company owns three wineries, Pine Ridge Winery in Napa Valley,
California, Archery Summit in the Willamette Valley of Oregon and Chamisal
Vineyards (aka Domaine Alfred) in the Edna Valley of California. Pine Ridge was
acquired in 1991 and has been conducting operations since 1978, the Company
started Archery Summit in 1993 and Chamisal Vineyards was acquired during 2008
and has been conducting operations since 1973. The Company's investment in
winery operations has grown, principally to fund the acquisition of land for
vineyard development, construct and develop Archery Summit, acquire Chamisal
Vineyards and increase production capacity and storage facilities at the
wineries. It can take up to five years for a new vineyard property to reach full
production and, depending upon the varietal produced, up to three years after
grape harvest before the wine can be sold. The Company controls approximately
223 acres of vineyards in Napa Valley, California, 120 acres of vineyards in the
Willamette Valley of Oregon and 82 acres of vineyards in the Edna Valley of
California, substantially all of which are owned and producing grapes. The
Company believes that its vineyards are located in some of the most highly
regarded appellations and areas of the Napa, Willamette and Edna Valleys. At
December 31, 2008, the Company's combined net investment in these wineries was
$90,800,000. The wineries sold approximately 90,000 9-liter equivalent cases of
wine generating revenues of $20,900,000 during 2008 and 68,000 9-liter
equivalent cases of wine generating revenues of $18,500,000 during 2007.
Additionally, in 2005 and 2006, the Company acquired an aggregate of 611 acres
of land in the Horse Heaven Hills of Washington's Columbia Valley, of which
approximately 85 acres are under vineyard development. At December 31, 2008, the
Company's total investment in the Washington vineyard property was $8,000,000.
17
These wineries primarily produce and sell wines in the very competitive
ultra premium and luxury segments of the premium table wine market. The
Company's wines are primarily sold to distributors, who then sell to retailers
and restaurants. As permitted under federal and local regulations, the wineries
have also been placing increasing emphasis on sales direct to consumers, which
they are able to do through the internet, wine clubs and at the wineries'
tasting rooms. During 2008, direct sales to consumers represented 21% of case
sales and 49% of wine revenues. Wholesale sales of the Company's wines in
California (excluding direct sales to consumers) amounted to approximately 20%
of 2008 wholesale wine revenues.
The Company's wines compete with small and large producers in the U.S.,
as well as with imported wines, and the ultimate consumer has many choices.
Demand for wine in the ultra premium and luxury market segments can rise and
fall with general economic conditions, and is also significantly affected by
grape supply. While the Company's current vineyard holdings in the Napa,
Willamette and Edna valleys will continue to be the most significant source for
its wine products in the immediate future, the Company also supplements certain
brands with purchased fruit to meet demand for its products and to provide the
raw materials for the launch of new products. The demand for the Company's wines
is also affected by the ratings given the Company's wines in industry and
consumer publications.
The wineries' production, sales and distribution activities are subject
to regulation by agencies of both federal and state governments. State
regulations that prohibited or restricted sales of wine direct to consumers by
producers that are located in another state continue to be amended or overturned
to permit increased direct sales to consumers in other states. For the year
ended December 31, 2008, the Company sold wine direct to consumers in 38 states
across the U.S.
Energy Projects
During the past few years, the Company has been incurring costs to
investigate and evaluate the development of a number of large scale domestic
energy projects. Certain of the large scale projects employ gasification
technology to convert different types of low grade fossil fuels into clean
energy products. The Company has also invested in certain energy projects that
do not employ gasification technologies, one of which is described below. The
Company has expensed costs to investigate, evaluate and obtain various permits
and approvals for its various energy projects of $33,600,000, $21,000,000 and
$8,300,000 during the years ended December 31, 2008, 2007 and 2006,
respectively.
Although there are a number of large scale projects the Company is
currently investigating, the Company is not obligated to develop any of the
projects, and no assurance can be given that the Company will be successful in
fully developing any of these projects. Any project that the Company might
develop would likely require a significant equity investment, which the Company
presently does not intend to fund by itself, the acquisition of substantial
non-recourse borrowings to build the projects (total development costs for these
types of projects range from $1 billion to $3 billion), the procurement of
purchase commitments for long-term supplies of feedstock, long-term commitments
from purchasers of the output, and significant technological and engineering
expertise to implement. The investigation, evaluation and financing of these
large scale projects take years to complete.
The Company is currently evaluating a gasification project, which would
be built in Louisiana. In April 2008, the Lake Charles Harbor & Terminal
District of Lake Charles, Louisiana sold $1,000,000,000 in tax exempt bonds that
will support the development of a $1,600,000,000 petroleum coke gasification
plant project by the Company's wholly-owned subsidiary, Lake Charles
Cogeneration LLC ("LCC"). The Lake Charles Cogeneration project is a new
chemical manufacturing project planning to use quench gasification technology to
produce energy products from low grade solid fuel sources such as petroleum
coke. The primary product to be produced by the Lake Charles Cogeneration
project will be substitute natural gas.
18
LCC does not currently have access to the bond proceeds, which are being
held in an escrow account by the bond trustee, and it will not have access to
the bond proceeds until certain conditions are satisfied. Upon the completion of
pending permitting, regulatory approval, design engineering and the satisfaction
of certain other conditions of the financing agreements, the bonds will be
remarketed for a longer term and the proceeds will be released to LCC to use for
the payment of development and construction costs for the project. If all
conditions have been met and LCC begins to draw down on the bond proceeds, any
amounts drawn will be recorded as long-term indebtedness of LCC and reflected on
the Company's consolidated balance sheet. The Company is not obligated to make
equity contributions to LCC until it completes its investigation and the project
is approved by the Company's board of directors.
A subsidiary of the Company has acquired a leasehold interest and
certain permits to construct and operate an onshore liquefied natural gas
("LNG") receiving terminal and associated facilities on the Skipanon Peninsula
near the confluence of the Skipanon and Columbia Rivers in Warrenton, Clatsop
County, Oregon. The project includes construction of an offshore dock and berth
for offloading LNG carriers, onshore facilities to receive and store up to
480,000 cubic meters of LNG and vaporizers to regasify LNG at a baseload rate of
1 billion standard cubic feet per day ("bscfd") with a peak rate of 1.5 bscfd.
The current plan includes construction of an approximate 121 mile long 36-inch
diameter natural gas pipeline to transport regasified natural gas to the U.S.
natural gas transmission grid, which in turn will interconnect with other
natural gas pipelines, including the interstate transmission system of Williams
Northwest Pipeline at the Molalla Gate Station in Molalla, Oregon. In addition,
a new 10 mile long 24-inch diameter lateral pipeline will be constructed to
connect the pipeline to a local storage facility. Numerous regulatory permits
and approvals and acquisitions of rights of way for the pipeline will be
required before project construction can commence; construction of the receiving
terminal and associated facilities is expected to begin in the fourth quarter of
2010 and construction of the pipeline is expected to begin in the fourth quarter
of 2011. Completion of the project is also subject to obtaining significant
financing from third parties which has not been arranged; the current estimated
project cost is $1,300,000,000.
Other Investments
AmeriCredit Corp.
As of December 31, 2008, the Company had acquired approximately 25% of
the outstanding common shares of ACF, a company listed on the NYSE (Symbol: ACF)
for aggregate cash consideration of $405,300,000. ACF is an independent auto
finance company that is in the business of purchasing and servicing automobile
sales finance contracts, historically for consumers who are typically unable to
obtain financing from other sources. At December 31, 2008, the Company's
investment in ACF is classified as an investment in an associated company and
carried at fair value of $249,900,000.
The Company has entered into a standstill agreement with ACF for the two
year period ending March 3, 2010, pursuant to which the Company has agreed not
to sell its shares if the buyer would own more than 4.9% of the outstanding
shares, unless the buyer agreed to be bound by terms of the standstill
agreement, to not increase its ownership interest to more than 30% of the
outstanding ACF common shares, and received the right to nominate two directors
to the board of directors of ACF. The Company and ACF have entered into a
registration rights agreement covering all of the ACF shares of common stock
owned by the Company.
Effective January 1, 2008, the Company adopted Statement of Financial
Accounting Standards No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities - Including an amendment of FASB Statement No. 115" ("SFAS
159"). SFAS 159 permits entities to choose to measure many financial instruments
and certain other items at fair value (the "fair value option"), and to report
unrealized gains and losses on items for which the fair value option is elected
in earnings. The Company elected the fair value option for its investment in
ACF, rather than apply the equity method of accounting. For the year ended
December 31, 2008, income (losses) related to associated companies includes
unrealized losses resulting from changes in the fair value of ACF of
$155,300,000.
19
Subsequent to December 31, 2008, the aggregate market value of the
Company's investment in ACF declined to $126,900,000 at February 20, 2009. If
the aggregate market value of the Company's investment in ACF remains unchanged
at March 31, 2009, this decline in market value would result in the recognition
of an unrealized loss during the first quarter of 2009 of $123,000,000. Further
declines in market values are also possible, which would result in the
recognition of additional unrealized losses in the consolidated statement of
operations.
Jefferies Group, Inc.
In April 2008, the Company sold to Jefferies 10,000,000 of the Company's
common shares, and received 26,585,310 shares of common stock of Jefferies and
$100,021,000 in cash. The Jefferies common shares were valued based on the
closing price of the Jefferies common stock on April 18, 2008, the last trading
date prior to the acquisition ($398,248,000 in the aggregate). Including shares
acquired in open market purchases during 2008, as of December 31, 2008, the
Company owns an aggregate of 48,585,385 Jefferies common shares (approximately
30% of the Jefferies outstanding common shares) for a total investment of
$794,400,000. At December 31, 2008, the Company's investment in Jefferies is
classified as an investment in an associated company and is carried at fair
value of $683,100,000. The Company elected the fair value option to account for
its investment in Jefferies rather than the equity method of accounting; for the
year ended December 31, 2008 income (losses) related to associated companies
includes unrealized losses resulting from changes in the fair value of Jefferies
of $111,200,000. Jefferies, a company listed on the NYSE (Symbol: JEF), is a
full-service global investment bank and institutional securities firm serving
companies and their investors.
Subsequent to December 31, 2008, the aggregate market value of the
Company's investment in Jefferies declined to $529,600,000 at February 20, 2009.
If the aggregate market value of the Company's investment in Jefferies remains
unchanged at March 31, 2009, this decline in market value would result in the
recognition of an unrealized loss during the first quarter of 2009 of
$153,500,000. Further declines in market values are also possible, which would
result in the recognition of additional unrealized losses in the consolidated
statement of operations.
The Company has entered into a standstill agreement with Jefferies,
pursuant to which for the two year period ending April 21, 2010, the Company
agreed, subject to certain provisions, to limit its investment in Jefferies to
not more than 30% of the outstanding Jefferies common shares and to not sell its
investment, and received the right to nominate two directors to the board of
directors of Jefferies. Jefferies also agreed to enter into a registration
rights agreement covering all of the Jefferies shares of common stock owned by
the Company.
Jefferies High Yield Holdings, LLC
During 2007, the Company and Jefferies formed JHYH, a newly formed
entity, and the Company and Jefferies each initially committed to invest
$600,000,000. The Company invested $250,000,000 in cash plus its $100,000,000
investment in JPOF II during 2007; any request for additional capital
contributions from the Company will now require the consent of the Company's
designees to the Jefferies board. The Company does not anticipate making
additional capital contributions in the near future. JHYH owns Jefferies High
Yield Trading, LLC ("JHYT"), a registered broker-dealer that is engaged in the
secondary sales and trading of high yield securities and special situation
securities, including bank debt, post-reorganization equity, public and private
equity, equity derivatives, credit default swaps and other financial
instruments. JHYT makes markets in high yield and distressed securities and
provides research coverage on these types of securities. JHYT does not invest or
make markets in sub-prime residential mortgage securities.
Jefferies and the Company each have the right to nominate two of a total
of four directors to JHYH's board, and each own 50% of the voting securities.
The organizational documents also permit passive investors to invest up to
$800,000,000 in JHYH. Jefferies also received additional JHYH securities
entitling it to 20% of the profits. The voting and non-voting interests are
entitled to a pro rata share of the balance of the profits of JHYH, and are
20
mandatorily redeemable in 2013, with an option to extend up to three additional
one-year periods. Under generally accepted accounting principles ("GAAP"), JHYH
is considered a variable interest entity that is consolidated by Jefferies,
since Jefferies is the primary beneficiary. The Company accounts for its
investment in JHYH under the equity method of accounting. The Company recorded
pre-tax income (losses) from this investment of $(69,100,000) and $4,300,000
during 2008 and 2007, respectively.
For the period from January 1, 2007 through March 31, 2007, and for the
year ended December 31, 2006, the Company recorded income under the equity
method of accounting from its investment in JPOF II of $3,000,000 and
$26,200,000, respectively, all of which was distributed to the Company shortly
after the end of each period. Over the seven years the Company had its
investment in JPOF II, the weighted average return on investment was
approximately 20% per year.
Fortescue
The Company has invested an aggregate of $452,200,000 in Fortescue's
Pilbara iron ore and infrastructure project in Western Australia, including
expenses. In exchange for its cash investment, the Company has received
277,986,000 common shares of Fortescue, representing approximately 9.9% of the
outstanding Fortescue common stock, and a $100,000,000 note of FMG that matures
in August 2019. Interest on the note is calculated as 4% of the revenue, net of
government royalties, invoiced from the iron ore produced from the project's
Cloud Break and Christmas Creek areas. The note is unsecured and subordinate to
the project's senior secured debt referred to below. Fortescue is a publicly
traded company on the Australian Stock Exchange, and the shares acquired by the
Company may be sold without restriction on the Australian Stock Exchange or in
accordance with applicable securities laws. The Company's investment in the
Fortescue common shares is classified as a non-current available for sale
investment and carried at market value as of each balance sheet date. At
December 31, 2008, the market value of the Fortescue common shares was
$377,000,000.
For accounting purposes, the Company allocated its initial Fortescue
investment to the common shares acquired (based on the market value at
acquisition), a 13 year zero-coupon note and a prepaid mining interest. The
zero-coupon note was recorded at an estimated initial fair value of $21,600,000,
representing the present value of the principal amount discounted at 12.5%. The
prepaid mining interest of $184,300,000 was initially classified with other
non-current assets, and is being amortized to expense as the 4% of revenue is
earned. Interest is payable semi-annually within 30 days of June 30th and
December 31st of each year; however, cash interest payments on the note are
currently being deferred due to covenants contained in the project's senior
secured debt. Any interest payment that is deferred will earn simple interest at
9.5%. The Company has recorded accrued interest on the FMG note of $40,500,000
at December 31, 2008. For informational purposes, Fortescue's recorded liability
for the FMG note on Fortescue's financial statements at December 31, 2008 was
Australian $2,180,600,000 ($1,532,100,000 at exchange rates in effect on
December 31, 2008); the ultimate value of the note will depend on the volume of
iron ore shipped and iron ore prices over the remaining term of the note, which
can fluctuate widely.
The project information presented in the paragraphs below was obtained
from Fortescue's website, (http://www.fmgl.com.au/), which contains substantial
additional information about Fortescue, its operating activities and the
project. Fortescue shipped its first iron ore in May 2008 and announced Project
Completion on July 18, 2008, a milestone defined in its debt agreements that
includes mining, railing, and shipping a minimum of 2 million tonnes of product
within a four week period. For the year ending December 31, 2008, Fortescue
mined 19.5 million tonnes of iron ore, processed 15.3 million tonnes and shipped
14.8 million tonnes. Fortescue's total revenue from iron ore sales for the year
ending December 31, 2008 was $1,071,700,000 or $72.32 per tonne shipped.
In April 2006, Fortescue announced a proved reserve estimate of 121
million metric tons of iron ore and a probable reserve estimate of 932 million
metric tons of iron ore, in accordance with the Australasian Joint Ore Reserves
Committee code. This reserve estimate is solely for the Cloud Break and
Christmas Creek mining tenements, which cover an area of approximately 770
square kilometers. Fortescue has additional tenements in the Pilbara region of
Western Australia and has since announced reserve estimates for some of its
other tenements. Although Fortescue has received all major approvals required
under the various governmental, environmental, and native title processes for
the Cloud Break and Christmas Creek tenements, it does not possess the approvals
or financing necessary for mining activities at its other tenements. Mining
revenues derived from tenements other than Cloud Break and Christmas Creek do
not increase the interest payable to the Company on the FMG note.
Fortescue's initial feasibility study was commissioned to identify a
quantity and quality of iron ore that would support an initial mine plan that
produces 45 million metric tons per annum ("mtpa") for a 20 year period.
Fortescue has since launched an optimization program and increased its base
mining plan to 55 mtpa. Fortescue has announced agreements with third parties,
including relationships with the largest Chinese steel mills, which intend to
21
purchase all of the initial 45 mtpa production as well as an additional 50 mtpa
of expansion tonnage. The pricing for these agreements is based on the first
negotiated price between any of the world's largest steel mills and one of the
world's three largest iron ore producers.
In addition to the Company's investment and equity investments from
other parties, Fortescue raised $2,051,000,000 of senior secured debt to fund
the construction of its infrastructure, which includes a 260 kilometer railroad,
port and related port infrastructure at Port Hedland, Australia, as well as a
crushing and screening plant, access roads and other infrastructure at the mine
site. All of the construction on the initial project as well as the optimization
program to expand production to 55 mtpa has been completed. In February 2009,
Fortescue announced that it had entered into a share subscription agreement with
Hunan Valin Iron and Steel Group Company Ltd. ("Valin") pursuant to which Valin
will purchase 225 million new shares issued by Fortescue at Australian $2.48 per
share, for a total investment of Australian $558,000,000. Closing of the
transaction is subject to regulatory approval in Australia.
Goober Drilling
During 2006, the Company acquired a 30% limited liability company
interest in Goober Drilling for aggregate consideration of $60,000,000,
excluding expenses, and agreed to lend to Goober Drilling, on a secured basis,
up to $126,000,000 to finance new rig equipment purchases and construction costs
and to repay existing debt. During 2007, the Company increased its equity
interest to 50% for additional payments aggregating $45,000,000. In addition,
the credit facility was amended to increase the borrowing capacity to
$138,500,000 and the interest rate to LIBOR plus 5%, the Company provided Goober
Drilling with an additional secured credit facility of $45,000,000 at an
interest rate of LIBOR plus 10%, and the Company provided another secured credit
facility of $15,000,000 at an interest rate at the greater of 8% or LIBOR plus
2.6%. At December 31, 2008, the aggregate outstanding loan amount was
$144,400,000 excluding accrued interest, and the Company's aggregate net
investment in Goober Drilling was $252,400,000.
Goober Drilling is a land based contract oil and gas drilling company
based in Stillwater, Oklahoma that provides drilling services to oil and natural
gas exploration and production companies in the Mid-Continent Region of the U.S.
The majority of wells drilled are natural gas wells. Goober Drilling currently
operates drilling rigs in Oklahoma, Texas and Arkansas. Goober Drilling, which
has been in business since 1991, typically generates revenues through drilling
contracts based on daily rates, footage (charged by depth of the well) or based
on a turnkey contract (fixed price to drill a well). In 2008, the majority of
drilling services were performed on a "day work" or daily rate basis. Goober
Drilling supplies the drilling rig and all ancillary equipment and drilling
personnel.
The contract drilling business is highly competitive. Customers award
contracts to contract drillers based on factors such as price, rig availability,
quality of service, proximity to the well site, experience with the specific
geological formation, condition and type of equipment, reputation, safety of
operations and customer relationships. Contracts for drilling services may be
awarded based solely on price.
Goober Drilling's business volume and profitability is significantly
affected by the actual and anticipated price of natural gas and levels of
natural gas in storage. The natural gas exploration and production industry is
cyclical and the level of exploration and production activity has historically
been very volatile. During periods of lower levels of drilling activity, price
competition for drilling services tends to increase which may result in reduced
revenues and profitability; conversely, during periods of increased drilling
activity drilling rigs are in demand often resulting in higher prices and
contractual commitments from customers to obtain exclusive use of a particular
rig for a longer term. Seasonality does not significantly impact Goober
Drilling's business or operations.
Additionally, the drilling activity of oil and natural gas exploration
and production companies is strongly affected by their ability to access the
capital markets. During the second half of 2008, at a time when oil and natural
gas prices were declining significantly, there was also a substantial reduction
of liquidity in the capital markets due to the deteriorating national and global
economic environment. Many of Goober Drilling's customers have reduced their
spending plans for exploration, production and development activities resulting
in decreased demand for Goober Drilling rigs. Decreases in drilling activity and
spending for any sustained period of time will cause a reduction in Goober
Drilling's daily rates, utilization rates and profitability.
As of December 31, 2008, Goober Drilling had 37 drilling rigs, of which 8
are under contract for a 1 to 3 year term, 10 are operating under term contracts
that will expire within the next 12 months, 4 are under well-to-well contracts
with specific customers, 3 are "floaters" or rigs that are made available on the
spot market and 12 are not currently in use. In addition, Goober Drilling is
building one rig subject to a three year term contract that is anticipated to be
placed in service in the second quarter of 2009. Components for the new rig were
purchased prior to the recent downturn in drilling activity.
22
CLC
CLC is a Spanish company that holds the exploration and mineral rights to
the Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet, a Canadian-based
global mining company traded on the Toronto stock exchange (Symbol: IMN). Inmet
acquired the interest in CLC in exchange for 5,600,000 newly issued Inmet common
shares, representing approximately 11.6% of Inmet's current outstanding common
shares. Although the Inmet shares have registration rights, they may not be sold
until the earlier of August 2009 or the date on which the Company is no longer
obligated under the guarantee discussed below. The Inmet shares are reflected on
the Company's consolidated balance sheet at their fair value of approximately
$90,000,000 at December 31, 2008. The Company retains a 30% interest in CLC.
CLC entered into an agreement with third party lenders for project
financing consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000 to finance subsidies and value-added tax. The Company and Inmet
have guaranteed 30% and 70%, respectively, of the obligations outstanding under
both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2008, approximately $215,000,000 was
outstanding under the senior secured credit facility and (euro)47,000,000 was
outstanding under the senior secured bridge credit facility. There is no more
borrowing capacity under either facility. The Company and Inmet have also
committed to provide financing to CLC which is currently estimated to be
(euro)340,000,000 ($436,100,000 at exchange rates in effect on February 20,
2009), of which the Company's share will be 30% ((euro)77,600,000 of which has
been loaned as of December 31, 2008). CLC's senior secured credit facilities
restrict CLC's ability to make distributions to Inmet and the Company; assuming
CLC achieves its mining plan, the Company would not expect to receive
distributions before 2010.
Inmet has reported that the Las Cruces deposit contains approximately 9.8
million tons of proven reserves and 7.8 million tons of probable reserves of
copper ore at an average grade of 6.2% copper. The reserve estimates are for the
entire deposit, not just the Company's share, assume a copper price of $1.10 per
pound, an exchange rate (euro)1.00 = US$1.20, incorporate losses for mining
dilution and recovery, an open pit cut-off grade of 1 percent copper and an
underground cut-off grade of 3 percent copper. The capital costs to build the
project are currently estimated at (euro)504,000,000 ($646,400,000 at exchange
rates in effect on February 20, 2009), including working capital, land
purchases, and contingencies, but excluding reclamation bonding requirements,
inflation, interest during construction, cost overruns and other financing
costs. Cash operating costs per pound of copper produced over the life of the
mine are expected to average (euro)0.49 per pound ($0.63 per pound) of copper
produced. The project's capital and operating costs are paid for in euros, while
copper revenues during the life of the mine are currently based on the U.S.
dollar. In order to minimize its exposure to currency fluctuations, CLC entered
into an agreement when it obtained its financing to swap (euro)171,000,000 of
euro denominated debt into $215,000,000 of U.S. dollar denominated debt. The
debt was fully converted into U.S. dollar denominated debt on June 30, 2008.
Garcadia
The Company has entered into a joint venture agreement with Garff
Enterprises, Inc. ("Garff") pursuant to which the joint venture has acquired
various automobile dealerships in various subsidiary companies ("Garcadia"). The
joint venture agreement specifies that the Company and Garff shall have equal
board representation and equal votes on all matters affecting Garcadia, and that
all cash flows from the joint venture will be allocated 65% to the Company and
35% to Garff, which reflects that the Company made a larger equity investment.
Garcadia's strategy is to acquire automobile dealerships in secondary market
locations meeting its specified return criteria. As of December 31, 2008,
Garcadia owned 15 dealerships comprised of domestic and foreign automobile
makers. The Company has received cash distributions of fees and earnings
aggregating $6,500,000, $4,900,000 and $1,000,000 for the years ended December
31, 2008, 2007 and 2006, respectively. In addition, the Company owns the land
for certain dealerships and leases it to the dealerships for rent aggregating
$3,800,000, $1,800,000 and $700,000 for the years ended December 31, 2008, 2007
and 2006, respectively. At December 31, 2008, the Company's investment in
Garcadia (excluding the land) was classified as an investment in associated
company with a carrying value of $72,100,000.
23
Other
In June 2007, the Company invested $200,000,000 to acquire a 10% limited
partnership interest in Pershing Square, a newly-formed private investment
partnership whose investment decisions are at the sole discretion of Pershing
Square's general partner. The stated objective of Pershing Square is to create
significant capital appreciation by investing in Target Corporation. The Company
recorded losses under the equity method of accounting from this investment of
$77,700,000 and $85,500,000 in 2008 and 2007, respectively, principally
resulting from declines in the market value of Target Corporation's common
stock. At December 31, 2008, the book value of the Company's investment in
Pershing Square was $36,700,000.
In January 2007, the Company invested $25,000,000 in Shortplus, a limited
partnership which principally invests through a master fund in a short-term
based portfolio of asset-backed securities. The Company recorded pre-tax income
from this investment under the equity method of accounting of $10,500,000 and
$54,500,000 in 2008 and 2007, respectively. During 2008 the Company received a
cash distribution from Shortplus of $50,000,000; at December 31, 2008, the book
value of the Company's investment in Shortplus was $39,900,000.
The Company has invested $50,000,000 in Wintergreen, a limited
partnership that invests in domestic and foreign debt and equity securities. The
Company recorded pre-tax income (losses) from this investment under the equity
method of accounting of $(32,600,000), $14,000,000 and $11,000,000 for the years
ended December 31, 2008, 2007 and 2006, respectively. At December 31, 2008, the
book value of the Company's investment in Wintergreen was $42,900,000. The
Company expects to fully redeem its interest during 2009.
The Company owns approximately 38% of the common stock of Light & Power
Holdings Ltd., the parent company of The Barbados Light and Power Company
Limited, the primary generator and distributor of electricity in Barbados. At
December 31, 2008, the Company's investment of $18,800,000 was accounted for on
the cost method of accounting, due to currency exchange restrictions and stock
transfer restrictions.
The Company beneficially owns equity interests representing more than 5%
of the outstanding capital stock of each of the following domestic public
companies at February 20, 2009 (determined in accordance with Rule 13d-3 of the
Securities Exchange Act of 1934): Jefferies (29.3%), ACF (24.9%), The FINOVA
Group Inc. ("FINOVA") (25.0%), HomeFed (31.4%), International Assets Holding
Corporation (15.3%) and Essex Rental Corp. (6.6%). In addition to the Company's
equity interests in Fortescue and Inmet discussed above, the Company also owns a
7.0% equity interest in JZ Capital Partners Limited, a British company traded on
the London Stock Exchange.
For further information about the Company's business, including the
Company's investments, reference is made to Item 7, Management's Discussion and
Analysis of Financial Condition and Results of Operations of this Report and
Notes to Consolidated Financial Statements.
Item 1A. Risk Factors.
------- ------------
Our business is subject to a number of risks. You should carefully
consider the following risk factors, together with all of the other information
included or incorporated by reference in this Report, before you decide whether
to purchase our common stock. The risks set out below are not the only risks we
face. If any of the following risks occur, our business, financial condition and
results of operations could be materially adversely affected. In such case, the
trading price of our common stock could decline, and you may lose all or part of
your investment.
Future acquisitions and dispositions of our operations and investments
are possible, changing the components of our assets and liabilities, and if
unsuccessful could reduce the value of our common shares.
We are dependent on certain key personnel. We are dependent on the
services of Ian M. Cumming and Joseph S. Steinberg, our Chairman of the Board
and President, respectively. Messrs. Cumming's and Steinberg's employment
agreements with us expire June 30, 2015. These individuals are also significant
shareholders of our Company. As of February 20, 2009, Messrs. Cumming and
Steinberg and trusts for the benefit of their respective families (excluding
certain private charitable foundations) beneficially owned approximately 10.6%
and 11.7% of our outstanding common shares, respectively. Accordingly, Messrs.
Cumming and Steinberg exert significant influence over all matters requiring
approval by our shareholders, including the election or removal of directors and
the approval of mergers or other business combination transactions.
24
We operate in a variety of industries and market sectors, all of which
are very competitive and susceptible to economic downturns and are adversely
affected by the current recession. A worsening of general economic or market
conditions may result in lower valuations for our businesses or investments.
Declines in the U.S. housing market have reduced revenues and
profitability of the manufacturing businesses and may continue to do so.
The prices and availability of key raw materials affects the
profitability of our manufacturing operations, and also impacts Sangart's
ability to conduct its clinical trials.
Pricing on STi Prepaid's prepaid phone card business is highly sensitive
to price declines and subject to intense competition. We believe in some
instances our competitors offer or appear to offer rates to consumers that are
below their cost in order to gain market share. This type of pricing by one or
more of our competitors can adversely affect our revenues and profits.
STi Prepaid relies on independent distributors to generate revenues, who
may not devote sufficient efforts to promote and sell our products rather than
the products of our competitors.
The Hard Rock Biloxi is in the early stages of operations relative to its
competitors and has yet to produce significant operating income. If Premier is
unable to manage the risks inherent in the establishment of a new business
enterprise, it would negatively impact operating results, which could result in
impairment charges if the net book value of Premier's property and equipment is
deemed unrecoverable.
The Hard Rock Biloxi is dependent upon patronage of persons living in the
Gulf Coast region. Downturns in local and regional economic conditions, an
increase in competition in the surrounding area and interruptions caused by
hurricanes could negatively impact operating results.
Increases in mortgage interest rate levels or the lack of available
consumer credit could reduce consumer demand for certain of our real estate
development projects.
Sangart is subject to extensive government regulation, cannot generate
any revenue without regulatory approval of its products and is also subject to
all of the risks inherent in establishing a new business.
There are other companies developing products for the same market that
Sangart is targeting, and if they are successful in bringing their product to
market before Sangart it may significantly impair Sangart's ability to compete
in the same market segment.
Sangart's success depends on its ability to obtain, maintain and defend
patent protection for its products and technologies, preserve trade secrets and
operate without infringing the intellectual property rights of others. The
patent positions of biopharmaceutical companies, such as Sangart, are generally
uncertain and involve complex legal and factual questions. If Sangart's
intellectual property positions are challenged, invalidated, circumvented or
expire, or if Sangart fails to maintain its third-party intellectual property
licenses in good standing, its ability to successfully bring Hemospan to market
would be adversely affected, it could incur monetary liabilities or be required
to cease using the technology or product in dispute.
Goober Drilling's revenues and profitability are impacted by natural gas
supplies and prices and the supply of drilling rigs in the marketplace. During
periods of decreased demand for natural gas, Goober Drilling's rig utilization
will decline and its competitors may also have excess capacity in the
marketplace, which would adversely impact Goober Drilling's revenues and
profitability.
The lack of liquidity in the capital markets has and could continue to
adversely affect exploration, production and development activities of Goober
Drilling's customers, which causes a reduction in rig utilization and
profitability. The combination of low oil and natural gas prices and the lack of
liquidity in the capital markets have forced Goober Drilling customers to reduce
drilling programs and may impair their ability to sustain their current level of
operations and meet their cash obligations. In addition to reduced rig
utilization and profitability, which could result in impairment charges for
certain rigs, the difficulties being experienced by Goober Drilling's customers
could increase Goober Drilling's bad debt expense.
25
The Company has a substantial investment in Jefferies, an investment
banking and securities firm whose operating results are greatly affected by the
economy and financial markets. Turmoil in the equity and credit markets has had
and may continue to have an adverse effect on the volume and size of
transactions Jefferies executes for its customers, resulting in reduced revenues
and profitability in its investment banking, asset management and trading
activities, as well as losses in its principal trading activities. Declines in
Jefferies operating results could adversely affect the value of the Company's
investment.
The Company has a substantial investment in ACF, a company that purchases
automobile loans made to sub-prime and other borrowers, whose operating results
are greatly affected by the economy and financial markets. If ACF's loan losses
increase as its borrowers experience economic hardships, or if its ability to
acquire new loans and grow its business is impaired, particularly due to the
turmoil in the credit markets that ACF needs to access to fund its operating
activities, its revenues and profits would decline, adversely affecting the
value of the Company's investment.
Subsequent to December 31, 2008, ACF failed to maintain a financial
covenant in one of its credit facilities and has been granted a waiver through
March 7, 2009. ACF is currently negotiating with its credit providers to amend
its facility; however, if ACF is unsuccessful the value of the Company's
investment could decline significantly.
The Company has substantial investments in Fortescue, Inmet and CLC,
entities which are engaged in the mining of base metals (principally iron ore
and copper), the prices of which have declined during 2008 reducing the value of
the Company's investments. If these prices decline further or delays occur in
bringing the mines into production, the value of the Company's investments could
decline.
The value of the investments in the Company's defined benefit pension
plan portfolio has declined significantly, and if the values do not recover or
decline further, the Company's unfunded defined pension plan liability could
increase significantly.
We could experience significant increases in operating costs and reduced
profitability due to competition for skilled management and staff employees in
our operating businesses.
From time to time we are subject to litigation, which if adversely
determined may have a material adverse effect on our consolidated financial
condition or results of operations.
We have large investments in unconsolidated public companies, including
Fortescue, Inmet, Jefferies and ACF, each of which is subject to litigation from
time to time, and if such litigation results in material losses the value of our
investments may decline.
We may not be able to generate sufficient taxable income to fully utilize
our NOLs. At December 31, 2008, the Company has recorded a valuation allowance
against substantially all of the net deferred tax asset due to the uncertainty
about its ability to generate future taxable income to utilize that asset.
We may not be able to insure certain risks economically. We cannot be
certain that we will be able to insure all risks that we desire to insure
economically or that all of our insurers or reinsurers will be financially
viable if we make a claim. If an uninsured loss or a loss in excess of insured
limits should occur, results of operations could be adversely affected.
We did not pay dividends on our common shares in 2008 and the payment of
dividends in the future is subject to the discretion of our Board of Directors.
Our common shares are subject to transfer restrictions. We and certain of
our subsidiaries have significant NOLs and other tax attributes, the amount and
availability of which are subject to certain qualifications, limitations and
uncertainties. In order to reduce the possibility that certain changes in
ownership could result in limitations on the use of the tax attributes, our
certificate of incorporation contains provisions that generally restrict the
ability of a person or entity from acquiring ownership (including through
attribution under the tax law) of 5% or more of our common shares and the
ability of persons or entities now owning 5% or more of our common shares from
acquiring additional common shares. The restriction will remain until the
earliest of (a) December 31, 2024, (b) the repeal of Section 382 of the Internal
Revenue Code (or any comparable successor provision) and (c) the beginning of
our taxable year to which these tax attributes may no longer be carried forward.
The restriction may be waived by our Board of Directors. Shareholders are
advised to carefully monitor their ownership of our common shares and consult
their own legal advisors and/or us to determine whether their ownership of our
common shares approaches the proscribed level.
26
Item 1B. Unresolved Staff Comments.
------- -------------------------
Not applicable.
Item 2. Properties.
------ ----------
Real estate investments that are part of the Company's Domestic Real
Estate segment are described in Item 1 of this Report. Idaho Timber's plants and
sawmills, which are the principal properties used in its business are described
in Item 1 of this Report.
Through its various subsidiaries, the Company owns and utilizes
facilities in Salt Lake City, Utah for corporate office space and other
activities (totaling approximately 21,800 square feet). Subsidiaries of the
Company own facilities primarily used for plastics manufacturing located in
Georgia, Virginia and Genk, Belgium (totaling approximately 457,300 square
feet), facilities and land in California, Oregon and Washington used for winery
operations (totaling approximately 160,300 square feet and 1,138 acres,
respectively) and facilities and land in Florida, South Carolina and Colorado
used for property management and services (totaling approximately 60,800 square
feet and 13 acres, respectively).
Premier's Hard Rock Hotel & Casino facility is approximately 592,000
square feet and is located on an 8.5 acre site which includes land that is owned
by Premier and adjacent water bottom which is leased from the State of
Mississippi.
The Company and its subsidiaries lease numerous manufacturing,
warehousing, office and headquarters facilities. The facilities vary in size and
have leases expiring at various times, subject, in certain instances, to renewal
options. A subsidiary of the Company also leases space in New York, New York for
corporate and other activities (approximately 32,600 square feet). See Notes to
Consolidated Financial Statements.
Item 3. Legal Proceedings.
------ -----------------
The Company and its subsidiaries are parties to legal proceedings that
are considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position or
liquidity.
In July 2008, IDT Telecom, Inc. and Union Telecard Alliance, LLC filed an
action in New York State Supreme Court entitled, IDT Telecom, Inc. and Union
---------------------------
Telecard Alliance, LLC v. Leucadia National Corporation, (No. 08602140, New York
---------------------- -----------------------------
County) against the Company alleging that the Company and its majority owned
subsidiary, STi Prepaid, LLC, unlawfully violated the consumer protection laws
of several states as a result of their alleged participation in allegedly
fraudulent marketing activities of the companies (collectively, the "Telco
Group") from which STi Prepaid acquired (on March 8, 2007) the assets of the
business now conducted by STi Prepaid. Plaintiffs seek unspecified monetary and
equitable relief. Leucadia filed a motion to dismiss the complaint for failure
to state grounds upon which relief can be granted. Following oral argument on
February 20, 2009, the court granted Leucadia's motion to dismiss without
prejudice and assessed costs against Plaintiffs.
Plaintiffs had previously filed a federal court action pending in the
District of New Jersey entitled, IDT Telecom and Union Telecard Alliance, LLC v.
--------------------------------------------
CVT Prepaid Solutions, Inc., et al., (No. 07-1076, D.N.J.) containing
----------------------------------
substantially the same allegations against STi Prepaid and the Telco Group, as
well as alleging that STi Prepaid's current business practices violate the
federal Lanham Act and consumer protection laws. Plaintiffs are seeking
equitable relief and monetary damages in an unspecified amount from STi Prepaid
for allegedly wrongful conduct from March 8, 2007 (the date STi Prepaid
commenced business operations), as well as on a theory of successor liability
for the conduct of the Telco Group prior to March 8, 2007. The trial is
currently scheduled to commence on April 21, 2009. The Company believes that the
material allegations of the complaint are without merit and intends to defend
the action vigorously. The Company believes that it is reasonably possible that
a loss that could be material could be incurred; however, any potential loss can
not be reasonably estimated.
27
Additionally, three purported class actions arising out of similar
conduct are also currently pending against STi Prepaid: Soto v. STi Prepaid, LLC
---- ---------------
et al., Case No. GIC 868083 (Superior Ct. San Diego County); Adighibe et al. v.
------ ---------------
Telco Group, Inc. et al., No. 07-CV-1206 (ILG) (CLP); Ramirez et al. v. STi
------------------------ ------------- ----
Prepaid, LLC et al., Civ. No. 08-1089 (SDW) (MCA) (D.N.J.) (where the Company is
------------------
also a defendant). The Company believes that the material allegations in these
actions are without merit and intends to defend these actions vigorously. The
Company believes that it is reasonably possible that a loss that could be
material could be incurred; however, any potential loss can not be reasonably
estimated.
Item 4. Submission of Matters to a Vote of Security Holders.
------ ---------------------------------------------------
Not applicable.
Item 10. Executive Officers of the Registrant.
------- ------------------------------------
All executive officers of the Company are elected at the organizational
meeting of the Board of Directors of the Company held annually and serve at the
pleasure of the Board of Directors. As of February 20, 2009, the executive
officers of the Company, their ages, the positions held by them and the periods
during which they have served in such positions were as follows:
Name Age Position with Leucadia Office Held Since
---- --- ---------------------- -----------------
Ian M. Cumming 68 Chairman of the Board June 1978
Joseph S. Steinberg 65 President January 1979
Thomas E. Mara 63 Executive Vice President May 1980
Joseph A. Orlando 53 Vice President and January 1994;
Chief Financial Officer April 1996
Barbara L. Lowenthal 54 Vice President and April 1996
Comptroller
Justin R. Wheeler 36 Vice President October 2006
Joseph M. O'Connor 33 Vice President May 2007
Rocco J. Nittoli 50 Vice President and September 2007;
Treasurer May 2007
Mr. Cumming has served as a director and Chairman of the Board of the
Company since June 1978 and as Chairman of the Board of FINOVA since August
2001. Mr. Cumming has also been a director of Skywest, Inc., a Utah-based
regional air carrier, since June 1986 and a director of HomeFed since May 1999.
Mr. Cumming has been a director of ACF since March 2008 and a director of
Jefferies since April 2008. Mr. Cumming is also an alternate director of
Fortescue should Mr. Steinberg be unavailable to vote on Fortescue board
matters.
Mr. Steinberg has served as a director of the Company since December 1978
and as President of the Company since January 1979. In addition, he has served
as a director of HomeFed since August 1998 (Chairman since December 1999) and
FINOVA since August 2001. Mr. Steinberg has been a director of Fortescue since
August 2006 and a director of Jefferies since April 2008.
Mr. Mara joined the Company in April 1977 and was elected Vice President
of the Company in May 1977. He has served as Executive Vice President of the
Company since May 1980 and as Treasurer of the Company from January 1993 to May
2007. In addition, he has served as a director and Chief Executive Officer of
FINOVA since September 2002 and as a director of Inmet since August 2005.
Mr. Orlando, a certified public accountant, has served as Chief Financial
Officer of the Company since April 1996 and as Vice President of the Company
since January 1994.
Ms. Lowenthal, a certified public accountant, has served as Vice
President and Comptroller of the Company since April 1996.
Mr. Wheeler joined the Company in March 2000, and has served in a variety
of capacities in the Company's subsidiaries and as Vice President of the Company
since October 2006. In addition, he has served as a director of ACF since March
2008 and as a director of International Assets Holding Corporation since
November 2004.
Mr. O'Connor joined the Company in August 2001 and has served as Vice
President of the Company since May 2007.
28
Mr. Nittoli joined the Company in September 1997, and has served in a
variety of capacities in the Company's subsidiaries and as Treasurer of the
Company since May 2007, and as Vice President of the Company since September
2007.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
------ -------------------------------------
The common shares of the Company are traded on the NYSE under the symbol
LUK. The following table sets forth, for the calendar periods indicated, the
high and low sales price per common share on the consolidated transaction
reporting system, as reported by the Bloomberg Professional Service provided by
Bloomberg L.P.
Common Share
------------
High Low
---- ---
2007
----
First Quarter $30.27 $26.61
Second Quarter 36.87 29.33
Third Quarter 49.14 35.78
Fourth Quarter 51.62 42.77
2008
----
First Quarter $47.92 $39.53
Second Quarter 56.90 45.72
Third Quarter 48.85 35.72
Fourth Quarter 45.00 12.19
2009
----
First Quarter (through February 20, 2009) $22.99 $13.87
As of February 20, 2009, there were approximately 2,453 record holders of
the common shares.
The Company did not pay any cash dividends in 2008 and paid cash
dividends of $0.25 per common share in 2007 and 2006. The payment of dividends
in the future is subject to the discretion of the Board of Directors and will
depend upon general business conditions, legal and contractual restrictions on
the payment of dividends and other factors that the Board of Directors may deem
to be relevant.
Certain subsidiaries of the Company have significant NOLs and other tax
attributes, the amount and availability of which are subject to certain
qualifications, limitations and uncertainties. In order to reduce the
possibility that certain changes in ownership could result in limitations on the
use of the Company's tax attributes, the Company's certificate of incorporation
contains provisions which generally restrict the ability of a person or entity
from acquiring ownership (including through attribution under the tax law) of
five percent or more of the common shares and the ability of persons or entities
now owning five percent or more of the common shares from acquiring additional
common shares. The restrictions will remain in effect until the earliest of (a)
December 31, 2024, (b) the repeal of Section 382 of the Internal Revenue Code
(or any comparable successor provision) or (c) the beginning of a taxable year
of the Company to which certain tax benefits may no longer be carried forward.
The Company did not purchase any of its common shares during the fourth
quarter of 2008.
The Board of Directors from time to time has authorized acquisitions of
the Company's common shares. In March 2007, the Company's Board of Directors
increased to 12,000,000 the maximum number of shares that the Company is
authorized to purchase. At December 31, 2008, the Company is authorized to
purchase 11,992,829 common shares.
29
In addition to conversion transactions previously reported on Form 8-K,
on December 19, 2008, the Company issued 687,692 common shares, par value $1.00
per share upon conversion of $15,794,000 principal amount of the Company's 3
3/4% Convertible Senior Subordinated Notes due 2014 pursuant to privately
negotiated transactions to induce conversion. The notes were convertible at a
rate of 43.5414 common shares per $1,000 principal amount of the notes. The
common shares were issued without registration pursuant to Section 3(a)(9) under
the Securities Act of 1933, as amended.
Stockholder Return Performance Chart
------------------------------------
Set forth below is a chart comparing the cumulative total stockholder
return on our common shares against the cumulative total return of the Standard
& Poor's 500 Stock Index and the Standard & Poor's 1500 Industrial Conglomerates
Index for the period commencing December 31, 2003 to December 31, 2008. Index
data was furnished by Standard & Poor's Compustat Services, Inc. The chart
assumes that $100 was invested on December 31, 2003 in each of our common stock,
the S&P 500 Index, and the S&P 1500 Industrial Conglomerates Index and that all
dividends were reinvested.
INDEXED RETURNS
Years Ending
Base
Period
Company / Index Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08
-------------------------------- ------- -------- -------- ------- ------- -------
Leucadia National Corporation 100 151.53 156.08 187.12 314.19 132.08
S&P 500 Index 100 110.88 116.33 134.70 142.10 89.53
S&P 1500 Industrial Conglomerates 100 119.15 114.74 124.71 130.04 63.36
30
Item 6. Selected Financial Data.
------ -----------------------
The following selected financial data have been summarized from the
Company's consolidated financial statements and are qualified in their entirety
by reference to, and should be read in conjunction with, such consolidated
financial statements and Item 7, Management's Discussion and Analysis of
Financial Condition and Results of Operations of this Report.
Year Ended December 31,
-----------------------------------------------------------------
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA: (a)
Revenues and other income (b) $ 1,080,653 $ 1,154,895 $ 862,672 $ 689,883 $ 379,566
Expenses 1,447,221 1,211,983 728,852 555,448 272,742
Income (loss) from continuing operations before income
taxes and income (losses) related to associated
companies (366,568) (57,088) 133,820 134,435 106,824
Income (loss) from continuing operations before income
(losses) related to associated companies (2,040,243) 502,683 92,049 1,265,473 127,368
Income (losses) related to associated companies, net of
taxes (539,068) (21,875) 37,720 (45,133) 76,479
Income (loss) from continuing operations (c) (2,579,311) 480,808 129,769 1,220,340 203,847
Income (loss) from discontinued operations, including
gain (loss) on disposal, net of taxes 43,886 3,486 59,630 415,701 (58,347)
Net income (loss) (2,535,425) 484,294 189,399 1,636,041 145,500
Year Ended December 31,
-----------------------------------------------------------------
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
Per share:
Basic earnings (loss) per common share:
Income (loss) from continuing operations $(11.19) $2.20 $ .60 $5.66 $ .96
Income (loss) from discontinued operations, including
gain (loss) on disposal .19 .02 .28 1.93 (.28)
------- ----- ----- ----- -----
Net income (loss) $(11.00) $2.22 $ .88 $7.59 $ .68
======= ===== ===== ===== =====
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $(11.19) $2.09 $ .60 $5.34 $ .93
Income (loss) from discontinued operations, including
gain (loss) on disposal .19 .01 .25 1.80 (.26)
------- ----- ----- ----- -----
Net income (loss) $(11.00) $2.10 $ .85 $7.14 $ .67
======= ===== ===== ===== =====
At December 31,
---------------------------------------------------------------------
2008 2007 2006 2005 2004
---- ---- ---- ---- ----
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA: (a)
Cash and investments $ 1,631,979 $ 4,216,690 $ 2,657,021 $ 2,687,846 $ 2,080,309
Total assets 5,198,493 8,126,622 5,303,824 5,260,884 4,800,403
Debt, including current maturities 2,081,456 2,136,550 1,159,461 1,162,382 1,131,922
Shareholders' equity 2,676,797 5,570,492 3,893,275 3,661,914 2,258,653
Book value per common share $11.22 $25.03 $18.00 $16.95 $10.50
Cash dividends per common share $ -- $ .25 $ .25 $ .13 $ .13
(a) Subsidiaries are reflected above as consolidated entities from the date of
acquisition as follows: ResortQuest, June 2007; STi Prepaid, March 2007;
Sangart, November 2005; and Idaho Timber, May 2005. As discussed above,
Premier is reflected as a consolidated subsidiary from May 2006 until
September 2006; it once again became a consolidated subsidiary in August
2007. For additional information, see Note 3 of Notes to Consolidated
Financial Statements.
31
(b) Includes net securities gains (losses) of $(144,542,000), $95,641,000,
$117,159,000, $208,816,000 and $136,564,000 for the years ended December
31, 2008, 2007, 2006, 2005 and 2004, respectively. Net securities gains
(losses) are net of impairment charges of $143,400,000, $36,800,000,
$12,900,000, $12,200,000 and $4,600,000 for the years ended December 31,
2008, 2007, 2006, 2005 and 2004, respectively.
(c) During 2008, the Company recorded a charge to income tax expense of
$1,672,100,000 to reserve for substantially all of its net deferred tax
asset due to the uncertainty about the Company's ability to generate
sufficient taxable income to realize the deferred tax asset. During 2007
and 2005, the Company concluded that it was more likely than not that it
would be able to realize a portion of the net deferred tax asset;
accordingly, $542,700,000 in 2007 and $1,135,100,000 in 2005 of the
deferred tax valuation allowance was reversed as a credit to income tax
expense.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
------ ---------------
The purpose of this section is to discuss and analyze the Company's
consolidated financial condition, liquidity and capital resources and results of
operations. This analysis should be read in conjunction with the consolidated
financial statements and related notes which appear elsewhere in this Report.
Liquidity and Capital Resources
General
The Company's investment portfolio, shareholders' equity and results of
operations can be significantly impacted by the changes in market values of
certain securities, particularly during times of increased volatility in
security prices. Changes in the market values of publicly traded available for
sale securities are reflected in other comprehensive income (loss) and
shareholders' equity. However, changes in the market prices of investments for
which the Company has elected the fair value option, and declines in the fair
values of public and non-public securities that the Company deems to be other
than temporary are reflected in the consolidated statements of operations and
shareholders' equity. The Company also has non-controlling investments in
entities that are engaged in investing and/or securities transactions activities
that are accounted for on the equity method of accounting (classified as
investments in associated companies), for which the Company records its share of
the entities' profits or losses in its consolidated statements of operations.
These entities typically invest in public securities with changes in market
values reflected in their earnings, which increases the Company's exposure to
volatility in the public securities markets.
During the second half of 2008, there was enormous volatility and loss of
value in public securities markets worldwide, and the market prices of the
Company's largest investments declined significantly. The Company's investment
in the common shares of Fortescue, which is accounted for as an available for
sale security, declined in value from $1,824,700,000 at December 31, 2007 to
$377,000,000 at December 31, 2008, which is reflected as an after-tax loss in
other comprehensive income (loss) and a decline in shareholders' equity of
$921,000,000. The market values of the Company's investments in ACF and
Jefferies, for which the fair value option was elected, also declined
significantly with unrealized losses reflected in operations as a component of
income (losses) related to associated companies. During the year ended December
31, 2008, the Company recognized unrealized losses related to its investment in
ACF of $155,300,000 and unrealized losses related to its investment in Jefferies
of $111,200,000. The Company also recorded impairment losses for declines in
value of securities deemed to be other than temporary in its consolidated
statement of operations of $143,400,000, reflected as a component of net
securities gains (losses) and $63,300,000, reflected as a component of income
(losses) related to associated companies.
Public securities markets have remained volatile subsequent to December
31, 2008; as of February 20, 2009, the fair value of the Company's investment in
ACF has declined to $126,900,000 and the fair value of the Company's investment
in Jefferies has declined to $529,600,000. If the aggregate market value of the
Company's investments in ACF and Jefferies remain unchanged at March 31, 2009,
these declines in market value would result in the recognition of an aggregate
unrealized loss during the first quarter of 2009 of $276,500,000. Further
declines in market values are possible, which would result in the recognition of
additional unrealized losses that would reduce shareholders' equity and,
depending upon the method of accounting employed for the investment, could
result in recognition of additional unrealized losses in the consolidated
statements of operations.
32
Liquidity
Leucadia National Corporation (the "Parent") is a holding company whose
assets principally consist of the stock of its direct subsidiaries, cash and
cash equivalents and other non-controlling investments in debt and equity
securities. The Parent continuously evaluates the retention and disposition of
its existing operations and investments and investigates possible acquisitions
of new businesses in order to maximize shareholder value. Accordingly, further
acquisitions, divestitures, investments and changes in capital structure are
possible. Its principal sources of funds are its available cash resources,
liquid investments, bank borrowings, public and private capital market
transactions, repayment of subsidiary advances, funds distributed from its
subsidiaries as tax sharing payments, management and other fees, and borrowings
and dividends from its subsidiaries, as well as dispositions of existing
businesses and investments.
In addition to cash and cash equivalents, the Company also considers
investments classified as current assets and investments classified as
non-current assets on the face of its consolidated balance sheet as being
generally available to meet its liquidity needs. Securities classified as
current and non-current investments are not as liquid as cash and cash
equivalents, but they are generally convertible into cash within a relatively
short period of time. As of December 31, 2008, the sum of these amounts
aggregated $1,632,000,000. However, since $529,300,000 of this amount is pledged
as collateral pursuant to various agreements, represents investments in
non-public securities or is held by subsidiaries that are party to agreements
that restrict the Company's ability to use the funds for other purposes
(including the Inmet shares), the Company does not consider those amounts to be
available to meet the Parent's liquidity needs. The $1,102,700,000 that is
available is comprised of cash and short-term bonds and notes of the U.S.
Government and its agencies, U.S. Government-Sponsored Enterprises and other
publicly traded debt and equity securities (including the investment in
Fortescue common shares). The Parent's available liquidity, and the investment
income realized from the Parent's cash, cash equivalents and marketable
securities is used to meet the Parent company's short-term recurring cash
requirements, which are principally the payment of interest on its debt and
corporate overhead expenses.
The Parent's only long-term cash requirement is to make principal
payments on its long-term debt ($1,794,300,000 principal outstanding as of
December 31, 2008), of which $475,000,000 is due in 2013, $221,100,000 is due in
2014, $500,000,000 is due in 2015, $500,000,000 is due in 2017 and $98,200,000
is due in 2027. Historically, the Parent has used its available liquidity to
make acquisitions of new businesses and other investments, but, except as
disclosed in this Report, the timing of any future investments and the cost can
not be predicted. Should the Company require additional liquidity for an
investment or any other purpose, the Parent also has an unsecured bank credit
facility of $100,000,000 that expires in June 2011 and bears interest based on
the Eurocurrency Rate or the prime rate. No amounts are currently outstanding
under the bank credit facility.
From time to time in the past, the Company has accessed public and
private credit markets and raised capital in underwritten bond financings. The
funds raised have been used by the Company for general corporate purposes,
including for its existing businesses and new investment opportunities. However,
given the current ongoing turmoil in the credit markets, if the Company were to
try to raise funds through an underwritten bond offering it would be at a higher
interest rate than in the past, or with terms that the Company may not find
acceptable. The Company has no current intention to seek additional bond
financing, and will rely on its existing liquidity to fund corporate overhead
expenses and corporate interest payments and, to fund new investing
opportunities, it may also dispose of existing businesses and investments. The
Parent's senior debt obligations are rated two levels below investment grade by
Moody's Investors Services and one level below investment grade by Standard &
Poor's and Fitch Ratings. Ratings issued by bond rating agencies are subject to
change at any time.
As of December 31, 2008, the Company had acquired approximately 25% of
the outstanding common shares of ACF for aggregate cash consideration of
$405,300,000 ($70,100,000 was invested as of December 31, 2007). ACF is an
independent auto finance company that is in the business of purchasing and
servicing automobile sales finance contracts, historically for consumers who are
typically unable to obtain financing from other sources. The Company has entered
into a standstill agreement with ACF for the two year period ending March 3,
2010, pursuant to which the Company has agreed not to sell its shares if the
buyer would own more than 4.9% of the outstanding shares, unless the buyer
agreed to be bound by terms of the standstill agreement, to not increase its
ownership interest to more than 30% of the outstanding ACF common shares, and
received the right to nominate two directors to the board of directors of ACF.
ACF also entered into a registration rights agreement covering all of the common
shares owned by the Company. At December 31, 2008, the Company's investment in
ACF is classified as an investment in an associated company and carried at fair
value of $249,900,000; the investment in ACF is one of two eligible items for
which the Company elected the fair value option described in SFAS 159.
33
In March 2008, the Company increased its equity investment in the common
shares of IFIS Limited ("IFIS"), a private company that primarily invests in
operating businesses in Argentina, from approximately 3% to 26% for an
additional cash investment of $83,900,000. IFIS owns a variety of investments,
and its largest investment is approximately 32% of the outstanding common shares
of Sociedad Anonima Comercial, Inmobiliaria, Financiera y Agropecuaria
("Cresud"), an Argentine agricultural company involved in a range of activities
including crop production, cattle raising and milk production. Cresud's common
shares trade on the Buenos Aires Stock Exchange (Symbol: CRES); in the U.S.,
Cresud trades as American Depository Shares or ADSs (each of which represents
ten common shares) on the NASDAQ Global Select Market (Symbol: CRESY). When the
Company acquired its additional interest in IFIS in 2008, it was classified as
an investment in associated companies and accounted for under the equity method
of accounting due to the size of the Company's voting interest. In January 2009,
IFIS raised a significant amount of new equity in a rights offering in which the
Company did not participate. As a result, the Company's ownership interest in
IFIS was reduced to 8% and the Company will no longer apply the equity method of
accounting for this investment.
The Company also acquired a direct equity interest in Cresud for an
aggregate cash investment of $54,300,000. At December 31, 2008, the Company
owned 3,364,174 Cresud ADSs, representing approximately 6.7% of Cresud's
outstanding common shares, and currently exercisable warrants to purchase
11,213,914 Cresud common shares (or 1,121,391 Cresud ADSs) at an exercise price
of $1.68 per share. The Company's direct investment in Cresud is classified as a
non-current available for sale investment and carried at fair value.
As a result of significant declines in quoted market prices for Cresud
and other investments of IFIS, combined with declines in worldwide food
commodity prices, the global mortgage and real estate crisis and political and
financial conditions in Argentina, the Company has determined that its
investments in IFIS and Cresud ADSs and warrants were impaired. As of December
31, 2008, the fair value of the Company's investment in IFIS was determined to
be $14,600,000, resulting in an impairment charge of $63,300,000 for the year
ended December 31, 2008. This charge is in addition to the Company's share of
IFIS's operating losses, which was $8,400,000 for the year ended December 31,
2008. As of December 31, 2008, the fair value of the Company's direct investment
in Cresud ADSs and warrants was determined to be $31,100,000, resulting in an
impairment charge of $23,200,000 for the year ended December 31, 2008.
In April 2008, the Company sold to Jefferies 10,000,000 of the Company's
common shares, and received 26,585,310 shares of common stock of Jefferies and
$100,021,000 in cash. The Jefferies common shares were valued based on the
closing price of the Jefferies common stock on April 18, 2008, the last trading
date prior to the acquisition ($398,248,000 in the aggregate). Including shares
acquired in open market purchases during 2008, as of December 31, 2008 the
Company owns an aggregate of 48,585,385 Jefferies common shares (approximately
30% of the Jefferies outstanding common shares) for a total investment of
$794,400,000. At December 31, 2008, the Company's investment in Jefferies is
carried at fair value of $683,100,000; the investment in Jefferies is one of two
eligible items for which the Company elected the fair value option described in
SFAS 159. Jefferies is a full-service global investment bank and institutional
securities firm serving companies and their investors.
In connection with its investment in Jefferies, the Company entered into
a standstill agreement, pursuant to which for the two year period ending April
21, 2010, the Company agreed, subject to certain provisions, to limit its
investment in Jefferies to not more than 30% of the outstanding Jefferies common
shares and to not sell its investment, and received the right to nominate two
directors to the board of directors of Jefferies. Jefferies also agreed to enter
into a registration rights agreement covering all of the Jefferies shares of
common stock owned by the Company.
As discussed above, in April 2008, the Lake Charles Harbor & Terminal
District of Lake Charles, Louisiana sold $1,000,000,000 in tax exempt bonds that
will support the development of a $1,600,000,000 petroleum coke gasification
plant project by the Company's wholly-owned subsidiary, Lake Charles
Cogeneration LLC ("LCC"). LCC does not currently have access to the bond
proceeds, which are being held in an escrow account by the bond trustee, and it
will not have access to the bond proceeds until certain conditions are
satisfied. Upon the completion of pending permitting, regulatory approval,
design engineering and the satisfaction of certain other conditions of the
financing agreements, the bonds will be remarketed for a longer term and the
proceeds will be released to LCC to use for the payment of development and
construction costs for the project. If all conditions have been met and LCC
begins to draw down on the bond proceeds, any amounts drawn will be recorded as
long-term indebtedness of LCC and reflected on the Company's consolidated
balance sheet. The Company is not obligated to make equity contributions to LCC
until it completes its investigation and the project is approved by the
Company's board of directors.
34
In September 2008, the Company invested an additional $20,000,000 in
Sangart upon its exercise of certain existing warrants, which increased its
ownership interest to approximately 89%. In the first quarter of 2009, the
Company invested an additional $28,500,000 in Sangart upon the exercise of its
remaining warrants, which increased its ownership interest to approximately 92%.
The additional investment the Company made in 2009, along with Sangart's
existing cash resources is expected to provide Sangart with sufficient capital
to fund activities into 2010. Thereafter, significant additional funding will be
needed for product development and clinical trial activities prior to regulatory
approval and commercial launch; the source of such funding has not as yet been
determined.
During 2008, the Company issued 5,611,913 common shares upon the
conversion of $128,887,000 principal amount of the Company's 3 3/4% Convertible
Senior Subordinated Notes due 2014, pursuant to privately negotiated
transactions to induce conversion. The number of common shares issued was in
accordance with the terms of the notes; however, the Company paid the former
noteholders $12,200,000 in addition to the shares. The additional cash payments
were expensed.
During the fourth quarter of 2008, the Company received distributions
totaling $44,900,000 from its subsidiary, Empire Insurance Company ("Empire"),
which has been undergoing a voluntary liquidation since 2001. The Company had
classified Empire as a discontinued operation in 2001 and fully wrote-off its
remaining book value based on its expected future cash flows at that time.
Although Empire no longer writes any insurance business, its orderly liquidation
over the years has resulted in reductions to its estimated claim reserves that
enabled Empire to pay the distributions, with the approval of the New York
Insurance Department. Since future distributions from Empire, if any, are
subject to New York insurance law or the approval of the New York Insurance
Department, income will only be recognized when received.
In February 2009, the Board of Directors authorized the Company, from
time to time, to purchase its outstanding debt securities through cash purchases
in open market transactions, privately negotiated transactions or otherwise.
Such repurchases, if any, will depend upon prevailing market conditions, the
Company's liquidity requirements and other factors. The amounts involved,
individually or in the aggregate, may be material. Depending upon market
conditions and other factors, such purchases may be commenced or suspended at
any time without notice.
In March 2007, the Board of Directors increased the number of the
Company's common shares that the Company is authorized to purchase. As a result,
the Company is authorized to purchase up to 12,000,000 common shares. Such
purchases may be made from time to time in the open market, through block trades
or otherwise. Depending on market conditions and other factors, such purchases
may be commenced or suspended at any time without notice. During the three year
period ended December 31, 2008, the only common shares acquired by the Company
were in connection with the exercise of stock options. As of February 20, 2009,
the Company is authorized to repurchase 11,992,829 common shares.
The Company and certain of its subsidiaries have substantial NOLs and
other tax attributes. The amount and availability of the NOLs and other tax
attributes are subject to certain qualifications, limitations and uncertainties.
In order to reduce the possibility that certain changes in ownership could
impose limitations on the use of the NOLs, the Company's certificate of
incorporation contains provisions which generally restrict the ability of a
person or entity from acquiring ownership (including through attribution under
the tax law) of five percent or more of the common shares and the ability of
persons or entities now owning five percent or more of the common shares from
acquiring additional common shares. The restrictions will remain in effect until
the earliest of (a) December 31, 2024, (b) the repeal of Section 382 of the
Internal Revenue Code (or any comparable successor provision) or (c) the
beginning of a taxable year of the Company to which certain tax benefits may no
longer be carried forward. For more information about the NOLs and other tax
attributes, see Note 17 of Notes to Consolidated Financial Statements.
Consolidated Statements of Cash Flows
As discussed above, the Company relies on the Parent's available
liquidity to meet its short-term and long-term needs, and to make acquisitions
of new businesses and investments. Except as otherwise disclosed herein, the
Company's operating businesses do not generally require material funds from the
Parent to support their operating activities, and the Parent does not depend on
positive cash flow from its operating segments to meet its liquidity needs. The
components of the Company's operating businesses and investments change
frequently as a result of acquisitions or divestitures, the timing of which is
impossible to predict but which often have a material impact on the Company's
consolidated statements of cash flows in any one period. Further, the timing and
amounts of distributions from certain of the Company's investments in
partnerships accounted for under the equity method are generally outside the
control of the Company. As a result, reported cash flows from operating,
investing and financing activities do not generally follow any particular
pattern or trend, and reported results in the most recent period should not be
expected to recur in any subsequent period.
35
Net cash of $8,800,000 was provided by operating activities in 2008 as
compared to $18,400,000 of net cash used for operating activities in 2007. The
change reflects increased funds generated from the trading portfolio, increased
distributions of earnings from associated companies and a use of funds for
increased interest expense payments. Funds used for operating activities during
2008 include the results of companies acquired during 2007, STi Prepaid and
ResortQuest, and the results of Premier following its reconsolidation in the
third quarter of 2007. STi Prepaid's telecommunications operations generated
funds from operating activities of $5,900,000 and $26,700,000 during the 2008
and 2007, respectively, the Company's property management and services segment
used funds of $7,800,000 in 2008 and generated funds from operating activities
of $4,000,000 in 2007, Premier generated funds of $13,300,000 in 2008 and used
funds of $30,100,000 in 2007 and the Company's manufacturing segments generated
funds of $36,900,000 and $30,400,000 in 2008 and 2007, respectively. The
decrease in funds generated by STi Prepaid principally reflects reduced
operating profits and additional investments in net working capital of acquired
businesses. The reduction in Premier's use of funds principally reflects cash
used in 2007 for bankruptcy and reconstruction related items. The decrease in
operating cash flows at the property management and services segment principally
results from the net change in restricted cash at ResortQuest. Funds used by
Sangart, a development stage company, increased to $35,000,000 during 2008 from
$24,800,000 during 2007. Funds provided by operating activities in 2008 also
include $44,900,000 of funds distributed by Empire, a discontinued operation. In
2008, distributions from associated companies principally include earnings
distributed by Shortplus ($50,000,000), JHYH ($4,300,000), Jefferies
($5,500,000), Goober Drilling ($16,100,000) and Garcadia ($10,300,000). In 2007,
distributions from associated companies principally include earnings distributed
by JPOF II ($29,200,000), EagleRock ($15,000,000) and Garcadia ($6,700,000).
Net cash of $18,400,000 was used for operating activities during 2007 as
compared to $91,500,000 of net cash provided by operating activities during
2006. The change reflects decreased collections of receivables and distributions
of earnings from associated companies, increased income tax payments and greater
corporate overhead expenses. The change in operating cash flows also reflects
increased funds generated from activity in the trading portfolio, decreased
payment of incentive compensation and decreased defined benefit pension plan
contributions. During 2006, cash provided by operating activities reflects the
collection of the balance of certain receivables from AT&T Inc. ($198,500,000).
The AT&T receivables resulted from a termination agreement entered into between
WilTel and its largest customer during 2005. In 2006, distributions from
associated companies principally include earnings distributed by JPOF II
($23,600,000) and EagleRock ($48,200,000). Contributions to the defined benefit
pension plans were $50,100,000 in 2006; no material contributions were made in
2007.
During 2007, STi Prepaid's telecommunications operations generated funds
from operating activities of $26,700,000 and the Company's property management
and services segment generated funds of $4,000,000. While it was a consolidated
subsidiary, Premier used funds of $30,100,000 in 2007 and $25,900,000 in 2006.
Funds provided by the Company's manufacturing segments decreased to $30,400,000
in 2007 as compared to $45,300,000 in 2006, reflecting reduced profitability.
Funds used by Sangart increased to $24,800,000 during 2007 from $19,400,000
during 2006. Funds provided by operating activities for 2006 also include
$9,100,000 of funds used by discontinued operations.
Net cash flows used for investing activities were $403,000,000 in 2008,
$957,400,000 in 2007 and $186,200,000 in 2006. During 2007, funds provided by
the disposal of real estate, property and equipment and other assets include the
sale of WilTel's former headquarters building for $53,500,000. During 2006,
funds provided by the disposal of real estate, property and equipment and other
assets include the sale of 8 acres of unimproved land in Washington, D.C. by 711
Developer, LLC ("Square 711"), a 90% owned subsidiary of the Company,
($75,700,000) and the sale of two associated companies ($56,400,000). During
2008, acquisitions, net of cash acquired principally include an acquisition by
the wineries ($19,200,000) and various small acquisitions by STi Prepaid. During
2007, acquisitions, net of cash acquired principally include assets acquired by
STi Prepaid from Telco ($85,400,000) and ResortQuest ($9,700,000) and cash
acquired upon the reconsolidation of Premier ($17,300,000). During 2006,
acquisitions, net of cash acquired principally include the acquisition of
Premier ($105,700,000). During 2006, proceeds from the disposal of discontinued
operations net of expenses and cash sold were $120,200,000, principally
reflecting the sale of Symphony Healthcare Services, LLC ("Symphony") and ATX
Communications, Inc. ("ATX") and the resolution of WilTel's working capital
adjustment relating to the December 2005 sale of WilTel. During 2006, collection
of insurance proceeds relate to Premier's recoveries with respect to Hurricane
Katrina. Investments in associated companies include Jefferies ($396,100,000),
ACF ($335,200,000), IFIS ($83,900,000), CLC ($56,700,000) and Garcadia
($34,000,000) in 2008, JHYH ($250,000,000), Pershing Square ($200,000,000),
Goober Drilling ($108,000,000), Ambrose ($75,000,000), Highland Opportunity
($74,000,000), Shortplus ($25,000,000), CLC ($53,500,000) and Premier
($160,500,000) in 2007, and Goober Drilling ($188,000,000), Safe Harbor
($50,000,000), Wintergreen ($30,000,000) and CLC ($12,100,000) in 2006. Capital
distributions from associated companies principally include Safe Harbor
($19,300,000), Goober Drilling ($36,000,000), Highland Opportunity
($40,000,000), Ambrose ($72,900,000) and EagleRock ($12,500,000) in 2008 and
Goober Drilling ($33,200,000) and Safe Harbor ($25,000,000) in 2007.
36
During 2008, funds used for acquisitions of and capital expenditures for
real estate investments principally relate to the Myrtle Beach project
($67,000,000), land used by certain Garcadia dealerships ($20,400,000) and the
real estate development projects in Maine ($7,500,000). During 2007, the change
in restricted cash principally results from the $56,500,000 escrow deposit made
in connection with the Panama City real estate project. Pursuant to the
indenture governing the Premier Notes, Premier was required to put insurance
proceeds it collected into restricted accounts, which is the principal reason
for the net change in restricted cash during 2006. Premier's cash flow activity
is reflected in the Company's 2006 consolidated statement of cash flows only
during the period it was a consolidated subsidiary (April through September
2006).
Net cash of $174,800,000 in 2008 and $1,145,500,000 in 2007 was provided
by financing activities and net cash of $5,200,000 was used for financing
activities in 2006. During 2007, issuance of debt, net of expenses, includes
$500,000,000 principal amount of 7 1/8% Senior Notes and $500,000,000 principal
amount of 8 1/8% Senior Notes. The increase in debt during 2008 principally
relates to the Myrtle Beach project's debt obligation and to repurchase
agreements, which are discussed below, and during 2006 principally relates to
repurchase agreements. Reduction of debt in 2008 includes the termination of a
capital lease obligation upon the Company's exercise of its right to purchase
corporate aircraft secured by a capital lease ($8,200,000). The reduction of
debt during 2007 principally relates to the repurchase agreements. The reduction
of debt during 2006 includes the repayment of debt of Square 711 ($32,000,000),
which was sold, and the maturity of the Company's 7 7/8% Senior Subordinated
Notes ($21,700,000). Issuance of common shares during 2008 principally reflects
cash consideration received on the sale of the Company's common shares to
Jefferies. Issuance of common shares for 2007 principally reflects the issuance
and sale of 5,500,000 of the Company's common shares. In addition, issuance of
common shares reflects the exercise of employee stock options for all periods.
Debt due within one year includes $151,100,000 and $125,000,000 as of
December 31, 2008 and 2007, respectively, relating to repurchase agreements of
one of the Company's subsidiaries. These fixed rate repurchase agreements have a
weighted average interest rate of approximately 2.25%, mature in January 2009
and are secured by non-current investments with a carrying value of $164,700,000
at December 31, 2008. Debt due within one year also includes $90,200,000 related
to the Myrtle Beach project, which matures in October 2009. The Company has an
option to extend the maturity of the loan for two successive twelve month
periods; however, the right to extend the loan is contingent upon the
relationship between the appraised value of the property and the aggregate loan
commitment as of the initial maturity date and the debt service coverage ratio.
Although the Company believes it will be able to extend the maturity date of the
loan, since the right to do so is not completely within the control of the
Company the loan has been classified as a current liability.
During 2001, a subsidiary of the Company borrowed $53,100,000 secured by
certain of its corporate aircraft, of which $37,100,000 is currently
outstanding. The Parent company has guaranteed this financing.
The Company's senior note indentures contain covenants that restrict its
ability to incur more Indebtedness or issue Preferred Stock of Subsidiaries
unless, at the time of such incurrence or issuance, the Company meets a
specified ratio of Consolidated Debt to Consolidated Tangible Net Worth, limit
the ability of the Company and Material Subsidiaries to incur, in certain
circumstances, Liens, limit the ability of Material Subsidiaries to incur Funded
Debt in certain circumstances, and contain other terms and restrictions all as
defined in the senior note indentures. The Company has the ability to incur
substantial additional indebtedness or make distributions to its shareholders
and still remain in compliance with these restrictions. If the Company is unable
to meet the specified ratio, the Company would not be able to issue additional
Indebtedness or Preferred Stock, but the Company's inability to meet the
applicable ratio would not result in a default under its senior note indentures.
The Company's bank credit agreement also contains covenants and restrictions
which are generally more restrictive than the senior note indentures; however,
the Company has the ability to terminate the bank credit agreement if no amounts
are outstanding. Certain of the debt instruments of subsidiaries of the Company
require that collateral be provided to the lender; principally as a result of
such requirements, the assets of subsidiaries which are subject to limitations
on transfer of funds to the Company were approximately $374,600,000 at December
31, 2008. For more information, see Note 13 of Notes to Consolidated Financial
Statements.
37
As shown below, at December 31, 2008, the Company's contractual cash
obligations totaled $3,281,602,000.
Payments Due by Period (in thousands)
-------------------------------------------------------------------------
Less than 1
Contractual Cash Obligations Total Year 1-3 Years 4-5 Years After 5 Years
---------------------------- ----- ----------- --------- --------- -------------
Debt, including current maturities $ 2,088,520 $ 248,713 $ 45,472 $ 475,025 $ 1,319,310
Estimated interest expense on debt 930,881 135,370 257,292 241,323 296,896
Estimated payments related to derivative
financial instruments 12,868 7,756 5,112 -- --
Planned funding of pension and
postretirement obligations 65,877 4,629 58,872 748 1,628
Operating leases, net of sublease
income 149,363 15,333 25,792 21,508 86,730
Asset purchase obligations 5,836 1,060 1,771 1,669 1,336
Other 28,257 2,091 2,916 3,000 20,250
------------ ---------- ---------- ---------- ------------
Total Contractual Cash Obligations $ 3,281,602 $ 414,952 $ 397,227 $ 743,273 $ 1,726,150
============ ========== ========== ========== ===========
The estimated interest expense on debt includes interest related to
variable rate debt which the Company determined using rates in effect at
December 31, 2008. Estimated payments related to a currency swap agreement are
based on the currency rate in effect at December 31, 2008. Amounts related to
the Company's consolidated pension liability ($62,200,000) are included in the
table in the less than 1 year period ($4,200,000) and the remainder in the 1-3
year period; however, the exact timing of those cash payments is uncertain. The
above amounts do not include liabilities for unrecognized tax benefits as the
timing of payments, if any, is uncertain. Such amounts aggregated $11,100,000 at
December 31, 2008; for more information, see Note 17 of Notes to Consolidated
Financial Statements.
At December 31, 2008, the Company had recorded a liability of
$62,200,000 on its consolidated balance sheet for its unfunded defined benefit
pension plan obligations. This amount represents the difference between the
present value of amounts owed to current and former employees (referred to as
the projected benefit obligation) and the market value of plan assets set aside
in segregated trust accounts. Since the benefits in these plans have been
frozen, future changes to the unfunded benefit obligation are expected to
principally result from benefit payments, changes in the market value of plan
assets, differences between actuarial assumptions and actual experience and
interest rates.
Although the Company did not make any significant pension plan
contributions during 2008, the Company does expect to make substantial
contributions to the segregated trust accounts in the future to reduce its plan
liabilities and reduce administrative and insurance costs associated with the
plans. The tax deductibility of these contributions is not a primary
consideration, principally due to the availability of the Company's NOLs to
otherwise reduce taxable income. Other than the $4,200,000 expected 2009
contribution, the timing and amount of additional contributions are uncertain;
however, the Company believes it will make substantial contributions over the
next few years to reduce, but not to entirely eliminate, its defined benefit
pension plan liability.
The Company maintained defined benefit pension plans covering certain
operating units prior to 1999, and WilTel also maintained defined pension
benefit plans that were not transferred in connection with the sale of WilTel.
As of December 31, 2008, certain amounts for these plans are reflected
separately in the table below (dollars in thousands):
38
The Company's WilTel's
Plans Plans
------------- -----------
Projected benefit obligation $50,628 $172,613
Funded status - balance sheet liability at December 31, 2008 2,623 59,626
Deferred losses included in other comprehensive income (loss) 11,318 49,921
Discount rate used to determine the projected benefit obligation 5.25% 6.20%
Calculations of pension expense and projected benefit obligations are
prepared by actuaries based on assumptions provided by management. These
assumptions are reviewed on an annual basis, including assumptions about
discount rates, interest credit rates and expected long-term rates of return on
plan assets. For the Company's plans, a discount rate was selected to result in
an estimated projected benefit obligation on a plan termination basis, using
current rates for annuity settlements and lump sum payments weighted for the
assumed elections of participants. For the WilTel plans, the timing of expected
future benefit payments was used in conjunction with the Citigroup Pension
Discount Curve to develop a discount rate that is representative of the high
quality corporate bond market.
These discount rates will be used to determine pension expense in 2009.
Holding all other assumptions constant, a 0.25% change in these discount rates
would affect aggregate pension expense by $500,000 and the aggregate benefit
obligation by $7,800,000.
The deferred losses in other comprehensive income (loss) primarily
result from differences between the actual and assumed return on plan assets and
changes in actuarial assumptions, including changes in discount rates and
changes in interest credit rates. Deferred losses are amortized to expense if
they exceed 10% of the greater of the projected benefit obligation or the market
value of plan assets as of the beginning of the year; such amount aggregated
$38,900,000 at December 31, 2008 for all plans. A portion of these excess
deferred losses will be amortized to expense during 2009 based on an
amortization period of twelve years.
The assumed long-term rates of return on plan assets are based on the
investment objectives of the specific plan, which are more fully discussed in
Note 18 of Notes to Consolidated Financial Statements. Prior to 2008,
differences between the actual and expected rates of return on plan assets have
not been material. During 2008, the fair value of the WilTel plan assets
declined significantly due to the decline in securities markets worldwide. This
decline is the reason for the significant increase in the balance sheet
liability for the WilTel plans during 2008.
Off-Balance Sheet Arrangements
At December 31, 2008, the Company's off-balance sheet arrangements
consist of guarantees and letters of credit aggregating $101,800,000. Pursuant
to an agreement that was entered into before the Company sold CDS Holding
Corporation ("CDS") to HomeFed in 2002, the Company agreed to provide project
improvement bonds for the San Elijo Hills project. These bonds, which are for
the benefit of the City of San Marcos, California and other government agencies,
are required prior to the commencement of any development at the project. CDS is
responsible for paying all third party fees related to obtaining the bonds.
Should the City or others draw on the bonds for any reason, CDS and one of its
subsidiaries would be obligated to reimburse the Company for the amount drawn.
At December 31, 2008, the amount of outstanding bonds was $5,000,000, which
expires at various times through 2010. Subsidiaries of the Company have
outstanding letters of credit aggregating $14,200,000 at December 31, 2008,
principally to secure various obligations. Substantially all of these letters of
credit expire before 2012.
As discussed above, the Company has also guaranteed 30% of the amounts
outstanding under CLC's senior secured credit facility and senior secured bridge
credit facility. At December 31, 2008, $215,000,000 was outstanding under the
senior secured credit facility and (euro)47,000,000 was outstanding under the
senior secured bridge credit facility; as a result, the Company's outstanding
guaranty at that date was $64,500,000 and (euro)14,100,000 ($18,100,000 at
exchange rates in effect on February 20, 2009), respectively.
39
Critical Accounting Estimates
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with GAAP. The preparation of these
financial statements requires the Company to make estimates and assumptions that
affect the reported amounts in the financial statements and disclosures of
contingent assets and liabilities. On an on-going basis, the Company evaluates
all of these estimates and assumptions. The following areas have been identified
as critical accounting estimates because they have the potential to have a
material impact on the Company's financial statements, and because they are
based on assumptions which are used in the accounting records to reflect, at a
specific point in time, events whose ultimate outcome won't be known until a
later date. Actual results could differ from these estimates.
Income Taxes - At December 31, 2008, the Company's net deferred tax asset
before valuation allowances was $2,347,500,000, of which $2,090,000,000
represents the potential future tax savings from federal and state NOLs. In
accordance with Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109"), the Company records a valuation allowance to reduce its
deferred tax asset to the net amount that is more likely than not to be
realized. The amount of any valuation allowance recorded does not in any way
adversely affect the Company's ability to use its NOLs to offset taxable income
in the future. If in the future the Company determines that it is more likely
than not that the Company will be able to realize its net deferred tax asset in
excess of its net recorded amount, an adjustment to increase the net deferred
tax asset would increase income in such period. If in the future the Company
were to determine that it would not be able to realize all or part of its net
recorded deferred tax asset, an adjustment to decrease the net deferred tax
asset would be charged to income in such period. SFAS 109 requires the Company
to consider all available evidence, both positive and negative, and to weight
the evidence when determining whether a valuation allowance is required.
Generally, greater weight is required to be placed on objectively verifiable
evidence when making this assessment, in particular on recent historical
operating results.
In prior periods, the Company's long track record of generating taxable
income, its cumulative taxable income for more recent past periods and its
projections of future taxable income were the most heavily weighted factors
considered when determining how much of the net deferred tax asset was more
likely than not to be realizable. During 2005 the Company concluded that it was
more likely than not that it would have future taxable income sufficient to
realize a portion of the Company's net deferred tax asset; accordingly,
$1,135,100,000 of the deferred tax valuation allowance was reversed as a credit
to income tax expense. An additional $542,700,000 of the valuation allowance was
reversed as a credit to income tax expense in 2007. The Company's estimate of
future taxable income considered all available evidence, both positive and
negative, about its operating businesses and investments, included an
aggregation of individual projections for each material operating business and
investment, estimated apportionment factors for state and local taxing
jurisdictions and included all future years that the Company estimated it would
have available NOLs.
During the second half of 2008 the Company recorded significant
unrealized losses on many of its largest investments (Fortescue, Inmet,
Jefferies, ACF and Cresud), recognized other than temporary impairments for a
number of other investments and reported reduced profitability from
substantially all of its operating businesses, all of which contributed to the
recognition of a pre-tax loss of $859,500,000 in the consolidated statement of
operations and a pre-tax loss in other comprehensive income (loss) of
$1,579,200,000 for the year ended December 31, 2008. The worldwide economic
downturn has adversely affected many of the Company's operating businesses and
investments, and the nature of the current economic difficulties make it
impossible to reliably project how long the downturn will last. Additionally,
the 2008 losses result in a cumulative loss in the Company's total comprehensive
income (loss) during the past three years. In assessing the realizability of the
net deferred tax asset at December 31, 2008, the Company concluded that its
operating losses for the more recent periods and current economic conditions
worldwide should be given more weight than its projections of future taxable
income during the period that it has NOLs available (until 2028), and be given
more weight than the Company's long track record of generating taxable income.
As a result, the Company concluded that a valuation allowance was required
against substantially all of the net deferred tax asset, and increased its
valuation allowance by $1,672,100,000 with a corresponding charge to income tax
expense.
Pursuant to SFAS 109, the Company will continue to evaluate the
realizability of its net deferred tax asset in future periods. However, before
the Company would reverse any portion of its valuation allowance, it will need
historical positive cumulative taxable income over a period of years to overcome
the recent negative evidence. At that time, any decrease to the valuation
allowance would be based significantly upon the Company's projections of future
taxable income, which are inherently uncertain.
40
The Company also records reserves for contingent tax liabilities based
on the Company's assessment of the probability of successfully sustaining its
tax filing positions.
Impairment of Long-Lived Assets - In accordance with Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", the Company evaluates its long-lived assets for
impairment whenever events or changes in circumstances indicate, in management's
judgment, that the carrying value of such assets may not be recoverable. When
testing for impairment, the Company groups its long-lived assets with other
assets and liabilities at the lowest level for which identifiable cash flows are
largely independent of the cash flows of other assets and liabilities (or asset
group). The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value. The Company recorded impairment losses
on various long-lived assets aggregating $3,200,000 during 2008; there were no
impairment losses recorded during 2007 or 2006.
As discussed in this Report, current economic conditions have adversely
affected most of the Company's operations and investments. A worsening of
current economic conditions or a prolonged recession could cause a decline in
estimated future cash flows expected to be generated by the Company's operations
and investments. If future undiscounted cash flows are estimated to be less than
the carrying amounts of the asset groups used to generate those cash flows in
subsequent reporting periods, particularly for those with large investments in
property and equipment (for example, manufacturing, gaming entertainment and
certain associated company investments), impairment charges would have to be
recorded.
Impairment of Securities - Investments with an impairment in value
considered to be other than temporary are written down to estimated fair value.
The write-downs are included in net securities gains (losses) in the
consolidated statements of operations. The Company evaluates its investments for
impairment on a quarterly basis.
The Company's determination of whether a security is other than
temporarily impaired incorporates both quantitative and qualitative information;
GAAP requires the exercise of judgment in making this assessment, rather than
the application of fixed mathematical criteria. The Company considers a number
of factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, the ability and intent to
hold investments to maturity, and other factors specific to the individual
investment. The Company's assessment involves a high degree of judgment and
accordingly, actual results may differ materially from the Company's estimates
and judgments. The Company recorded impairment charges for securities of
$143,400,000, $36,800,000 and $12,900,000 for the years ended December 31, 2008,
2007 and 2006, respectively.
Business Combinations - At acquisition, the Company allocates the cost of
a business acquisition to the specific tangible and intangible assets acquired
and liabilities assumed based upon their relative fair values. Significant
judgments and estimates are often made to determine these allocated values, and
may include the use of appraisals, consider market quotes for similar
transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts earlier
issued financial statements may have to be restated. Any excess of the cost of a
business acquisition over the fair values of the net assets and liabilities
acquired is recorded as goodwill, which is not amortized to expense. Recorded
goodwill of a reporting unit is required to be tested for impairment on an
annual basis, and between annual testing dates if events or circumstances change
that would more likely than not reduce the fair value of a reporting unit below
its net book value. At December 31, 2008, the book value of goodwill was
$9,300,000.
41
Subsequent to the finalization of the purchase price allocation, any
adjustments to the recorded values of acquired assets and liabilities would be
reflected in the Company's consolidated statement of operations. Once final, the
Company is not permitted to revise the allocation of the original purchase
price, even if subsequent events or circumstances prove the Company's original
judgments and estimates to be incorrect. In addition, long-lived assets recorded
in a business combination like property and equipment, amortizable intangibles
and goodwill may be deemed to be impaired in the future resulting in the
recognition of an impairment loss. The assumptions and judgments made by the
Company when recording business combinations will have an impact on reported
results of operations for many years into the future.
Purchase price allocations for all of the Company's acquisitions have
been finalized. Adjustments to the initial purchase price allocations were not
material.
Use of Fair Value Estimates - Effective January 1, 2008 (except as
described below), the Company adopted Statement of Financial Accounting
Standards No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair
value, establishes a framework for measuring fair value, establishes a hierarchy
that prioritizes inputs to valuation techniques and expands disclosures about
fair value measurements. The fair value hierarchy gives the highest priority to
unadjusted quoted prices in active markets for identical assets or liabilities
(Level 1), the next priority to inputs that don't qualify as Level 1 inputs but
are nonetheless observable, either directly or indirectly, for the particular
asset or liability (Level 2), and the lowest priority to unobservable inputs
(Level 3). The Company elected to defer the effectiveness of SFAS 157 for one
year only with respect to nonfinancial assets and nonfinancial liabilities that
are recognized or disclosed at fair value in the financial statements on a
nonrecurring basis. The adoption of SFAS 157 did not have any impact on the
Company's consolidated financial statements other than expanded disclosures;
however, fair value measurements for new assets or liabilities and fair value
measurements for existing nonfinancial assets and nonfinancial liabilities may
be materially different under SFAS 157.
Over 80% of the Company's investment portfolio is classified as available
for sale securities, which are carried at estimated fair value in the Company's
consolidated balance sheet. The estimated fair values are principally based on
publicly quoted market prices (Level 1 inputs), which can rise or fall in
reaction to a wide variety of factors or events, and as such are subject to
market-related risks and uncertainties. The Company has a segregated portfolio
of mortgage pass-through certificates issued by U.S. Government agencies (GNMA)
and by U.S. Government-Sponsored Enterprises (FHLMC or FNMA) which are carried
on the balance sheet at their estimated fair value of $293,200,000. Although the
markets that these types of securities trade in are generally active, market
prices are not always available for the identical security. The fair value of
these investments are based on observable market data including benchmark
yields, reported trades, issuer spreads, benchmark securities, bids and offers.
These estimates of fair value are considered to be Level 2 inputs, and the
amounts realized from the disposition of these investments has not been
materially different from their estimated fair values.
The Company has a segregated portfolio of corporate bonds, which are
carried on the balance sheet at their estimated fair value of $31,400,000.
Although these bonds trade in brokered markets, the market for certain bonds is
sometimes inactive. The fair values of these investments are based on reported
trading prices, bid and ask prices and quotes obtained from independent market
makers in the securities. These estimates of fair values are also considered to
be Level 2 inputs.
Contingencies - The Company accrues for contingent losses when the
contingent loss is probable and the amount of loss can be reasonably estimated.
Estimates of the likelihood that a loss will be incurred and of contingent loss
amounts normally require significant judgment by management, can be highly
subjective and are subject to material change with the passage of time as more
information becomes available. Estimating the ultimate impact of litigation
matters is inherently uncertain, in particular because the ultimate outcome will
rest on events and decisions of others that may not be within the power of the
Company to control. The Company does not believe that any of its current
litigation will have a material adverse effect on its consolidated financial
position, results of operations or liquidity; however, if amounts paid at the
resolution of litigation are in excess of recorded reserve amounts, the excess
could be material to results of operations for that period. As of December 31,
2008, the Company's accrual for contingent losses was not material.
42
Results of Operations
General
Substantially all of the Company's operating businesses sell products or
services that are impacted by general economic conditions in the U.S. and to a
lesser extent internationally. Poor general economic conditions have reduced the
demand for products or services sold by the Company's operating subsidiaries
and/or resulted in reduced pricing for products or services. Troubled industry
sectors, like the residential real estate market, have had an adverse direct
impact not only on the Company's real estate and property management and
services segments, but have also had an adverse indirect impact on some of the
Company's other operating segments, including manufacturing and gaming
entertainment. The discussions below concerning revenue and profitability by
segment consider current economic conditions and the impact such conditions have
had and may continue to have on each segment; however, should general economic
conditions worsen and/or if the country experiences a prolonged recession, the
Company believes that all of its businesses would be adversely impacted.
The Company does not have any operating businesses that are participants
in the sub-prime real estate lending sector, though a tightening in consumer
lending standards has had and will continue to have a direct or indirect
negative impact on certain of the Company's operations. The Company's investment
portfolio includes mortgage-backed securities of $293,200,000 at December 31,
2008; however, all of these securities are issued by U.S. Government agencies or
U.S. Government-Sponsored Enterprises. The Company has also invested in certain
investment partnerships (one of which is consolidated) that invest in securities
whose values are directly affected by the sub-prime lending crisis. The
Company's exposure to changes in their values is limited to the net book value
of its investment in such partnerships. At December 31, 2008, the aggregate book
value of the Company's investments in such partnerships was approximately
$83,100,000.
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber for the years ended December
31, 2008, 2007 and 2006 were $235,300,000, $292,200,000 and $345,700,000,
respectively; gross profits were $11,600,000, $25,100,000 and $30,000,000,
respectively; salaries and incentive compensation expenses were $6,400,000,
$7,800,000 and $9,400,000, respectively; depreciation and amortization expenses
were $4,400,000, $4,600,000 and $4,900,000, respectively; and pre-tax income was
$800,000, $9,100,000 and $12,000,000, respectively. Idaho Timber's 2008 revenues
and other income include $4,200,000 from the settlement of an insurance claim.
Idaho Timber's revenues for 2008 continued to reflect the weak demand
resulting from reductions in housing starts and the abundant supply of
high-grade lumber in the marketplace. Shipment volume in 2008 declined by 20% as
compared to 2007; average selling prices did not significantly change in 2008 as
compared to 2007. Idaho Timber expects that the abundance of existing homes
available for sale in the market will continue to negatively impact housing
starts and Idaho Timber's revenues during 2009. Until housing starts begin to
increase, annual dimension lumber shipping volume may remain flat or could
decline further. Curtailment of production at primary sawmills due to their
operating losses could reduce excess supply to some degree; however, spread (as
discussed below) may not improve since price pressure for low-grade lumber may
increase if supplies are reduced. Idaho Timber's revenues for 2008 also reflect
the loss of a large home center board customer, which discontinued purchasing
pine boards through its vendor managed inventory program effective July 1, 2008.
Revenues from this customer pursuant to this program were $8,000,000 for the six
months ended June 30, 2008.
The weak demand resulting from reductions in housing starts and the
abundant supply of high-grade lumber in the marketplace also impacted Idaho
Timber's revenues for 2007. Although shipment volume increased throughout much
of 2007 as compared to the last quarter of 2006, the full year shipment volume
in 2007 declined by 3.5% as compared to 2006. In addition, average selling
prices for 2007 declined almost 12% as compared to 2006.
While raw material costs, the largest component of cost of sales
(approximately 80% of cost of sales), declined for 2008 as compared to 2007,
principally due to the same market conditions that negatively impacted revenues,
raw material cost per thousand board feet did not significantly change for 2008
as compared to 2007. The difference between Idaho Timber's selling price and raw
material cost per thousand board feet (spread) is closely monitored, and the
rate of change in pricing and cost is not necessarily the same. The spread for
2008 declined by 14% as compared to 2007, and was significantly lower in the
fourth quarter of 2008 as compared to the prior quarters in 2008, 2007 and 2006.
Although Idaho Timber reduced its manufacturing costs in the fourth quarter, the
smaller spread combined with low shipment volume resulted in negative gross
profit for the quarter. To the extent that shipment volume remains depressed and
cost of raw material remains high relative to selling price, Idaho Timber could
experience negative gross profit in future quarters.
43
Raw material costs declined during 2007 as compared to 2006 principally
due to the same market conditions that negatively impacted revenues. However,
raw material costs gradually increased throughout 2007, reflecting less
availability of low-grade lumber due to increased shipments to Asia and Europe
and lower Canadian lumber imports. Spreads declined throughout 2007, and were
lower by approximately 8% for the full year as compared to 2006.
Manufacturing - Conwed Plastics
Pre-tax income for Conwed Plastics was $14,000,000, $17,400,000 and
$17,900,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Its manufacturing revenues and other income were $106,000,000, $105,400,000 and
$106,400,000, and gross profits were $30,000,000, $31,300,000 and $34,400,000
for the years ended December 31, 2008, 2007 and 2006, respectively.
While Conwed Plastics' revenues from the packaging and filtration markets
increased during 2008 largely due to acquisitions made in 2007, and in the
European markets due to an acquisition in 2007, new customers and the impact of
foreign exchange, its business continued to be adversely impacted in those
markets related to the housing industry. Markets that are impacted by the
slowdown in the housing industry, which began in the second half of 2006,
include the carpet cushion, building and construction, erosion control and turf
reinforcement markets. In addition, revenues from the erosion control market
declined in 2008 as some business was lost to competitors. Conwed Plastics
expects revenues to continue to be adversely impacted in those markets related
to housing, and also expects that the poor domestic and international economic
conditions will continue to adversely impact its other markets in the future.
The slowdown in housing starts and a slow start in road construction due
to weather conditions were principally responsible for the revenue decline in
most of Conwed Plastics' markets during 2007. In addition, increased competition
in the erosion control market caused a decline in revenues during 2007. Revenues
also declined due to the removal of netting as a component of a customer's
bedding product. Conwed Plastics did realize increased revenues of $7,000,000
from its packaging market, principally due to acquisitions in May 2006, and in
February, July and October of 2007.
Raw material costs increased by approximately 23% in 2008 as compared to
2007 and by approximately 13% in 2007 as compared to 2006. The primary raw
material in Conwed Plastics' products is a polypropylene resin, which is a
byproduct of the oil refining process, whose price tends to fluctuate with the
price of oil. The increasing volatility of oil and natural gas prices along with
current general economic conditions worldwide make it difficult to predict
future raw material costs. In addition to managing resin purchases, Conwed
Plastics has improved its ability to reduce and/or reuse scrap and continues to
seek further improvements in order to increase raw material utilization.
Gross margins declined in 2008 as compared to 2007 principally due to
product mix and raw material cost increases. Gross margins declined in 2007 as
compared to 2006 primarily due to product mix, increased raw material costs and
greater depreciation and amortization expense related to acquisitions and
equipment upgrades. Gross margin and pre-tax results for 2007 as compared to
2006 reflect $800,000 of greater amortization expense on intangible assets
resulting from acquisitions and depreciation expense.
Pre-tax results for 2008 reflect $1,300,000 of higher salaries and
incentive compensation expense as compared to 2007 principally due to an
increase in estimated incentive bonus expense and greater headcount related to
acquisitions. Pre-tax results for 2007 reflects $2,200,000 of lower salaries and
incentive compensation expense as compared to 2006 principally due to lower
pre-tax profits and the conversion of certain European management employees from
salaried employees to contract based professionals.
44
Telecommunications
STi Prepaid's telecommunications revenues and other income for the year
ended December 31, 2008 and for the period from the asset acquisition (March
2007) through December 31, 2007 were $452,400,000 and $363,200,000,
respectively; telecommunications cost of sales were $392,500,000 and
$309,000,000, respectively; salaries and incentive compensation expenses were
$10,600,000 and $8,100,000, respectively; depreciation and amortization expenses
were $1,400,000 and $500,000, respectively; selling, general and other expenses
were $35,900,000 and $27,000,000, respectively; and pre-tax income was
$11,900,000 and $18,400,000, respectively.
Prepaid calling card revenue, which increased from $316,700,000 for the
2007 period to $342,600,000 for the year ended December 31, 2008, includes
$18,800,000 of revenues from acquisitions made by STi Prepaid during the year.
While prepaid calling card revenues have either declined or largely been flat
throughout most of 2008 (exclusive of the revenues from acquisitions), and have
declined compared to those for the fourth quarter of 2007, gross margins have
improved principally due to fewer launches of new prepaid calling cards with low
introductory rates and a reduction in certain unprofitable prepaid calling card
business. During the fourth quarter of 2008, prepaid calling card revenues
(excluding revenues from acquisitions), declined compared to the third quarter
of 2008. STi Prepaid believes that the adverse economic conditions may have
contributed to this decline and may continue to adversely affect its business.
Carrier wholesale service business, which has lower gross margins than the
prepaid calling card business, increased from $29,700,000 for the 2007 period to
$79,800,000 for the year ended December 31, 2008. Pre-tax results for 2008 also
reflect $2,900,000 of higher selling, general and other expenses and $1,100,000
of higher salaries and incentive compensation expense from the acquisitions.
Property Management and Services
Property management and services revenues and other income for the year
ended December 31, 2008 and from the date of acquisition of ResortQuest (June
2007) through December 31, 2007 were $142,000,000 and $81,500,000, respectively;
direct operating expenses were $113,800,000 and $66,000,000, respectively;
salaries and incentive compensation expenses were $5,600,000 and $4,000,000,
respectively; depreciation and amortization expenses were $4,600,000 and
$3,100,000, respectively; selling, general and other expenses were $19,900,000
and $14,900,000, respectively; and pre-tax losses were $1,900,000 and
$6,500,000, respectively.
While ResortQuest's occupancy percentage for the year ended December 31,
2008 did not significantly change as compared to that for 2007 (inclusive of the
pre-acquisition period), its occupancy percentage for the fourth quarter of 2008
declined as compared to the fourth quarter of 2007. In addition, its average
daily rates ("ADR") for 2008, particularly those for the fourth quarter,
declined compared to those for the same periods in 2007. The declines in
occupancy and ADRs primarily reflect fewer reservations for its ski locations,
which typically have higher ADRs than beach locations, an increase in available
properties in certain beach locations, as well as rate discounts given on
properties due to competition and excess availability. Reservations did increase
at beach and golf locations but not enough to offset the overall decline in
occupancy percentage. Subsequent to year-end, ResortQuest has seen a further
decline in advance reservations for its ski locations and many of its beach
locations. ResortQuest believes that the decline in advance reservations is
largely due to the adverse economic conditions, and with respect to its fly to
markets, fewer flights at increased fares. Both ResortQuest and its competitors
have begun offering large discounts to entice customers.
ResortQuest recorded net real estate brokerage revenues of $8,700,000 for
2008, principally upon the completion of certain large development projects. Its
real estate brokerage services, which are concentrated in Northwest Florida,
tend to be cyclical, and experience the same volatility that residential real
estate and new construction markets experience. Since acquisition, its real
estate brokerage business has been and will continue to be negatively impacted
by the depressed real estate market.
45
Gaming Entertainment
As more fully discussed above, Premier was accounted for as a
consolidated subsidiary when acquired during 2006; however, while in bankruptcy
proceedings from September 19, 2006 to emergence on August 10, 2007, Premier was
accounted for under the equity method of accounting. Upon emergence from
bankruptcy, Premier was once again consolidated by the Company. Premier's casino
and hotel operations opened to the public on June 30, 2007; prior to opening,
Premier's activities principally consisted of rebuilding and repairing the hotel
and casino facilities that were severely damaged by Hurricane Katrina, and its
bankruptcy proceedings.
For the year ended December 31, 2008 and for the period from emergence
from bankruptcy (date of reconsolidation) through December 31, 2007, Premier's
revenues and other income were $119,100,000 and $38,500,000, respectively;
direct operating expenses were $94,000,000 and $37,800,000, respectively;
interest expense was $900,000 and $500,000, respectively; salaries and incentive
compensation expenses were $2,500,000 and $1,400,000, respectively; depreciation
and amortization expenses were $17,000,000 and $6,300,000, respectively;
selling, general and other expenses were $3,800,000 and $1,800,000,
respectively; and pre-tax income (losses) were $1,000,000 and $(9,300,000),
respectively. For the period from date of acquisition (April 2006) through its
filing for bankruptcy in September 2006, Premier's pre-tax losses were not
material. The Company's share of Premier's net loss under the equity method of
accounting from January 1, 2007 to the date of emergence from bankruptcy was
$22,300,000 and not material during 2006.
Revenues and other income for 2008 include a $7,300,000 gain from the
settlement and collection of Premier's remaining insurance claim relating to
Hurricane Katrina and $5,600,000 resulting from capital contributions from the
minority interest. In prior periods, the Company recorded 100% of the losses
after cumulative loss allocations to the minority interest had reduced the
minority interest liability to zero. Since the minority interest liability
remains at zero after considering the capital contributions, the entire capital
contribution was recorded as income, effectively reimbursing the Company for a
portion of the minority interest losses that were not previously allocated to
the minority interest. Pre-tax results for 2008 include $1,100,000 of charges
relating to Hurricane Gustav, primarily to write off damaged assets, for which
there will not be any insurance recovery, and a charge of $800,000 to write down
certain gaming assets that will not be used.
Gaming revenues increased in each quarter of 2008 as compared to the
fourth quarter of 2007. However, gaming revenues for the fourth quarter of 2008
declined compared to the prior quarters of 2008 reflecting seasonality in the
Gulf Coast gaming market and unfavorable economic conditions. During the fourth
quarter of 2008, Premier reduced its workforce and implemented other cost
reductions. Premier believes that current adverse economic conditions are likely
to have a negative impact on the local gaming market in 2009, which could cause
competition among gaming operations in Biloxi to escalate. Since Premier's
competitors in the Gulf Coast gaming market have been in operation longer, they
have more established gaming operations and customer databases, and many are
larger and have greater financial resources.
Domestic Real Estate
Pre-tax income (loss) for the domestic real estate segment was
$(14,400,000), $(8,200,000) and $44,000,000 for the years ended December 31,
2008, 2007 and 2006, respectively. Pre-tax results for the domestic real estate
segment are largely dependent upon the performance of the segment's operating
properties, the current status of the Company's real estate development projects
and non-recurring gains or losses recognized when real estate assets are sold.
As a result, pre-tax results for this segment for any particular year are not
predictable and do not follow any consistent pattern.
The Company did not have any major real estate sales during 2008 or
2007, resulting in significantly lower pre-tax results than in 2006. Real estate
revenues and other income for 2008 include income of $3,700,000 from the
favorable settlement of a lawsuit. During 2008 and 2007, real estate revenues
and other income include $4,600,000 and $3,900,000, respectively, of charges
related to the accounting for the mark-to-market value of an interest rate
derivative relating to the Myrtle Beach project's debt obligation. Pre-tax
results for 2007 include $1,600,000 of incentive compensation accruals related
to the Myrtle Beach project. During 2006, pre-tax income includes the sale by
Square 711, which resulted in a pre-tax gain of $48,900,000, and the sale of
other land parcels in Utah for a pre-tax gain of $11,200,000. In addition, in
2006, the Company recognized pre-tax profit related to its 95-lot development
project in South Walton County, Florida of $3,600,000. Such amount principally
resulted from the completion of certain required improvements to land previously
sold. Pre-tax results for 2006 reflect $8,100,000 of incentive compensation
accruals related to the Myrtle Beach project.
46
Residential property sales volume, prices and new building starts have
declined significantly in many U. S. markets, including markets in which the
Company has real estate operations in various stages of development. The
slowdown in residential sales has been exacerbated by the turmoil in the
mortgage lending and credit markets during the past two years, which has
resulted in stricter lending standards and reduced liquidity for prospective
home buyers. The Company has deferred its development plans for certain of its
real estate development projects, and is not actively soliciting bids for its
fully developed projects. The Company intends to wait for market conditions to
improve before marketing certain of its projects for sale.
Medical Product Development
Pre-tax losses (net of minority interest) for Sangart for the years ended
December 31, 2008, 2007 and 2006 were $32,300,000, $31,500,000 and $21,100,000,
respectively. Sangart's losses for these periods reflect research and
development costs (which are included in selling, general and other expenses in
the consolidated statements of operations) of $13,900,000, $22,100,000 and
$16,500,000, respectively, and salaries and incentive compensation expenses of
$13,100,000, $8,800,000 and $6,400,000, respectively.
As more fully discussed above, Sangart is a development stage company
that does not have any revenues from product sales. Earlier this year Sangart,
completed patient enrollment in two Phase III clinical trials in Europe of
Hemospan(R), its current medical product candidate that were designed to
demonstrate Hemospan's safety and effectiveness in preventing and treating low
blood pressure during orthopedic hip replacement surgeries and in reducing the
incidence of operative and postoperative complications. Because these Phase III
trials were conducted in a patient population having a relatively low incidence
of medical complications, they were unable to demonstrate a clinical benefit of
better outcomes than the control group. Sangart has decided not to pursue
marketing approval to use Hemospan for these purposes at this time, but plans to
conduct additional clinical trials of Hemospan in a different therapeutic area
that may better demonstrate its clinical benefit and strengthen the likelihood
of regulatory approval. Such studies will take several years to complete at
substantial cost, and until they are successfully completed, if ever, Sangart
will not be able to request marketing approval and generate revenues from
Hemospan sales. In the first quarter of 2009, the Company invested an additional
$28,500,000 in Sangart upon the exercise of its remaining warrants. The Company
is unable to predict with certainty when, if ever, it will report operating
profits for this segment.
When the Company increases its investment in Sangart, the additional
investment is accounted for under the purchase method of accounting. Under the
purchase method, the price paid is allocated to Sangart's individual assets and
liabilities based on their relative fair values; in Sangart's case, a portion of
the fair value of assets acquired was initially allocated to research and
development. However, since under current GAAP the Company is not permitted to
recognize research and development as an asset under the purchase method, any
amounts initially allocated to research and development are immediately
expensed. The Company expensed acquired research and development of $2,100,000,
$4,100,000 and $7,500,000 for the years ended December 31, 2008, 2007 and 2006,
respectively, which is included in the caption selling, general and other
expenses in the consolidated statements of operations. Purchase accounting rules
have been amended subsequent to December 31, 2008; as a result any amounts
allocated to research and development will no longer be immediately expensed in
future periods.
The increase in salaries and incentive compensation in 2008 as compared
to 2007 was principally due to increased headcount in connection with the Phase
III trials and development efforts, greater share-based compensation expense,
and compensation costs for a newly hired officer. The increase in salaries and
incentive compensation in 2007 as compared to 2006 was due to increased
headcount in connection with the commencement of the Phase III trials, including
the need to increase Hemospan production for the clinical trials. Pre-tax
results for 2008 also reflect $1,600,000 of severance expense relating to a
former officer and headcount reductions.
47
Corporate and Other Operations
Investment and other income decreased in 2008 as compared to 2007.
Investment income declined $41,500,000 in 2008 principally due to lower interest
rates on a reduced amount of fixed income securities. Other income, which
increased $33,300,000 in 2008, includes $40,500,000 of income related to
Fortescue's Pilbara iron ore and infrastructure project in Western Australia.
The Company is entitled to receive 4% of the revenue, net of government
royalties, invoiced from certain areas of Fortescue's project, which commenced
production in May 2008. Amounts are payable semi-annually within thirty days of
June 30th and December 31st of each year subject to restricted payment
provisions of Fortescue's debt agreements; payments are currently being deferred
pursuant to those agreements. Depreciation and amortization expenses for 2008
include prepaid mining interest amortization of $2,800,000, which is being
amortized over time in proportion to the amount of ore produced. Other income
for 2008 also reflects an increase of $7,500,000 in income from purchased
delinquent credit card receivables. Investment and other income for 2007
includes the receipt of escrowed proceeds from the sale of an associated company
in 2006 of $11,400,000 that had not been previously recognized, and $8,500,000
related to the termination of a joint development agreement with another party.
This amount substantially reimbursed the Company for its prior expenditures,
which were fully expensed as incurred. Investment and other income includes
income (charges) of $(1,800,000), $(1,900,000) and $1,200,000 for the years
ended December 31, 2008, 2007 and 2006, respectively, related to the accounting
for mark-to-market values of Corporate derivatives.
Investment and other income decreased in 2007 as compared to 2006.
Investment and other income during 2006 includes $34,700,000 related to the
sales of two associated companies; investment and other income during 2007
includes the receipt of escrowed proceeds from one of those sales of $11,400,000
that had not been previously recognized. In addition, investment and other
income for 2006 includes $7,400,000 from the recovery of bankruptcy claims.
Interest income also declined by $22,400,000 in 2007 as compared to 2006,
principally due to the sale of interest bearing securities to generate cash to
purchase Fortescue's securities and interests in associated companies. For 2007,
investment and other income includes $8,500,000 related to the termination of a
joint development agreement with another party, and $4,200,000 of foreign
exchange gains.
Net securities gains (losses) for Corporate and Other Operations
aggregated $(144,500,000), $95,600,000, and $117,200,000 for the years ended
December 31, 2008, 2007 and 2006, respectively. Net securities gains (losses)
are net of impairment charges of $143,400,000, $36,800,000 and $12,900,000
during 2008, 2007 and 2006, respectively. The impaired securities include the
Company's investment in various debt and equity securities and reflect the
significant decline in value of worldwide securities markets during 2008. The
impairment charges result from declines in fair values of securities believed to
be other than temporary, principally for securities classified as available for
sale securities. Included in net securities gains for 2007 is a gain of
$37,800,000 from the sale of Eastman. Included in net securities gains for 2006
is a gain of $37,400,000 from the sale of Level 3 common stock.
The Company's decision to sell securities and realize security gains or
losses is generally based on its evaluation of an individual security's value at
the time and the prospect for changes in its value in the future. The decision
could also be influenced by the status of the Company's tax attributes or
liquidity needs; however, sales in recent years have not been influenced by
these considerations. Therefore, the timing of realized security gains or losses
is not predictable and does not follow any pattern from year to year.
The increase in interest expense during 2008 as compared to 2007
primarily reflects interest expense relating to the 8 1/8% Senior Notes issued
in September 2007 and the 7 1/8% Senior Notes issued in March 2007. Interest
expense for 2008 also reflects decreased interest expense related to the fixed
rate repurchase agreements and the 3 3/4% Convertible Senior Subordinated Notes,
$128,900,000 of which were converted during 2008. The increase in interest
expense during 2007 as compared to 2006 primarily reflects interest expense
relating to the 7 1/8% Senior Notes, the 8 1/8% Senior Notes and the fixed rate
repurchase agreements. Interest expense during 2006 also includes interest on
$21,700,000 principal amount of 7 7/8% Subordinated Notes, which matured in the
third quarter of 2006, and interest expense relating to Premier prior to its
deconsolidation of $8,000,000.
Principally due to reductions in incentive bonus expense and less
share-based compensation expense, salaries and incentive compensation expense
decreased by $9,100,000 in 2008 as compared to 2007 and by $4,900,000 in 2007 as
compared to 2006. As a result of the adoption of SFAS 123R in 2006, the Company
recorded share-based compensation expense relating to grants made under the
Company's senior executive warrant plan and the fixed stock option plan of
$10,100,000 in 2008, $11,200,000 in 2007 and $15,200,000 in 2006. Share-based
compensation expense in 2007 reflected increased expenses relating to the stock
option plan due to the accelerated vesting of stock options of an officer of the
Company who resigned. Share-based compensation expense in 2006 reflected grants
made under the warrant plan in 2006 for which a portion vested upon issuance.
48
The increase in selling, general and other expenses of $28,300,000 in
2008 as compared to 2007 primarily reflects greater expenses (largely
professional fees and other costs) related to the investigation and evaluation
of energy projects, $16,200,000 of expenses incurred relating to the induced
conversion of $128,887,000 principal amount of the Company's 3 3/4% Convertible
Senior Subordinated Notes during the fourth quarter of 2008 and $6,100,000 of
severance expense. Selling, general and other expenses for 2008 also include
charges of $5,300,000 from asset disposals and writedowns. Selling, general and
other expenses related to energy projects were $31,000,000, $18,400,000 and
$8,300,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Selling, general and other expenses for 2007 include a charge of $7,500,000 for
the settlement of litigation related to MK Resources Company, greater legal
fees, including those incurred in connection with that litigation, and higher
professional fees.
The increase in selling, general and other expenses of $32,900,000 in
2007 as compared to 2006 primarily reflects higher professional fees and other
costs, which largely relate to analyses of potential and existing investments
and projects, including energy projects, and increased legal fees, including
those incurred in connection with litigation related to MK Resources. This
litigation was settled during 2007, and selling, general and other expenses
include a charge of $7,500,000 for that settlement.
As more fully discussed above, during 2008 the Company concluded that a
valuation allowance was required against substantially all of the net deferred
tax asset, and increased its valuation allowance by $1,672,100,000 with a
corresponding charge to income tax expense. During 2007 the Company's revised
projections of future taxable income enabled it to conclude that it was more
likely than not that it will have future taxable income sufficient to realize a
portion of the Company's net deferred tax asset; accordingly, $542,700,000 of
the deferred tax valuation allowance was reversed as a credit to income tax
expense. The income tax provision reflects the reversal of tax reserves
aggregating $4,100,000, $2,300,000 and $8,000,000 for the years ended December
31, 2008, 2007 and 2006, respectively, as a result of the expiration of the
applicable statute of limitations and the favorable resolution of various state
and federal income tax contingencies.
Associated Companies
Income (losses) related to associated companies includes the following
for the years ended December 31, 2008, 2007 and 2006 (in thousands):
2008 2007 2006
----------- -------- ---------
ACF $ (155,300) $ -- $ --
Jefferies (105,700) -- --
IFIS (71,700) -- --
Pershing Square (77,700) (85,500) --
Shortplus 10,500 54,500 --
Highland Opportunity (17,200) (17,600) --
Wintergreen (32,600) 14,000 11,000
EagleRock (19,000) (11,800) 16,400
Goober Drilling 24,900 13,600 2,000
HomeFed (3,100) 1,500 2,900
JPOF II -- 3,000 26,200
JHYH (69,100) 4,300 --
Ambrose (1,000) (1,100) --
Premier -- (22,300) (300)
Safe Harbor -- 1,800 (7,600)
CLC (5,900) 4,000 3,800
Other (13,900) 10,400 5,700
---------- -------- --------
Income (losses) related to associated
companies before income taxes (536,800) (31,200) 60,100
Income tax (expense) benefit (2,300) 9,300 (22,400)
---------- -------- --------
Income (losses) related to associated
companies, net of taxes $ (539,100) $(21,900) $ 37,700
========== ======== ========
49
As discussed above, the Company elected the fair value option to account
for its investments in Jefferies and ACF, resulting in the recognition of
unrealized losses in the consolidated statements of operations for these
investments.
The Company's share of IFIS's losses include an impairment charge of
$63,300,000. In January 2009, IFIS raised a significant amount of new equity in
a rights offering in which the Company did not participate. As a result, the
Company's ownership interest in IFIS was reduced to 8% and the Company will no
longer apply the equity method of accounting for this investment.
In June 2007, the Company acquired a 10% limited partnership interest in
Pershing Square, a newly-formed private investment partnership whose investment
decisions are at the sole discretion of Pershing Square's general partner. The
stated objective of Pershing Square is to create capital appreciation by
investing in Target Corporation. Losses recorded by Pershing Square principally
result from a decline in the market value of Target Corporation's common stock.
Shortplus, Highland Opportunity, Wintergreen, EagleRock, Ambrose and Safe
Harbor are investment partnerships or limited liability corporations whose
investment decisions are at the sole discretions of their respective general
partners or managing members. These entities invest in a variety of debt and
equity securities. The Company has fully redeemed its interests in Highland
Opportunity, Ambrose and Safe Harbor and has sent redemption notices to the
managers of EagleRock and Wintergreen.
The Company owns approximately 31.4% of HomeFed, a California real estate
development company, which it acquired in 2002. The Company's share of HomeFed's
reported earnings fluctuates with the level of real estate sales activity at
HomeFed's development projects.
In April 2007, the Company and Jefferies expanded and restructured the
Company's equity investment in JPOF II, and formed JHYH. The Company contributed
$250,000,000 to JHYH along with its investment in JPOF II. The Company's share
of JPOF II's earnings was distributed to the Company shortly after the end of
each period.
The Company accounted for Premier under the equity method of accounting
while it was in bankruptcy (September 2006 to August 2007).
Discontinued Operations
Symphony
In July 2006, the Company sold Symphony for $107,000,000 and classified
its historical operating results as a discontinued operation. After satisfaction
of Symphony's outstanding credit agreement by the buyer ($31,700,000 at date of
sale) and certain sale related obligations, the Company realized net cash
proceeds of $62,300,000. Pre-tax income of Symphony was $200,000 for 2006. Gain
on disposal of discontinued operations for 2006 includes a pre-tax gain on the
sale of Symphony of $53,300,000 ($33,500,000 after tax).
ATX
In September 2006, the Company sold ATX for $85,700,000 and classified
its historical operating results as a discontinued operation. Pre-tax losses of
ATX were $1,200,000 for 2006. Gain on disposal of discontinued operations for
2006 includes a pre-tax gain on the sale of ATX of $41,600,000 ($26,100,000
after tax). Losses of $1,100,000 in 2008 relate to an indemnification obligation
to the purchaser.
WilTel
The Company sold WilTel in December 2005. Gain on disposal of
discontinued operations for 2007 includes a pre-tax gain of $800,000 ($500,000
after tax) from the resolution of sale-related contingencies. Gain on disposal
of discontinued operations during 2006 includes $2,400,000 of pre-tax gains
($1,500,000 after tax) principally for the resolution of certain sale-related
contingencies and obligations and working capital adjustments.
50
Other
As discussed above, during the fourth quarter of 2008 the Company
received distributions totaling $44,900,000 from Empire, a subsidiary of the
Company that had been classified as a discontinued operation in 2001 and fully
written-off. For income tax purposes, the payments are treated as non-taxable
distributions paid by a subsidiary.
Gain on disposal of discontinued operations for 2007 includes a pre-tax
gain of $4,000,000 ($2,800,000 after tax) related to the collection of
additional amounts from the sale of the Company's interest in an Argentine shoe
manufacturer in 2005 that had not been previously recognized (collectibility was
uncertain).
In 2006, the Company sold its gas properties and recorded a pre-tax loss
on disposal of discontinued operations of $900,000. Income (loss) from
discontinued operations for 2006 includes $2,900,000 of pre-tax losses related
to these gas properties.
In 2006, the Company received $3,000,000 from a former insurance
subsidiary which, for many years, had been undergoing liquidation proceedings
controlled by state insurance regulators. The Company reflected the amount
received as a gain on disposal of discontinued operations. For income tax
purposes, the payment is treated as a non-taxable distribution paid by a
subsidiary; as a result, no tax expense was recorded.
Recently Issued Accounting Standards
In March 2008, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 161, "Disclosures about
Derivative Instruments and Hedging Activities - an amendment of FASB Statement
No. 133" ("SFAS 161"). SFAS 161, which is effective for fiscal years beginning
after November 15, 2008, requires enhanced disclosures about an entity's
derivative and hedging activities, including the objectives and strategies for
using derivatives, disclosures about fair value amounts of, and gains and losses
on, derivative instruments, and disclosures about credit-risk-related contingent
features in derivative agreements. The Company is currently evaluating the
impact of adopting SFAS 161 on its consolidated financial statements.
In December 2007, the FASB issued Statement of Financial Accounting
Standards No. 141R, "Business Combinations" ("SFAS 141R") and Statement of
Financial Accounting Standards No. 160, "Noncontrolling Interests in
Consolidated Financial Statements" ("SFAS 160"). SFAS 141R and SFAS 160 are
effective for fiscal years beginning after December 15, 2008. SFAS 141R will
change how business combinations are accounted for and will impact financial
statements both on the acquisition date and in subsequent periods. Adoption of
SFAS 141R is not expected to have a material impact on the Company's
consolidated financial statements although it may have a material impact on
accounting for business combinations in the future which can not currently be
determined. SFAS 160 will materially change the accounting and reporting for
minority interests in the future, which will be recharacterized as
noncontrolling interests and classified as a component of stockholders' equity.
Upon adoption of SFAS 160, the Company will be required to apply its
presentation and disclosure requirements retrospectively, which will require the
reclassification of minority interests on the historical consolidated balance
sheets, require the historical consolidated statements of operations to reflect
net income attributable to the Company and to noncontrolling interests, and
require other comprehensive income to reflect other comprehensive income
attributable to the Company and to noncontrolling interests.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such statements may relate, but are not limited, to projections of
revenues, income or loss, development expenditures, plans for growth and future
operations, competition and regulation, as well as assumptions relating to the
foregoing. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995.
51
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates," "expects," "anticipates," "believes,"
"plans," "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
Factors that could cause actual results to differ materially from any
results projected, forecasted, estimated or budgeted or may materially and
adversely affect the Company's actual results include, but are not limited to,
those set forth in Item 1A. Risk Factors and elsewhere in this Report and in the
Company's other public filings with the Securities and Exchange Commission.
Undue reliance should not be placed on these forward-looking statements,
which are applicable only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements to reflect
events or circumstances that arise after the date of this Report or to reflect
the occurrence of unanticipated events.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
-------- -----------------------------------------------------------
The following includes "forward-looking statements" that involve risk
and uncertainties. Actual results could differ materially from those projected
in the forward-looking statements.
The Company's market risk arises principally from interest rate risk
related to its investment portfolio and its borrowing activities and equity
price risk.
The Company's investment portfolio is primarily classified as available
for sale, and consequently, is recorded on the balance sheet at fair value with
unrealized gains and losses reflected in shareholders' equity. Included in the
Company's available for sale investment portfolio are fixed income securities,
which comprised approximately 47% of the Company's total investment portfolio at
December 31, 2008. These fixed income securities are primarily rated "investment
grade" or are U.S. governmental agency issued or U.S. Government-Sponsored
Enterprises. The estimated weighted average remaining life of these fixed income
securities was approximately 1.6 years at December 31, 2008. The Company's fixed
income securities, like all fixed income instruments, are subject to interest
rate risk and will fall in value if market interest rates increase. At December
31, 2007, fixed income securities comprised approximately 34% of the Company's
total investment portfolio and had an estimated weighted average remaining life
of 1.7 years.
Also included in the Company's available for sale investment portfolio
are equity securities, which are recorded on the balance sheet at an aggregate
fair value of $561,400,000 (aggregate cost of $422,000,000) and which comprised
approximately 40% of the Company's total investment portfolio at December 31,
2008. The majority of this amount consists of two publicly traded securities,
including the investment in Fortescue common shares, which is carried at fair
value of $377,000,000, and the investment in Inmet, which is carried at fair
value of $90,000,000. Although the Company is currently restricted from selling
the Inmet common shares, the investment is subject to price risk. As discussed
more fully above in Management's Discussion and Analysis of Financial Condition
and Results of Operations, the Company evaluates its investments for impairment
on a quarterly basis.
The Company is also subject to price risk related to its investments in
ACF and Jefferies, for which it has elected the fair value option. At December
31, 2008, these investments are classified as investments in associated
companies and carried at fair values of $249,900,000 and $683,100,000,
respectively.
At December 31, 2008 and 2007, the Company's portfolio of trading
securities was not material to the total investment portfolio.
The Company is subject to interest rate risk on its long-term fixed
interest rate debt. Generally, the fair market value of debt securities with a
fixed interest rate will increase as interest rates fall, and the fair market
value will decrease as interest rates rise.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are primarily sensitive to
changes in interest rates. For investment securities and debt obligations, the
table presents principal cash flows by expected maturity dates. For the variable
rate borrowings, the weighted average interest rates are based on implied
forward rates in the yield curve at the reporting date. For securities and
liabilities with contractual maturities, the table presents contractual
principal cash flows adjusted for the Company's historical experience and
prepayments of mortgage-backed securities.
52
For additional information, see Notes 6, 13 and 22 of Notes to
Consolidated Financial Statements.
Expected Maturity Date
----------------------
2009 2010 2011 2012 2013 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities:
U.S. Government and agencies $256,431 $ 2,165 $ 1,480 $ 1,074 $ 810 $ 2,305 $ 264,265 $ 264,265
Weighted Average
Interest Rate 1.91% 4.72% 4.71% 4.69% 4.69% 4.68%
U.S. Government-
Sponsored Enterprises $154,103 $ 52,969 $ 39,649 $ 29,327 $ 21,781 $ 56,235 $ 354,064 $ 354,064
Weighted Average
Interest Rate 3.34% 5.17% 5.15% 5.14% 5.13% 5.13%
Other Fixed Maturities:
Rated Investment Grade $ 20,254 $ -- $ -- $ -- $ -- $ 1,078 $ 21,332 $ 21,332
Weighted Average
Interest Rate 3.04% -- -- -- -- .96%
Rated Less Than Investment
Grade/Not Rated $ 17,235 $ -- $ 124 $ -- $ 550 $ 2,749 $ 20,658 $ 20,658
Weighted Average Interest
Rate 8.97% -- 8.50% -- 10.00% 4.50%
Rate Sensitive Liabilities:
Fixed Interest Rate Borrowings $151,789 $ 113 $ 27 $ -- $475,000 $1,319,310 $1,946,239 $1,566,327
Weighted Average
Interest Rate 2.28% 10.16% 10.78% -- 7.07% 7.05%
Variable Interest Rate
Borrowings $ 96,924 $ 12,423 $ 32,909 $ 25 $ -- $ -- $ 142,281 $ 142,281
Weighted Average
Interest Rate 3.54% 5.40% 6.25% 4.80% -- --
Rate Sensitive Derivative
Financial Instruments:
Euro currency swap $ 2,085 $ 522 $ -- $ -- $ -- $ -- $ 2,607 $ (1,424)
Average Pay Rate 5.89% 5.89% -- -- -- --
Average Receive Rate 7.60% 7.60% -- -- -- --
Pay Fixed/Receive Variable
Interest Rate Swap $ 2,114 $115,923 $ 32,879 $ -- $ -- $ -- $ 150,916 $ (11,708)
Average Pay Rate 5.06% 5.06% 5.01% -- -- --
Average Receive Rate 1.39% 1.98% 2.25% -- -- --
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $100,000 $ -- $ -- $ -- $ 100,000 $ 100,000
Weighted Average
Interest Rate 2.26% 2.89% 3.12% -- -- --
53
Item 8. Financial Statements and Supplementary Data.
------ -------------------------------------------
Financial Statements and supplementary data required by this Item 8 are
set forth at the pages indicated in Item 15(a) below.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
------ ---------------------
None.
Item 9A. Controls and Procedures.
------- -----------------------
Evaluation of disclosure controls and procedures
------------------------------------------------
(a) The Company's management evaluated, with the participation of the
Company's principal executive and principal financial officers, the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2008. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2008.
Changes in internal control over financial reporting
----------------------------------------------------
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2008, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in Rules 13a-15(f)
or 15d-15(f) promulgated under the Securities Exchange Act of 1934. Internal
control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and procedures that:
o Pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and disposition of the
assets of the Company;
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management
and directors of the Company; and
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
54
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2008. In making
this assessment, the Company's management used the criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
Based on our assessment and those criteria, management concluded that, as
of December 31, 2008, the Company's internal control over financial reporting
was effective.
The effectiveness of the Company's internal control over financial
reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers
LLP, an independent registered public accounting firm, as stated in their report
which appears herein.
Item 9B. Other Information.
------- -----------------
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant.
------- --------------------------------------------------
The information to be included under the caption "Election of Directors"
and "Information Concerning the Board and Board Committees" in the Company's
definitive proxy statement to be filed with the Commission pursuant to
Regulation 14A of the Exchange Act in connection with the 2009 annual meeting of
shareholders of the Company (the "Proxy Statement") is incorporated herein by
reference. In addition, reference is made to Item 10 in Part I of this Report.
Item 11. Executive Compensation.
------- ----------------------
The information to be included under the caption "Executive Compensation"
in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
------- --------------------------------------------------------------
The information to be included under the caption "Information on Stock
Ownership" in the Proxy Statement is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
------- ----------------------------------------------
The information to be included under the caption "Executive Compensation
- Certain Relationships and Related Transactions" in the Proxy Statement is
incorporated herein by reference.
Item 14. Independent Accounting Firm Fees.
-------- --------------------------------
The information to be included under the caption "Independent Accounting
Firm Fees" in the Proxy Statement is incorporated herein by reference.
55
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).
56
(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.
3.1 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).*
57
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")).*
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).*
58
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., STi Prepaid,
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")).*
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.
59
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 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).**
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.
32.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.***
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.***
32.3 Certification of Principal Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.***
(c) Financial statement schedules.
(1) Pershing Square IV, 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).**
(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 Highland 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.
** To be filed by amendment pursuant to Item 3-09(b) of Regulation S-X.
*** Furnished herewith pursuant to item 601(b) (32) of Regulation S-K.
60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
February 27, 2009 By: /s/ Barbara L. Lowenthal
--------------------------------
Barbara L. Lowenthal
Vice President and Comptroller
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on the date set forth above.
Signature Title
--------- -----
/s/ Ian M. Cumming
---------------------------------- Chairman of the Board
Ian M. Cumming (Principal Executive Officer)
/s/ Joseph S. Steinberg
---------------------------------- President and Director
Joseph S. Steinberg (Principal Executive Officer)
/s/ Joseph A. Orlando
---------------------------------- Vice President and Chief
Joseph A. Orlando Financial Officer
(Principal Financial Officer)
/s/ Barbara L. Lowenthal
---------------------------------- Vice President and Comptroller
Barbara L. Lowenthal (Principal Accounting Officer)
/s/ Paul M. Dougan Director
----------------------------------
Paul M. Dougan
/s/ Lawrence D. Glaubinger Director
----------------------------------
Lawrence D. Glaubinger
/s/ Alan J. Hirschfield Director
----------------------------------
Alan J. Hirschfield
/s/ James E. Jordan Director
----------------------------------
James E. Jordan
/s/ Jeffrey C. Keil Director
----------------------------------
Jeffrey C. Keil
/s/ Jesse Clyde Nichols, III Director
----------------------------------
Jesse Clyde Nichols, III
61
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of Leucadia National Corporation:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1)(2) present fairly, in all material respects, the
financial position of Leucadia National Corporation and its subsidiaries at
December 31, 2008 and 2007, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2008 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(1)(2) presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2008, based on criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for these financial statements and financial statement schedule, for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in "Management's Report on Internal Control over Financial Reporting"
appearing under Item 9A. Our responsibility is to express opinions on these
financial statements, on the financial statement schedule, and on the Company's
internal control over financial reporting based on our integrated audits. We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audits of the financial statements included 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.
Our audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audits provide a reasonable basis for
our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
New York, New York
February 27, 2009
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
(Dollars in thousands, except par value)
2008 2007
---- ----
ASSETS
------
Current assets:
Cash and cash equivalents $ 237,503 $ 456,970
Investments 366,464 983,199
Trade, notes and other receivables, net 138,363 133,765
Prepaids and other current assets 124,308 146,199
---------- ----------
Total current assets 866,638 1,720,133
Non-current investments ($164,675 and $129,056 collateralizing current liabilities) 1,028,012 2,776,521
Notes and other receivables, net 17,756 16,388
Intangible assets, net and goodwill 84,848 79,506
Deferred tax asset, net 40,235 1,113,925
Other assets 619,790 544,432
Property, equipment and leasehold improvements, net 534,640 512,804
Investments in associated companies ($933,057 measured using fair
value option at December 31, 2008) 2,006,574 1,362,913
---------- ----------
Total $5,198,493 $8,126,622
========== ==========
LIABILITIES
-----------
Current liabilities:
Trade payables and expense accruals $ 205,870 $ 229,560
Deferred revenue 98,453 86,993
Other current liabilities 9,880 10,992
Debt due within one year 248,713 132,405
---------- ----------
Total current liabilities 562,916 459,950
Other non-current liabilities 107,443 71,061
Long-term debt 1,832,743 2,004,145
---------- ----------
Total liabilities 2,503,102 2,535,156
---------- ----------
Commitments and contingencies
Minority interest 18,594 20,974
---------- ----------
SHAREHOLDERS' EQUITY
--------------------
Common shares, par value $1 per share, authorized 600,000,000 shares;
238,498,598 and 222,574,440 shares issued and outstanding, after deducting
46,888,660 and 56,886,204 shares
held in treasury 238,499 222,574
Additional paid-in capital 1,413,595 783,145
Accumulated other comprehensive income (loss) (29,280) 975,365
Retained earnings 1,053,983 3,589,408
---------- ----------
Total shareholders' equity 2,676,797 5,570,492
---------- ----------
Total $5,198,493 $8,126,622
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 2008, 2007 and 2006
(In thousands, except per share amounts)
2008 2007 2006
---- ---- ----
REVENUES AND OTHER INCOME:
--------------------------
Manufacturing $ 336,833 $ 397,113 $ 450,835
Telecommunications 451,864 361,742 --
Property management and service fees 141,605 80,892 --
Gaming entertainment 105,842 38,042 --
Investment and other income 189,051 181,465 294,678
Net securities gains (losses) (144,542) 95,641 117,159
------------ ---------- ---------
1,080,653 1,154,895 862,672
------------ ---------- ---------
EXPENSES:
---------
Cost of sales:
Manufacturing 295,200 340,703 386,466
Telecommunications 392,469 309,045 --
Direct operating expenses:
Property management and services 113,768 65,992 --
Gaming entertainment 93,987 37,772 --
Interest 145,471 111,537 79,392
Salaries and incentive compensation 87,569 88,269 89,501
Depreciation and amortization 54,133 35,238 22,105
Selling, general and other expenses 264,624 223,427 151,388
------------ ---------- ---------
1,447,221 1,211,983 728,852
------------ ---------- ---------
Income (loss) from continuing operations before income taxes and
income (losses) related to associated companies (366,568) (57,088) 133,820
------------ ---------- ---------
Income tax provision (benefit):
Current 1,568 155 (4,902)
Deferred 1,672,107 (559,926) 46,673
------------ ---------- ---------
1,673,675 (559,771) 41,771
------------ ---------- ---------
Income (loss) from continuing operations before income (losses)
related to associated companies (2,040,243) 502,683 92,049
Income (losses) related to associated companies, net of taxes (539,068) (21,875) 37,720
------------ ---------- ---------
Income (loss) from continuing operations (2,579,311) 480,808 129,769
Income (loss) from discontinued operations, net of taxes 44,904 159 (3,960)
Gain (loss) on disposal of discontinued operations, net of taxes (1,018) 3,327 63,590
------------ ---------- ---------
Net income (loss) $ (2,535,425) $ 484,294 $ 189,399
============ ========== =========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $(11.19) $2.20 $ .60
Income (loss) from discontinued operations .19 -- (.02)
Gain (loss) on disposal of discontinued operations -- .02 .30
------- ----- -----
Net income (loss) $(11.00) $2.22 $ .88
======= ===== =====
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $(11.19) $2.09 $ .60
Income (loss) from discontinued operations .19 -- (.02)
Gain (loss) on disposal of discontinued operations -- .01 .27
------- ----- -----
Net income (loss) $(11.00) $2.10 $ .85
======= ===== =====
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2008, 2007 and 2006
(In thousands)
2008 2007 2006
---- ---- ----
Net cash flows from operating activities:
-----------------------------------------
Net income (loss) $(2,535,425) $ 484,294 $ 189,399
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operations:
Deferred income tax provision (benefit) 1,672,063 (567,864) 99,990
Depreciation and amortization of property, equipment and leasehold improvements 56,060 41,216 35,884
Other amortization 16,223 1,227 (11,884)
Share-based compensation 12,183 11,176 15,164
Excess tax benefit from exercise of stock options (1,828) (4,022) (456)
Provision for doubtful accounts 2,386 566 1,089
Net securities (gains) losses 144,542 (95,641) (117,159)
(Income) losses related to associated companies 536,816 31,218 (60,056)
Distributions from associated companies 87,211 55,769 75,725
Net gains related to real estate, property and equipment and other assets (29,244) (30,040) (109,107)
Income related to Fortescue's Pilbara project (40,467) -- --
Loss on debt conversion 16,239 -- --
(Gain) loss on disposal of discontinued operations 1,018 (4,748) (99,456)
Investments classified as trading, net 90,929 45,128 4,469
Net change in:
Restricted cash 3,321 22,799 8,690
Trade, notes and other receivables 6,445 11,989 183,263
Prepaids and other assets 3,838 (588) (2,914)
Trade payables and expense accruals (19,228) 835 (73,342)
Other liabilities (3,836) (1,267) (47,230)
Deferred revenue (10,594) (16,356) --
Income taxes payable 713 (10,834) (6,628)
Other (553) 6,774 6,081
----------- ----------- ----------
Net cash provided by (used for) operating activities 8,812 (18,369) 91,522
----------- ----------- ----------
Net cash flows from investing activities:
-----------------------------------------
Acquisition of property, equipment and leasehold improvements (76,066) (37,700) (39,021)
Acquisitions of and capital expenditures for real estate investments (108,082) (97,393) (71,505)
Proceeds from disposals of real estate, property and equipment, and other assets 13,106 81,247 188,836
Proceeds from (payments related to) disposal of discontinued operations,
net of expenses and cash of operations sold (1,018) 4,245 120,228
Acquisitions, net of cash acquired (20,659) (90,269) (105,282)
Collection of insurance proceeds 15,289 -- 109,383
Net change in restricted cash 139 (65,715) (90,959)
Advances on notes and other receivables (18,119) (20,172) (31,518)
Collections on notes, loans and other receivables 35,242 38,868 29,823
Investments in associated companies (955,633) (1,010,211) (313,152)
Capital distributions from associated companies 184,244 69,543 4,845
Investment in Fortescue Metals Group Ltd -- (44,217) (408,030)
Purchases of investments (other than short-term) (4,409,391) (5,759,504) (3,661,421)
Proceeds from maturities of investments 439,595 688,355 1,149,123
Proceeds from sales of investments 4,498,386 5,286,321 2,933,601
Other (64) (757) (1,127)
----------- ----------- ----------
Net cash used for investing activities (403,031) (957,359) (186,176)
----------- ----------- ----------
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
For the years ended December 31, 2008, 2007 and 2006
(In thousands)
2008 2007 2006
---- ---- ----
Net cash flows from financing activities:
-----------------------------------------
Issuance of debt, net of issuance costs $ 88,657 $ 1,017,852 $ 96,676
Reduction of debt (15,862) (75,509) (66,223)
Issuance of common shares 106,324 253,441 3,838
Premium paid on debt conversion (12,232) -- --
Purchase of common shares for treasury (122) (163) (187)
Excess tax benefit from exercise of stock options 1,828 4,022 456
Dividends paid -- (55,644) (54,085)
Other 6,225 1,461 14,313
--------- ----------- ---------
Net cash provided by (used for) financing activities 174,818 1,145,460 (5,212)
--------- ----------- ---------
Effect of foreign exchange rate changes on cash (66) 39 108
--------- ----------- ---------
Net increase (decrease) in cash and cash equivalents (219,467) 169,771 (99,758)
Cash and cash equivalents at January 1, 456,970 287,199 386,957
--------- ----------- ----------
Cash and cash equivalents at December 31, $ 237,503 $ 456,970 $ 287,199
========= =========== =========
Supplemental disclosures of cash flow information:
--------------------------------------------------
Cash paid during the year for:
Interest $ 144,319 $ 90,640 $ 82,072
Income tax payments, net $ 3,152 $ 11,078 $ 6,707
Non-cash investing activities:
-----------------------------
Common stock issued for acquisition of Jefferies Group, Inc. common shares $ 398,248 $ -- $ --
Non-cash financing activities:
-----------------------------
Issuance of common shares for debt conversion $ 128,890 $ -- $ --
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended December 31, 2008, 2007 and 2006
(In thousands, except par value and per share amounts)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
----- ------- ------------- -------- -----
Balance, January 1, 2006 $ 216,058 $ 501,914 $ (81,502) $ 3,025,444 $ 3,661,914
-----------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $34,149 60,187 60,187
Net change in unrealized foreign exchange
gain (loss), net of taxes of $2,137 3,768 3,768
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $128 (224) (224)
Net change in minimum pension liability, net
of taxes of $6,958 12,263 12,263
Net income 189,399 189,399
-----------
Comprehensive income 265,393
-----------
Share-based compensation expense 15,164 15,164
Adjustment to initially apply SFAS 158, net of
taxes of $444 782 782
Exercise of options to purchase common shares,
including excess tax benefit 300 3,994 4,294
Purchase of common shares for treasury (7) (180) (187)
Dividends ($.25 per common share) (54,085) (54,085)
--------- ---------- --------- ----------- -----------
Balance, December 31, 2006 216,351 520,892 (4,726) 3,160,758 3,893,275
-----------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of taxes of $549,415 959,872 959,872
Net change in unrealized foreign exchange
gain (loss), net of taxes of $3,512 6,126 6,126
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $87 168 168
Net change in pension liability and
postretirement benefits, net of taxes of $7,843 13,925 13,925
Net income 484,294 484,294
-----------
Comprehensive income 1,464,385
-----------
Share-based compensation expense 11,176 11,176
Issuance of common shares 5,500 236,500 242,000
Exercise of options to purchase common shares,
including excess tax benefit 728 14,735 15,463
Purchase of common shares for treasury (5) (158) (163)
Dividends ($.25 per common share) (55,644) (55,644)
--------- ---------- --------- ----------- -----------
Balance, December 31, 2007 222,574 783,145 975,365 3,589,408 5,570,492
-----------
Comprehensive loss:
Net change in unrealized gain (loss)
on investments, net of taxes of $556,853 (973,676) (973,676)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $3,764 (6,582) (6,582)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $540 944 944
Net change in pension liability and
postretirement benefits, net of taxes of $14,488 (25,331) (25,331)
Net loss (2,535,425) (2,535,425)
-----------
Comprehensive loss (3,540,070)
-----------
Share-based compensation expense 11,207 11,207
Sale of common shares to Jefferies Group, Inc. 10,000 488,269 498,269
Issuance of common shares for debt conversion 5,612 123,278 128,890
Exercise of options to purchase common shares,
including excess tax benefit 315 7,816 8,131
Purchase of common shares for treasury (2) (120) (122)
--------- ---------- --------- ----------- -----------
Balance, December 31, 2008 $ 238,499 $1,413,595 $ (29,280) $ 1,053,983 $ 2,676,797
========= ========== ========= =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Nature of Operations:
---------------------
The Company is a diversified holding company engaged in a variety of businesses,
including manufacturing, telecommunications, property management and services,
gaming entertainment, real estate activities, medical product development and
winery operations. The Company also has significant investments in the common
stock of two public companies that are accounted for at fair value, one of which
is a full service investment bank and the other an independent auto finance
company. The Company also owns equity interests in operating businesses and
investment partnerships which are accounted for under the equity method of
accounting, including a broker-dealer engaged in making markets and trading of
high yield and special situation securities, land based contract oil and gas
drilling, real estate activities and development of a copper mine in Spain. The
Company continuously evaluates the retention and disposition of its existing
operations and investments and frequently investigates the acquisition of new
businesses. Changes in the mix of the Company's owned businesses and investments
should be expected.
The manufacturing operations are conducted through Idaho Timber, LLC ("Idaho
Timber") and Conwed Plastics, LLC ("Conwed Plastics"). Idaho Timber's principal
product lines include remanufacturing dimension lumber; remanufacturing,
bundling and bar coding of home center boards for large retailers; and
production of 5/4" radius-edge, pine decking. Idaho Timber also manufactures
and/or distributes a number of other specialty wood products. Idaho Timber
operates eleven facilities located throughout the United States.
Conwed Plastics manufactures and markets lightweight plastic netting used for a
variety of purposes including, among other things, building and construction,
erosion control, packaging, agricultural, carpet padding, filtration and
consumer products. Conwed Plastics manufacturing segment has four domestic
manufacturing facilities, and it owns and operates manufacturing and sales
facilities in Belgium and Mexico.
The telecommunications business is conducted by the Company's 75% owned
subsidiary, STi Prepaid, LLC ("STi Prepaid"). STi Prepaid is a provider of
international prepaid phone cards and other telecommunications services in the
United States.
The property management and services business is conducted through ResortQuest
International, Inc. ("ResortQuest"). ResortQuest is engaged in offering
management services to vacation properties in beach and mountain resort
locations in the continental United States, as well as in real estate brokerage
services and other rental and property owner services in resort locations.
The gaming entertainment business is conducted through Premier Entertainment
Biloxi, LLC ("Premier"). Premier owns the Hard Rock Hotel & Casino Biloxi ("Hard
Rock Biloxi") located in Biloxi, Mississippi.
The domestic real estate operations include a mixture of commercial properties,
residential land development projects and other unimproved land, all in various
stages of development.
The Company's medical product development operations are conducted through its
majority-owned subsidiary, Sangart, Inc. ("Sangart"). Sangart is developing a
product called Hemospan(R), which is a solution of cell-free hemoglobin that is
designed for intravenous administration to treat a wide variety of medical
conditions, including use as an alternative to red blood cell transfusions.
The winery operations consist of three wineries, Pine Ridge Winery in Napa
Valley, California, Archery Summit in the Willamette Valley of Oregon and
Chamisal Vineyards in the Edna Valley of California, and a vineyard development
project in the Columbia Valley of Washington. The wineries primarily produce and
sell wines in the ultra premium and luxury segments of the premium table wine
market.
Certain amounts for prior periods have been reclassified to be consistent with
the 2008 presentation.
F-7
2. Significant Accounting Policies:
--------------------------------
(a) Critical Accounting Estimates: The preparation of financial statements in
-----------------------------
conformity with accounting principles generally accepted in the United States
("GAAP") requires the Company to make estimates and assumptions that affect the
reported amounts in the financial statements and disclosures of contingent
assets and liabilities. On an on-going basis, the Company evaluates all of these
estimates and assumptions. The following areas have been identified as critical
accounting estimates because they have the potential to have a material impact
on the Company's financial statements, and because they are based on assumptions
which are used in the accounting records to reflect, at a specific point in
time, events whose ultimate outcome won't be known until a later date. Actual
results could differ from these estimates.
Income Taxes - At December 31, 2008, the Company's net deferred tax asset before
valuation allowances was $2,347,500,000, of which $2,090,000,000 represents the
potential future tax savings from federal and state net operating loss
carryforwards ("NOLs"). In accordance with Financial Accounting Standards No.
109, "Accounting for Income Taxes" ("SFAS 109"), the Company records a valuation
allowance to reduce its deferred tax asset to the net amount that is more likely
than not to be realized. The amount of any valuation allowance recorded does not
in any way adversely affect the Company's ability to use its NOLs to offset
taxable income in the future. If in the future the Company determines that it is
more likely than not that the Company will be able to realize its deferred tax
asset in excess of its net recorded amount, an adjustment to increase the net
deferred tax asset would increase income in such period. If in the future the
Company were to determine that it would not be able to realize all or part of
its net recorded deferred tax asset, an adjustment to decrease the net deferred
tax asset would be charged to income in such period. SFAS 109 requires the
Company to consider all available evidence, both positive and negative, and to
weight the evidence when determining whether a valuation allowance is required.
Generally, greater weight is required to be placed on objectively verifiable
evidence when making this assessment, in particular on recent historical
operating results.
In prior periods, the Company's long track record of generating taxable income,
its cumulative taxable income for more recent past periods and its projections
of future taxable income were the most heavily weighted factors considered when
determining how much of the net deferred tax asset was more likely than not to
be realizable. During 2005 the Company concluded that it was more likely than
not that it would have future taxable income sufficient to realize a portion of
the Company's net deferred tax asset; accordingly, $1,135,100,000 of the
deferred tax valuation allowance was reversed as a credit to income tax expense.
An additional $542,700,000 of the valuation allowance was reversed as a credit
to income tax expense in 2007. The Company's estimate of future taxable income
considered all available evidence, both positive and negative, about its
operating businesses and investments, included an aggregation of individual
projections for each material operating business and investment, estimated
apportionment factors for state and local taxing jurisdictions and included all
future years that the Company estimated it would have available NOLs.
During the second half of 2008, the Company recorded significant unrealized
losses on many of its largest investments, recognized other than temporary
impairments for a number of other investments and reported reduced profitability
from substantially all of its operating businesses, all of which contributed to
the recognition of a pre-tax loss of $859,500,000 in the consolidated statement
of operations and a pre-tax loss in other comprehensive income (loss) of
$1,579,200,000 for the year ended December 31, 2008. The worldwide economic
downturn has adversely affected many of the Company's operating businesses and
investments, and the nature of the current economic difficulties make it
impossible to reliably project how long the downturn will last. Additionally,
the 2008 losses result in a cumulative loss in the Company's total comprehensive
income (loss) during the past three years. In assessing the realizability of the
net deferred tax asset at December 31, 2008, the Company concluded that its
operating losses for the more recent periods and current economic conditions
worldwide should be given more weight than its projections of future taxable
income during the period that it has NOLs available (until 2028), and be given
more weight than the Company's long track record of generating taxable income.
As a result, the Company concluded that a valuation allowance was required
against substantially all of the net deferred tax asset, and increased its
valuation allowance by $1,672,100,000 with a corresponding charge to income tax
expense.
F-8
Pursuant to SFAS 109, the Company will continue to evaluate the realizability of
its deferred tax asset in future periods. However, before the Company would
reverse any portion of its valuation allowance, it will need historical positive
cumulative taxable income over a period of years to overcome the recent negative
evidence. At that time, any decrease to the valuation allowance would be based
significantly upon the Company's projections of future taxable income, which are
inherently uncertain.
The Company also records reserves for contingent tax liabilities based on the
Company's assessment of the probability of successfully sustaining its tax
filing positions.
Impairment of Long-Lived Assets - In accordance with Statement of Financial
Accounting Standards No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company evaluates its long-lived assets for impairment
whenever events or changes in circumstances indicate, in management's judgment,
that the carrying value of such assets may not be recoverable. When testing for
impairment, the Company groups its long-lived assets with other assets and
liabilities at the lowest level for which identifiable cash flows are largely
independent of the cash flows of other assets and liabilities (or asset group).
The determination of whether an asset group is recoverable is based on
management's estimate of undiscounted future cash flows directly attributable to
the asset group as compared to its carrying value. If the carrying amount of the
asset group is greater than the undiscounted cash flows, an impairment loss
would be recognized for the amount by which the carrying amount of the asset
group exceeds its estimated fair value. The Company recorded impairment losses
on various long-lived assets aggregating $3,200,000 during 2008; there were no
impairment losses recorded during 2007 or 2006.
Current economic conditions have adversely affected most of the Company's
operations and investments. A worsening of current economic conditions or a
prolonged recession could cause a decline in estimated future cash flows
expected to be generated by the Company's operations and investments. If future
undiscounted cash flows are estimated to be less than the carrying amounts of
the asset groups used to generate those cash flows in subsequent reporting
periods, particularly for those with large investments in property and equipment
(for example, manufacturing, gaming entertainment and certain associated company
investments), impairment charges would have to be recorded.
Impairment of Securities - Investments with an impairment in value considered to
be other than temporary are written down to estimated fair value. The
write-downs are included in net securities gains (losses) in the consolidated
statements of operations. The Company evaluates its investments for impairment
on a quarterly basis.
The Company's determination of whether a security is other than temporarily
impaired incorporates both quantitative and qualitative information; GAAP
requires the exercise of judgment in making this assessment, rather than the
application of fixed mathematical criteria. The Company considers a number of
factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, the ability and intent to
hold investments to maturity, and other factors specific to the individual
investment. The Company's assessment involves a high degree of judgment and
accordingly, actual results may differ materially from the Company's estimates
and judgments. The Company recorded impairment charges for securities of
$143,400,000, $36,800,000 and $12,900,000 for the years ended December 31, 2008,
2007 and 2006, respectively.
Business Combinations - At acquisition, the Company allocates the cost of a
business acquisition to the specific tangible and intangible assets acquired and
liabilities assumed based upon their relative fair values. Significant judgments
and estimates are often made to determine these allocated values, and may
include the use of appraisals, consider market quotes for similar transactions,
employ discounted cash flow techniques or consider other information the Company
believes relevant. The finalization of the purchase price allocation will
typically take a number of months to complete, and if final values are
materially different from initially recorded amounts earlier issued financial
statements may have to be restated. Any excess of the cost of a business
acquisition over the fair values of the net assets and liabilities acquired is
recorded as goodwill, which is not amortized to expense. Recorded goodwill of a
reporting unit is required to be tested for impairment on an annual basis, and
between annual testing dates if events or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its net book
value. At December 31, 2008, the book value of goodwill was $9,300,000.
F-9
Subsequent to the finalization of the purchase price allocation, any adjustments
to the recorded values of acquired assets and liabilities would be reflected in
the Company's consolidated statement of operations. Once final, the Company is
not permitted to revise the allocation of the original purchase price, even if
subsequent events or circumstances prove the Company's original judgments and
estimates to be incorrect. In addition, long-lived assets recorded in a business
combination like property and equipment, amortizable intangibles and goodwill
may be deemed to be impaired in the future resulting in the recognition of an
impairment loss. The assumptions and judgments made by the Company when
recording business combinations will have an impact on reported results of
operations for many years into the future.
Purchase price allocations for all of the Company's acquisitions have been
finalized. Adjustments to the initial purchase price allocations were not
material.
Use of Fair Value Estimates - Effective January 1, 2008 (except as described
below), the Company adopted Statement of Financial Accounting Standards No. 157,
"Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes
a framework for measuring fair value, establishes a hierarchy that prioritizes
inputs to valuation techniques and expands disclosures about fair value
measurements. The fair value hierarchy gives the highest priority to unadjusted
quoted prices in active markets for identical assets or liabilities (Level 1),
the next priority to inputs that don't qualify as Level 1 inputs but are
nonetheless observable, either directly or indirectly, for the particular asset
or liability (Level 2), and the lowest priority to unobservable inputs (Level
3). The Company elected to defer the effectiveness of SFAS 157 for one year only
with respect to nonfinancial assets and nonfinancial liabilities that are
recognized or disclosed at fair value in the financial statements on a
nonrecurring basis. The adoption of SFAS 157 did not have any impact on the
Company's consolidated financial statements other than expanded disclosures;
however, fair value measurements for new assets or liabilities and fair value
measurements for existing nonfinancial assets and nonfinancial liabilities may
be materially different under SFAS 157.
Over 80% of the Company's investment portfolio is classified as available for
sale securities, which are carried at estimated fair value in the Company's
consolidated balance sheet. The estimated fair values are principally based on
publicly quoted market prices (Level 1 inputs), which can rise or fall in
reaction to a wide variety of factors or events, and as such are subject to
market-related risks and uncertainties. The Company has a segregated portfolio
of mortgage pass-through certificates issued by U.S. Government agencies (GNMA)
and by U.S. Government-Sponsored Enterprises (FHLMC or FNMA) which are carried
on the balance sheet at their estimated fair value of $293,200,000. Although the
markets that these types of securities trade in are generally active, market
prices are not always available for the identical security. Therefore, the fair
value of these investments are based on observable market data including
benchmark yields, reported trades, issuer spreads, benchmark securities, bids
and offers. These estimates of fair value are considered to be Level 2 inputs,
and the amounts realized from the disposition of these investments has not been
materially different from their estimated fair values.
The Company has a segregated portfolio of corporate bonds, which are carried on
the balance sheet at their estimated fair value of $31,400,000. Although these
bonds trade in brokered markets, the market for certain bonds is sometimes
inactive. The fair values of these investments are based on reported trading
prices, bid and ask prices and quotes obtained from independent market makers in
the securities. These estimates of fair values are also considered to be Level 2
inputs.
Contingencies - The Company accrues for contingent losses when the contingent
loss is probable and the amount of loss can be reasonably estimated. Estimates
of the likelihood that a loss will be incurred and of contingent loss amounts
normally require significant judgment by management, can be highly subjective
and are subject to material change with the passage of time as more information
becomes available. Estimating the ultimate impact of litigation matters is
inherently uncertain, in particular because the ultimate outcome will rest on
events and decisions of others that may not be within the power of the Company
to control. The Company does not believe that any of its current litigation will
have a material adverse effect on its consolidated financial position, results
of operations or liquidity; however, if amounts paid at the resolution of
litigation are in excess of recorded reserve amounts, the excess could be
material to results of operations for that period. As of December 31, 2008, the
Company's accrual for contingent losses was not material. See Note 19 for more
information.
F-10
(b) Consolidation Policy: The consolidated financial statements include the
--------------------
accounts of the Company, all variable interest entities of which the Company or
a subsidiary is the primary beneficiary, and all majority-controlled entities
that are not variable interest entities. The Company considers special
allocations of cash flows and preferences, if any, to determine amounts
allocable to minority interests. All intercompany transactions and balances are
eliminated in consolidation.
Associated companies include equity interests in other entities that are
accounted for on the equity method of accounting. These include investments in
corporations that the Company does not control but has the ability to exercise
significant influence and investments in limited partnerships in which the
Company's interest is more than minor.
Effective January 1, 2008, the Company adopted Statement of Financial Accounting
Standards No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities - Including an amendment of FASB Statement No. 115" ("SFAS 159").
SFAS 159 permits entities to choose to measure many financial instruments and
certain other items at fair value (the "fair value option") and to report
unrealized gains and losses on items for which the fair value option is elected
in earnings. Investments in associated companies also include equity interests
in two entities for which the Company elected the fair value option, rather than
apply the equity method of accounting.
(c) Cash Equivalents: The Company considers short-term investments, which have
----------------
maturities of less than three months at the time of acquisition, to be cash
equivalents. Cash and cash equivalents include short-term investments of
$42,100,000 and $303,200,000 at December 31, 2008 and 2007, respectively.
(d) Investments: At acquisition, marketable debt and equity securities are
-----------
designated as either i) held to maturity, which are carried at amortized cost,
ii) trading, which are carried at estimated fair value with unrealized gains and
losses reflected in results of operations, or iii) available for sale, which are
carried at estimated fair value with unrealized gains and losses reflected as a
separate component of shareholders' equity, net of taxes. Equity securities that
do not have readily determinable fair values are carried at cost. The cost of
securities sold is based on average cost. Held to maturity investments are made
with the intention of holding such securities to maturity, which the Company has
the ability to do.
(e) Property, Equipment and Leasehold Improvements: Property, equipment and
----------------------------------------------
leasehold improvements are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are provided principally on the
straight-line method over the estimated useful lives of the assets or, if less,
the term of the underlying lease.
(f) Revenue Recognition: Revenues are recognized when the following conditions
-------------------
are met: (1) collectibility is reasonably assured; (2) title to the product has
passed or the service has been rendered and earned; (3) persuasive evidence of
an arrangement exists; and (4) there is a fixed or determinable price.
Manufacturing revenues are recognized when title passes, which for Idaho Timber
is generally upon the customer's receipt of the goods and for Conwed Plastics
upon shipment of goods. Revenues from sales of prepaid phone cards are deferred
when the cards are initially sold and are recognized when the cards are used by
the consumer and/or administrative fees are charged in accordance with the
cards' terms, resulting in a reduction of the outstanding obligation to the
customer. ResortQuest typically receives cash deposits on advance bookings of
its vacation properties that are recorded as deferred revenue. Property
management revenues are recognized ratably over the rental period based on
ResortQuest's proportionate share of the total rental price of the property.
Real estate brokerage revenues are recorded when the transactions are complete.
Gaming entertainment revenues consist of casino gaming, hotel, food and
beverage, and entertainment revenues. Casino gaming revenue is the aggregate of
gaming wins and losses, reduced for the cash value of rewards earned by
customers based on their level of play on slot machines. Hotel, food and
beverage, and entertainment revenues are recognized as services are performed.
Revenue from the sale of real estate is generally recognized when title passes;
however, if the Company is obligated to make improvements to the real estate
subsequent to closing, a portion of revenues are deferred and recognized under
the percentage of completion method of accounting.
(g) Cost of Sales: Manufacturing inventories are stated at the lower of cost or
-------------
market, with cost principally determined under the first-in-first-out method.
Manufacturing cost of sales principally includes product and manufacturing
costs, inbound and outbound shipping costs and handling costs. STi Prepaid's
cost of sales primarily consists of origination, transport and termination of
telecommunications traffic, and connectivity costs paid to underlying service
providers.
F-11
Direct operating expense for property management and services includes expenses
relating to housekeeping, maintenance, reservations, marketing, and other costs
associated with rental and management. Direct operating expenses also include
the cost of sales and operating expenses related to food and beverage sales.
Direct operating expense for gaming entertainment includes expenses relating to
casino gaming, hotel, food and beverage, and entertainment, which primarily
consists of employees' compensation and benefits, cost of sales related to food
and beverage sales, marketing and advertising, gaming taxes, insurance,
supplies, license fees and royalties.
(h) Research and Development Costs: Research and development costs are expensed
------------------------------
as incurred.
(i) Income Taxes: The Company provides for income taxes using the liability
------------
method. The Company records interest and penalties, if any, with respect to
uncertain tax positions as components of income tax expense.
(j) Derivative Financial Instruments: The Company reflects its derivative
--------------------------------
financial instruments in its balance sheet at fair value. The Company has
utilized derivative financial instruments to manage the impact of changes in
interest rates on certain debt obligations, hedge net investments in foreign
subsidiaries and manage foreign currency risk on certain available for sale
securities. Although the Company believes that these derivative financial
instruments are practical economic hedges of the Company's risks, except for the
hedge of the net investment in foreign subsidiaries, they do not meet the
effectiveness criteria under GAAP, and therefore are not accounted for as
hedges. Amounts recorded as income (charges) in investment and other income were
$(6,400,000), $(5,800,000) and $1,200,000 for the years ended December 31, 2008,
2007 and 2006, respectively; net unrealized losses were $100,000 and $1,100,000
at December 31, 2008 and 2007, respectively.
From time to time the Company may also make speculative investments in
derivative financial instruments which are classified as trading securities; see
Note 6 for more information.
(k) Translation of Foreign Currency: Foreign currency denominated investments
-------------------------------
and financial statements are translated into U.S. dollars at current exchange
rates, except that revenues and expenses are translated at average exchange
rates during each reporting period; resulting translation adjustments are
reported as a component of shareholders' equity. Net foreign exchange
transaction gains (losses) were $2,300,000 for 2008, $4,100,000 for 2007 and
$(2,700,000) for 2006. Net unrealized foreign exchange translation gains were
$400,000, $7,000,000 and $900,000 at December 31, 2008, 2007 and 2006,
respectively.
(l) Share-Based Compensation: Effective January 1, 2006, the Company adopted
------------------------
Statement of Financial Accounting Standards No. 123R, "Share-Based Payment"
("SFAS 123R"), using the modified prospective method. SFAS 123R requires that
the cost of all share-based payments to employees, including grants of employee
stock options and warrants, be recognized in the financial statements based on
their fair values. The cost is recognized as an expense over the vesting period
of the award. The fair value of each award is estimated at the date of grant
using the Black-Scholes option pricing model.
(m) Recently Issued Accounting Standards: In March 2008, the Financial
------------------------------------
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161,
which is effective for fiscal years beginning after November 15, 2008, requires
enhanced disclosures about an entity's derivative and hedging activities,
including the objectives and strategies for using derivatives, disclosures about
fair value amounts of, and gains and losses on, derivative instruments, and
disclosures about credit-risk-related contingent features in derivative
agreements. The Company is currently evaluating the impact of adopting SFAS 161
on its consolidated financial statements.
In December 2007, the FASB issued Statement of Financial Accounting Standards
No. 141R, "Business Combinations" ("SFAS 141R") and Statement of Financial
Accounting Standards No. 160, "Noncontrolling Interests in Consolidated
Financial Statements" ("SFAS 160"). SFAS 141R and SFAS 160 are effective for
fiscal years beginning after December 15, 2008. SFAS 141R will change how
business combinations are accounted for and will impact financial statements
both on the acquisition date and in subsequent periods. Adoption of SFAS 141R is
not expected to have a material impact on the Company's consolidated financial
statements although it may have a material impact on accounting for business
F-12
combinations in the future which can not currently be determined. SFAS 160 will
materially change the accounting and reporting for minority interests in the
future, which will be recharacterized as noncontrolling interests and classified
as a component of stockholders' equity. Upon adoption of SFAS 160, the Company
will be required to apply its presentation and disclosure requirements
retrospectively, which will require the reclassification of minority interests
on the historical consolidated balance sheets, require the historical
consolidated statements of operations to reflect net income attributable to the
Company and to noncontrolling interests, and require other comprehensive income
to reflect other comprehensive income attributable to the Company and to
noncontrolling interests.
3. Acquisitions:
------------
STi Prepaid
In March 2007, STi Prepaid purchased 75% of the assets of Telco Group, Inc. and
its affiliates (collectively, "Telco") for an aggregate purchase price of
$121,800,000 in cash, including expenses. The remaining Telco assets were
contributed to STi Prepaid by the former owner in exchange for a 25% interest
in STi Prepaid.
The acquisition cost was principally allocated to components of working capital
and to deferred tax assets. In connection with the acquisition, the Company
revised its projections of future taxable income and reassessed the required
amount of its deferred tax valuation allowance. As a result of the reassessment,
the Company concluded that it was more likely than not that it could realize
additional deferred tax assets in the future; accordingly, a reduction to the
deferred tax valuation allowance of $98,600,000 was recognized in the purchase
price allocation (in addition to certain acquired deferred tax assets). Based
upon its allocation of the purchase price, the Company recorded STi Prepaid
intangible assets of $4,400,000.
ResortQuest
In June 2007, the Company completed the acquisition of ResortQuest for
$11,900,000, including expenses and working capital adjustments finalized
subsequent to the closing date.
Premier
During 2006, the Company indirectly acquired a controlling voting interest in
Premier for an aggregate purchase price of $90,800,000, excluding expenses. The
Company owns approximately 61% of the common units of Premier and all of
Premier's preferred units, which accrue an annual preferred return of 17%. The
Company also acquired Premier's junior subordinated note due August 2012, and
during 2007 provided Premier with a $180,000,000 senior secured credit facility
to partially fund Premier's bankruptcy plan of reorganization (discussed below).
As of December 31, 2008, the Company's aggregate investment in Premier was
$249,600,000. At acquisition, the Company consolidated Premier as a result of
its controlling voting interest; during the pendency of bankruptcy proceedings
Premier was deconsolidated and accounted for under the equity method.
Premier owns the Hard Rock Biloxi, which opened to the public on June 30, 2007.
The Hard Rock Biloxi was scheduled to open to the public on August 31, 2005;
however, two days prior to opening, Hurricane Katrina hit the Mississippi Gulf
Coast and severely damaged the hotel and related structures and completely
destroyed the casino. On September 19, 2006, Premier and its subsidiary filed
voluntary petitions for reorganization under the bankruptcy code, before the
United States Bankruptcy Court for the Southern District of Mississippi,
Southern Division. Premier filed its petitions in order to seek the court's
assistance in gaining access to Hurricane Katrina-related insurance proceeds (an
aggregate of $161,200,000) which had been denied to Premier by its pre-petition
secured bondholders.
Premier filed an amended disclosure statement and plan of reorganization on
February 22, 2007 which provided for the payment in full of all of Premier's
creditors, including payment of principal and accrued interest due to the
holders of Premier's 10 3/4% senior secured notes at par (the "Premier Notes").
On July 30, 2007, the court entered an order confirming the plan, subject to a
modification which Premier filed on August 1, 2007; Premier emerged from
bankruptcy and once again became a consolidated subsidiary of the Company on
August 10, 2007. The plan was funded in part with the $180,000,000 senior
secured credit facility provided by a subsidiary of the Company. The credit
facility matures on February 1, 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 governing the Premier Notes. Since
the plan did not result in any change in ownership of the voting interests in
Premier, the Company did not apply "fresh start" accounting and did not treat
the reconsolidation of Premier as the acquisition of a business that, under the
purchase method of accounting, requires the measurement of assets and
liabilities at fair value. Accordingly, the Company reconsolidated the assets
and liabilities of Premier upon its emergence from bankruptcy using its
historical basis in Premier's assets and liabilities.
See Note 19 for information concerning contingencies related to Premier.
F-13
4. Investments in Associated Companies:
-----------------------------------
The Company has investments in several Associated Companies. The amounts
reflected as income (losses) related to associated companies in the consolidated
statements of operations are net of income tax provisions (benefits) of
$2,300,000, $(9,300,000) and $22,400,000 for the years ended December 31, 2008,
2007 and 2006, respectively. Included in consolidated retained earnings at
December 31, 2008 is approximately $76,500,000 of undistributed earnings of the
associated companies accounted for on the equity method of accounting.
AmeriCredit Corp. ("ACF")
As of December 31, 2008, the Company had acquired approximately 25% of the
outstanding voting securities of ACF, a company listed on the New York Stock
Exchange ("NYSE") (Symbol: ACF), for aggregate cash consideration of
$405,300,000 ($70,100,000 was invested as of December 31, 2007). ACF is an
independent auto finance company that is in the business of purchasing and
servicing automobile sales finance contracts, historically to consumers who are
typically unable to obtain financing from other sources. The Company has entered
into a standstill agreement with ACF for the two year period ending March 3,
2010, pursuant to which the Company has agreed not to sell its shares if the
buyer would own more than 4.9% of the outstanding shares, unless the buyer
agreed to be bound by terms of the standstill agreement, to not increase its
ownership interest to more than 30% of the outstanding ACF common shares, and
received the right to nominate two directors to the board of directors of ACF.
The Company and ACF have entered into a registration rights agreement covering
all of the ACF shares of common stock owned by the Company. At December 31,
2008, the Company's investment in ACF is carried at fair value of $249,900,000;
income (losses) related to associated companies includes unrealized losses
resulting from changes in the fair value of ACF of $155,300,000 for the year
ended December 31, 2008. At December 31, 2007, the Company's investment in ACF
was classified as non-current investments and carried at fair value of
$71,500,000.
The Company's investment in ACF is one of two eligible items for which the fair
value option identified in SFAS 159 was elected, commencing on the date the
Company acquired the right to vote 20% of the ACF common stock and the
investment became subject to the equity method of accounting. If ACF were
accounted for under the equity method, the Company would have to record its
share of ACF's results of operations employing a quarterly reporting lag because
of ACF's own public reporting requirements. In addition, electing the fair value
option for ACF eliminates some of the uncertainty involved with impairment
considerations, since the quoted market price for ACF common shares provides a
readily determinable fair value at each balance sheet date. For these reasons
the Company elected the fair value option for its investment in ACF.
Subsequent to December 31, 2008, the aggregate market value of the Company's
investment in ACF declined to $126,900,000 at February 20, 2009. If the
aggregate market value of the Company's investment in ACF remains unchanged at
March 31, 2009, this decline in market value would result in the recognition of
an unrealized loss during the first quarter of 2009 of $123,000,000. Further
declines in market values are also possible, which would result in the
recognition of additional unrealized losses in the consolidated statement of
operations.
Jefferies Group, Inc. ("Jefferies")
In April 2008, the Company sold to Jefferies 10,000,000 of the Company's common
shares, and received 26,585,310 shares of common stock of Jefferies and
$100,021,000 in cash. The Jefferies common shares were valued based on the
closing price of the Jefferies common stock on April 18, 2008, the last trading
date prior to the acquisition ($398,248,000 in the aggregate). Including shares
acquired in open market purchases during 2008, as of December 31, 2008 the
Company owns an aggregate of 48,585,385 Jefferies common shares (approximately
30% of the Jefferies outstanding common shares) for a total investment of
$794,400,000. At December 31, 2008, the Company's investment in Jefferies is
carried at fair value of $683,100,000; income (losses) related to associated
companies includes unrealized losses resulting from changes in the fair value of
Jefferies of $111,200,000 for the year ended December 31, 2008. Jefferies, a
company listed on the NYSE (Symbol: JEF), is a full-service global investment
bank and institutional securities firm serving companies and their investors.
F-14
The Jefferies shares acquired, together with the Company's representation on the
Jefferies board of directors, enables the Company to qualify to use the equity
method of accounting for this investment. The Company's investment in Jefferies
is one of two eligible items for which the fair value option identified in SFAS
159 was elected, commencing on the date the investment became subject to the
equity method of accounting. The Company's rationale for electing the fair value
option for Jefferies is the same as its rationale for its investment in ACF
discussed above.
Subsequent to December 31, 2008, the aggregate market value of the Company's
investment in Jefferies declined to $529,600,000 at February 20, 2009. If the
aggregate market value of the Company's investment in Jefferies remains
unchanged at March 31, 2009, this decline in market value would result in the
recognition of an unrealized loss during the first quarter of 2009 of
$153,500,000. Further declines in market values are also possible, which would
result in the recognition of additional unrealized losses in the consolidated
statement of operations.
In connection with its investment in Jefferies, the Company entered into a
standstill agreement, pursuant to which for the two year period ending April 21,
2010, the Company agreed, subject to certain provisions, to limit its investment
in Jefferies to not more than 30% of the outstanding Jefferies common shares and
to not sell its investment, and received the right to nominate two directors to
the board of directors of Jefferies. Jefferies also agreed to enter into a
registration rights agreement covering all of the Jefferies shares of common
stock owned by the Company.
IFIS Limited ("IFIS")
In March 2008, the Company increased its equity investment in the common shares
of IFIS, a private company that primarily invests in operating businesses in
Argentina, from approximately 3% to 26% for an additional cash investment of
$83,900,000. IFIS owns a variety of investments, and its largest investment is
approximately 32% of the outstanding common shares of Sociedad Anonima
Comercial, Inmobiliaria, Financiera y Agropecuaria ("Cresud"). Cresud is an
Argentine agricultural company involved in a range of activities including crop
production, cattle raising and milk production. Cresud's common shares trade on
the Buenos Aires Stock Exchange (Symbol: CRES); in the U.S., Cresud trades as
American Depository Shares or ADSs (each of which represents ten common shares)
on the NASDAQ Global Select Market (Symbol: CRESY). When the Company acquired
its additional interest in IFIS in 2008, it was classified as an investment in
associated companies and accounted for under the equity method of accounting due
to the size of the Company's voting interest. In January 2009, IFIS raised a
significant amount of new equity in a rights offering in which the Company did
not participate. As a result, the Company's ownership interest in IFIS was
reduced to 8% and the Company will no longer apply the equity method of
accounting for this investment.
The Company also acquired a direct equity interest in Cresud for an aggregate
cash investment of $54,300,000. At December 31, 2008, the Company owned
3,364,174 Cresud ADSs, representing approximately 6.7% of Cresud's outstanding
common shares, and currently exercisable warrants to purchase 11,213,914 Cresud
common shares (or 1,121,391 Cresud ADSs) at an exercise price of $1.68 per
share. The Company sold all of the warrants in February 2009. The Company's
direct investment in Cresud is classified as a non-current available for sale
investment and carried at fair value.
As a result of significant declines in quoted market prices for Cresud and other
investments of IFIS, combined with declines in worldwide food commodity prices,
the global mortgage and real estate crisis and political and financial
conditions in Argentina, the Company has determined that its investments in IFIS
and Cresud ADSs and warrants were impaired. As of December 31, 2008, the fair
value of the Company's investment in IFIS was determined to be $14,600,000,
resulting in an impairment charge of $63,300,000 for the year ended December 31,
2008. This charge is in addition to the Company's share of IFIS's operating
losses, which was $8,400,000 for the year ended December 31, 2008. As of
December 31, 2008, the fair value of the Company's direct investment in Cresud
ADSs and warrants was determined to be $31,100,000, resulting in an impairment
charge of $23,200,000 for the year ended December 31, 2008.
F-15
Goober Drilling, LLC ("Goober Drilling")
During 2006, the Company acquired a 30% limited liability company interest in
Goober Drilling for aggregate consideration of $60,000,000, excluding expenses,
and agreed to lend to Goober Drilling, on a secured basis, up to $126,000,000 to
finance new rig equipment purchases and construction costs and to repay existing
debt. Goober Drilling is a land based contract oil and gas drilling company
based in Stillwater, Oklahoma that provides land based drilling services to oil
and natural gas exploration and production companies in the Mid-Continent Region
of the U.S., primarily in Oklahoma, Texas and Arkansas. During 2007, the Company
increased its equity interest to 50% for additional payments aggregating
$45,000,000. In addition, the credit facility was amended to increase the
borrowing capacity to $138,500,000 and the interest rate to LIBOR plus 5%, the
Company provided Goober Drilling with an additional secured credit facility of
$45,000,000 at an interest rate of LIBOR plus 10%, and the Company provided
another secured credit facility of $15,000,000 at an interest rate at the
greater of 8% or LIBOR plus 2.6%. At December 31, 2008, the aggregate
outstanding loan amount was $144,400,000 excluding accrued interest. For the
years ended December 31, 2008, 2007 and 2006, the Company recorded $24,900,000,
$13,600,000 and $2,000,000, respectively, of pre-tax income from this investment
under the equity method of accounting.
The Company's investment in Goober Drilling exceeds the Company's share of its
underlying net assets by approximately $35,900,000 at December 31, 2008. This
excess is being amortized over a three to fifteen year period.
Cobre Las Cruces, S.A. ("CLC")
CLC is a Spanish company that holds the exploration and mineral rights to the
Las Cruces copper deposit in the Pyrite Belt of Spain. It was a consolidated
subsidiary of the Company from its acquisition in September 1999 until August
2005, at which time the Company sold a 70% interest to Inmet Mining Corporation
("Inmet"), a Canadian-based global mining company traded on the Toronto stock
exchange (Symbol: IMN). Inmet acquired the interest in CLC in exchange for
5,600,000 newly issued Inmet common shares, representing approximately 11.6% of
Inmet's current outstanding common shares. For more information on the Inmet
shares, see Note 6. The Company retains a 30% interest in CLC.
CLC entered into an agreement with third party lenders for project financing
consisting of a ten year senior secured credit facility of up to $240,000,000
and a senior secured bridge credit facility of up to (euro)69,000,000 to finance
subsidies and value-added tax. The Company and Inmet have guaranteed 30% and
70%, respectively, of the obligations outstanding under both facilities until
completion of the project as defined in the project financing agreement. At
December 31, 2008 approximately $215,000,000 was outstanding under the senior
secured credit facility and (euro)47,000,000 was outstanding under the senior
secured bridge credit facility. The Company and Inmet have also committed to
provide financing to CLC which is currently estimated to be (euro)340,000,000
($436,100,000 at exchange rates in effect on February 20, 2009), of which the
Company's share will be 30% ((euro)77,600,000 of which has been loaned as of
December 31, 2008). For the years ended December 31, 2008, 2007 and 2006, the
Company recorded pre-tax income (losses) of $(5,900,000), $4,000,000 and
$3,800,000, respectively, from this investment under the equity method of
accounting.
HomeFed Corporation ("HomeFed")
During 2002, the Company sold one of its real estate subsidiaries, CDS Holding
Corporation ("CDS"), to HomeFed for a purchase price of $25,000,000, consisting
of $1,000,000 in cash and 2,474,226 shares of HomeFed's common stock. At
December 31, 2008, the Company owns approximately 31.4% of HomeFed's outstanding
common stock. For the years ended December 31, 2008, 2007 and 2006, the Company
recorded $(3,100,000), $1,500,000 and $2,900,000, respectively, of pre-tax
income (losses) from this investment under the equity method of accounting.
HomeFed is engaged, directly and through subsidiaries, in the investment in and
development of residential real estate projects in the State of California.
HomeFed is a public company traded on the NASD OTC Bulletin Board (Symbol:
HOFD).
F-16
The Company's investment in HomeFed is the only other investment in an
associated company that is also a publicly traded company but for which the
Company did not elect the fair value option. HomeFed's common stock is not
listed on any stock exchange, and price information for the common stock is not
regularly quoted on any automated quotation system. It is traded in the
over-the-counter market with high and low bid prices published by the National
Association of Securities Dealers OTC Bulletin Board Service; however, trading
volume is minimal. For these reasons the Company did not elect the fair value
option for HomeFed.
As a result of a 1998 distribution to all of the Company's shareholders,
approximately 7.7% and 9.4% of HomeFed is owned by the Company's Chairman and
President, respectively. Both are also directors of HomeFed and the Company's
President serves as HomeFed's Chairman.
Jefferies Partners Opportunity Fund II, LLC ("JPOF II") and Jefferies High Yield
Holdings, LLC ("JHYH")
During 2000, the Company invested $100,000,000 in the equity of JPOF II, a
limited liability company, which was a registered broker-dealer. JPOF II was
managed by Jefferies. JPOF II invested in high yield securities, special
situation investments and distressed securities and provided trading services to
its customers and clients. For the period from January 1, 2007 through March 31,
2007 (date of termination), and for the year ended December 31, 2006, the
Company recorded pre-tax income from this investment under the equity method of
accounting of $3,000,000 and $26,200,000, respectively. These earnings were
distributed by JPOF II as dividends shortly after the end of each period.
During 2007, the Company and Jefferies formed JHYH, a newly formed entity, and
the Company and Jefferies each initially committed to invest $600,000,000. The
Company invested $250,000,000 in cash plus its $100,000,000 investment in JPOF
II during 2007; any request for additional capital contributions from the
Company will now require the consent of the Company's designees to the Jefferies
board. The Company does not anticipate making additional capital contributions
in the near future. JHYH owns Jefferies High Yield Trading, LLC ("JHYT"), a
registered broker-dealer that is engaged in the secondary sales and trading of
high yield securities and special situation securities formerly conducted by
Jefferies, including bank debt, post-reorganization equity, public and private
equity, equity derivatives, credit default swaps and other financial
instruments. JHYT makes markets in high yield and distressed securities and
provides research coverage on these types of securities. JHYT does not invest or
make markets in sub-prime residential mortgage securities.
Jefferies and the Company each have the right to nominate two of a total of four
directors to JHYH's board, and each own 50% of the voting securities. The
organizational documents also permit passive investors to invest up to
$800,000,000. Jefferies also received additional JHYH securities entitling it to
20% of the profits. The voting and non-voting interests are entitled to a pro
rata share of the profits of JHYH, and are mandatorily redeemable in 2013, with
an option to extend up to three additional one-year periods. Under GAAP, JHYH is
considered a variable interest entity that is consolidated by Jefferies, since
Jefferies is the primary beneficiary. The Company owns less than 50% of JHYH's
capital, including its indirect interest through its investment in Jefferies,
and will not absorb a majority of its expected losses or receive a majority of
its expected residual returns.
The Company accounts for its investment in JHYH under the equity method of
accounting. The Company recorded pre-tax income (losses) from this investment of
$(69,100,000) and $4,300,000 during 2008 and 2007, respectively. During 2008,
the Company received distributions of $4,300,000 from JHYH. The Company has not
provided any guarantees, nor is it contingently liable for any of JHYH's
liabilities, all of which are non-recourse to the Company. The Company's maximum
exposure to loss as a result of its investment in JHYH is limited to the book
value of its investment ($280,900,000 at December 31, 2008) plus any additional
capital it decides to invest.
F-17
Wintergreen Partners Fund, L.P. ("Wintergreen")
The Company has invested an aggregate of $50,000,000 in Wintergreen, a limited
partnership that invests in domestic and foreign debt and equity securities. For
the years ended December 31, 2008, 2007 and 2006, the Company recorded
$(32,600,000), $14,000,000 and $11,000,000, respectively, of pre-tax income
(losses) from this investment under the equity method of accounting. At December
31, 2008, the book value of the Company's investment in Wintergreen was
$42,900,000. The Company expects to fully redeem its interest during 2009.
EagleRock Capital Partners (QP), LP ("EagleRock")
During 2001, the Company invested $50,000,000 in EagleRock, a limited
partnership that invests and trades in securities and other investment vehicles.
At December 31, 2008, the book value of the Company's equity investment in
EagleRock was $2,000,000; the Company received distributions of $12,500,000,
$15,000,000 and $48,200,000 from EagleRock in 2008, 2007 and 2006, respectively.
Pre-tax income (losses) of $(19,000,000), $(11,800,000) and $16,400,000 for the
years ended December 31, 2008, 2007 and 2006, respectively, were recorded from
this investment under the equity method of accounting. EagleRock is in the
process of liquidating its investments and distributing proceeds to its
partners.
Highland Funds
In January 2007, the Company invested $74,000,000 in Highland Opportunity Fund,
L.P. ("Highland Opportunity"), a limited partnership which principally invests
through a master fund in mortgage-backed and asset-backed securities, and
$25,000,000 in HFH ShortPLUS Fund, L.P. ("Shortplus"), a limited partnership
which principally invests through a master fund in a short-term based portfolio
of asset-backed securities. For the years ended December 31, 2008 and 2007, the
Company recorded pre-tax income (losses) of $(17,200,000) and $(17,600,000),
respectively, for Highland Opportunity and $10,500,000 and $54,500,000,
respectively, for Shortplus. During 2008, the Company redeemed its investment in
Highland Opportunity and received distributions of $40,000,000. During 2008, the
Company received distributions of $50,000,000 from Shortplus. At December 31,
2008, the book value of the Company's investment in Shortplus was $39,900,000.
Pershing Square IV, L.P. ("Pershing Square")
In June 2007, the Company invested $200,000,000 to acquire a 10% limited
partnership interest in Pershing Square, a newly-formed private investment
partnership whose investment decisions are at the sole discretion of Pershing
Square's general partner. The stated objective of Pershing Square is to create
significant capital appreciation by investing in Target Corporation. For the
years ended December 31, 2008 and 2007, the Company recorded $77,700,000 and
$85,500,000, respectively, of pre-tax losses from this investment under the
equity method of accounting, principally resulting from declines in the market
value of Target Corporation's common stock. At December 31, 2008, the book value
of the Company's investment in Pershing Square was $36,700,000.
RCG Ambrose, L.P. ("Ambrose")
In September 2007, the Company invested $75,000,000 in Ambrose, a limited
partnership which principally invests through a master fund in anticipated
corporate transactions including mergers, acquisitions, recapitalizations and
similar events. For the years ended December 31, 2008 and 2007, the Company
recorded $1,000,000 and $1,100,000, respectively, of pre-tax losses from this
investment under the equity method of accounting. During 2008, the Company
redeemed its investment in Ambrose and received distributions of $72,900,000.
The following table provides summarized data with respect to the Associated
Companies accounted for on the equity method of accounting included in results
of operations for the three years ended December 31, 2008. (Amounts are in
thousands.)
F-18
2008 2007
---- ----
Assets $ 5,076,600 $ 5,761,200
Liabilities 1,808,900 1,446,500
------------- ------------
Net assets $ 3,267,700 $ 4,314,700
============= ============
The Company's portion of the reported net assets $ 894,200 $ 1,175,700
============= ============
2008 2007 2006
---- ---- ----
Total revenues (including securities gains (losses)) $ (482,400) $ 158,900 $ 640,400
Income (loss) from continuing operations before
extraordinary items $ (1,460,700) $ (625,100) $ 214,600
Net income (loss) $ (1,460,700) $ (625,100) $ 214,600
The Company's equity in net income (loss) $ (275,800) $ (31,200) $ 60,100
As permitted under SFAS 159, the Company elected the fair value option for two
of its associated companies investments, ACF and Jefferies, rather than apply
the equity method of accounting. The following table provides summarized data
for the year ended December 31, 2008 with respect to ACF and Jefferies. (Amounts
are in thousands.)
Assets $ 34,131,800
Liabilities 30,032,400
------------
Net assets $ 4,099,400
============
Total revenues $ 3,655,500
Loss from continuing operations before extraordinary items $ (614,900)
Net loss $ (614,900)
Except for its investment in CLC, the Company has not provided any guarantees,
nor is it contingently liable for any of the liabilities reflected in the above
tables. All such liabilities are non-recourse to the Company. The Company's
exposure to adverse events at the investee companies is limited to the book
value of its investment.
5. Discontinued Operations:
-----------------------
Symphony Health Services, LLC ("Symphony")
In July 2006, the Company sold Symphony for approximately $107,000,000. After
satisfaction of Symphony's outstanding credit agreement by the buyer
($31,700,000 at date of sale) and certain sale related obligations, the Company
realized net cash proceeds of $62,300,000 and recorded a pre-tax gain on sale of
discontinued operations of $53,300,000 ($33,500,000 after tax).
ATX Communications, Inc. ("ATX")
In September 2006, the Company sold ATX for aggregate cash consideration of
approximately $85,700,000 and recorded a pre-tax gain on sale of discontinued
operations of $41,600,000 ($26,100,000 after tax). Losses of $1,100,000 in 2008
relate to an indemnification obligation to the purchaser.
F-19
WilTel Communications Group, LLC ("WilTel")
In December 2005, the Company sold WilTel to Level 3 Communications, Inc.
("Level 3"). Gain on disposal of discontinued operations for 2007 includes a
pre-tax gain of $800,000 ($500,000 after tax) from the resolution of
sale-related contingencies. Gain on disposal of discontinued operations during
2006 includes $2,400,000 of pre-tax gains ($1,500,000 after tax) principally for
the resolution of certain sale-related contingencies and obligations and working
capital adjustments.
During 2007, WilTel's former headquarters building, which was not included in
the sale to Level 3 and was retained by the Company, was sold for net cash
proceeds of $53,500,000 resulting in a small gain.
Other
In 2008, the Company received distributions totaling $44,900,000 from its
subsidiary, Empire Insurance Company ("Empire"), which has been undergoing a
voluntary liquidation since 2001. The Company had classified Empire as a
discontinued operation in 2001 and fully wrote-off its remaining book value
based on its expected future cash flows at that time. Although Empire no longer
writes any insurance business, its orderly liquidation over the years has
resulted in reductions to its estimated claim reserves that enabled Empire to
pay the distributions, with the approval of the New York Insurance Department.
The distributions were recognized as income from discontinued operations; for
income tax purposes, the payments are treated as non-taxable distributions paid
by a subsidiary. Since future distributions from Empire, if any, are subject to
New York insurance law or the approval of the New York Insurance Department,
income will only be recognized when received.
Gain on disposal of discontinued operations for 2007 includes a pre-tax gain of
$4,000,000 ($2,800,000 after tax) related to the collection of additional
amounts from the sale of the Company's interest in an Argentine shoe
manufacturer in 2005 that had not been previously recognized (collectibility was
uncertain).
In 2006, the Company sold its gas properties and recorded a pre-tax loss on
disposal of discontinued operations of $900,000. Income (loss) from discontinued
operations for 2006 includes $2,900,000 of pre-tax losses related to these gas
properties.
In 2006, the Company received $3,000,000 from a former insurance subsidiary
which, for many years, had been undergoing liquidation proceedings controlled by
state insurance regulators. The Company reflected the amount received as a gain
on disposal of discontinued operations. For income tax purposes, the payment is
treated as a non-taxable distribution paid by a subsidiary; as a result, no tax
expense was recorded.
A summary of the results of discontinued operations is as follows for the year
ended December 31, 2006 (in thousands):
F-20
2006
----
Revenues and other income:
Telecommunications revenues $ 118,987
Healthcare revenues 110,370
Investment and other income 2,790
---------
232,147
---------
Expenses:
Telecommunications cost of sales 72,231
Healthcare cost of sales 95,628
Interest 1,321
Salaries 26,889
Depreciation and amortization 10,018
Selling, general and other expenses 29,888
---------
235,975
---------
Loss from discontinued operations before income taxes (3,828)
Income tax provision 132
---------
Loss from discontinued operations, net of taxes $ (3,960)
=========
Results of discontinued operations for 2008 and 2007 were not material.
6. Investments:
------------
A summary of investments classified as current assets at December 31, 2008 and
2007 is as follows (in thousands):
2008 2007
------------------------------ ------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
--------- ------------- --------- -------------
Investments available for sale $ 360,814 $ 362,628 $ 897,470 $ 899,053
Trading securities -- -- 47,180 71,618
Other investments, including accrued interest income 3,966 3,836 12,528 12,528
--------- ---------- --------- ----------
Total current investments $ 364,780 $ 366,464 $ 957,178 $ 983,199
========= ========== ========= ==========
The amortized cost, gross unrealized gains and losses and estimated fair value
of available for sale investments classified as current assets at December 31,
2008 and 2007 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ --------- -------- --------
2008
----
Bonds and notes:
United States Government and agencies $ 251,895 $ 925 $ -- $ 252,820
U.S. Government-Sponsored Enterprises 72,273 46 -- 72,319
All other corporates 36,646 1,263 420 37,489
----------- ------- ------- ---------
Total fixed maturities $ 360,814 $ 2,234 $ 420 $ 362,628
=========== ======= ======= =========
2007
----
Bonds and notes:
United States Government and agencies $ 735,721 $ 1,634 $ 189 $ 737,166
U.S. Government-Sponsored Enterprises 159,365 138 8 159,495
All other corporates 2,384 17 9 2,392
----------- ------- ------- ---------
Total fixed maturities $ 897,470 $ 1,789 $ 206 $ 899,053
=========== ======= ======= =========
F-21
At December 31, 2007, trading securities was comprised of other investments,
principally an investment in credit default swaps carried at fair value of
$22,000,000, and the INTL Consilium Emerging Market Absolute Return Fund, LLC's
investment in a master fund. For 2007, net securities gains (losses) include
$19,500,000 of unrealized gains related to the credit default swaps. The
Company's objective in making this speculative investment was to realize capital
appreciation.
A summary of non-current investments at December 31, 2008 and 2007 is as follows
(in thousands):
2008 2007
-------------------------------- -------------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
----------- ------------- ----------- -------------
Investments available for sale $ 723,222 $ 859,122 $ 914,230 $ 2,580,890
Other investments 168,890 168,890 195,631 195,631
----------- ----------- ----------- -----------
Total non-current investments $ 892,112 $ 1,028,012 $ 1,109,861 $ 2,776,521
=========== =========== =========== ===========
Non-current investments include 5,600,000 common shares of Inmet, which have a
cost of $78,000,000 and carrying values of $90,000,000 and $78,000,000 at
December 31, 2008 and 2007, respectively. Although the Inmet shares have
registration rights, they may not be sold until the earlier of August 2009 or
the date on which the Company is no longer obligated under the guarantee of
CLC's credit facilities. As required under GAAP, because of the transfer
restriction the Inmet shares were carried at the initially recorded value until
one year prior to the termination of the transfer restrictions; accordingly,
starting in the third quarter of 2008 the Inmet shares are carried at market
value. The Inmet shares are included in non-current investments available for
sale at December 31, 2008 and in other non-current investments at December 31,
2007.
In August 2006, pursuant to a subscription agreement with Fortescue Metals Group
Ltd ("Fortescue") and its subsidiary, FMG Chichester Pty Ltd ("FMG"), the
Company invested an aggregate of $408,000,000, including expenses, in
Fortescue's Pilbara iron ore and infrastructure project in Western Australia. In
exchange for its cash investment, the Company received 264,000,000 common shares
of Fortescue, representing approximately 9.99% of the outstanding Fortescue
common stock, and a $100,000,000 note of FMG that matures in August 2019. In
July 2007, Fortescue sold new common shares in an underwritten public offering
to raise additional capital for its mining project and to fund future growth. In
connection with this offering, the Company exercised its pre-emptive rights to
maintain its ownership position and acquired an additional 13,986,000 common
shares of Fortescue for $44,200,000. Non-current available for sale investments
include 277,986,000 common shares of Fortescue, representing approximately 9.9%
of the outstanding Fortescue common stock at December 31, 2008 and 2007.
Fortescue is a publicly traded company on the Australian Stock Exchange (Symbol:
FMG), and the shares acquired by the Company may be sold without restriction on
the Australian Stock Exchange or in accordance with applicable securities laws.
The Fortescue shares have a cost of $246,300,000 and market values of
$377,000,000 and $1,824,700,000 at December 31, 2008 and 2007, respectively.
Interest on the FMG note is calculated as 4% of the revenue, net of government
royalties, invoiced from the iron ore produced from the project's Cloud Break
and Christmas Creek areas, which commenced production in May 2008. The note is
unsecured and subordinate to the project's senior secured debt. Interest is
payable semi-annually within 30 days of June 30th and December 31st of each
year; however, cash interest payments on the note are currently being deferred
due to covenants contained in the project's senior secured debt. Any interest
payment that is deferred will earn simple interest at 9.5%. The Company has
recorded accrued interest on the FMG note of $40,500,000 at December 31, 2008.
For accounting purposes, the Company allocated its initial Fortescue investment
to the common shares acquired (based on the market value at acquisition), a 13
year zero-coupon note and a prepaid mining interest. The zero-coupon note was
recorded at an estimated initial fair value of $21,600,000, representing the
present value of the principal amount discounted at 12.5%. The prepaid mining
interest of $184,300,000 was initially classified with other non-current assets
and is being amortized to expense as the 4% of revenue is earned. Depreciation
and amortization expense for the year ended December 31, 2008 includes prepaid
mining interest amortization of $2,800,000.
F-22
The amortized cost, gross unrealized gains and losses and estimated fair value
of non-current investments classified as available for sale at December 31, 2008
and 2007 are as follows (in thousands):
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ----------- --------
2008
----
Bonds and notes:
United States Government and agencies $ 11,839 $ -- $ 394 $ 11,445
U.S. Government-Sponsored Enterprises 284,696 753 3,704 281,745
All other corporates 4,648 87 234 4,501
----------- ---------- -------- ----------
Total fixed maturities 301,183 840 4,332 297,691
----------- ---------- -------- ----------
Equity securities:
Common stocks:
Banks, trusts and insurance companies 13,750 2,890 -- 16,640
Industrial, miscellaneous and all other 408,289 143,067 6,565 544,791
----------- ---------- -------- ----------
Total equity securities 422,039 145,957 6,565 561,431
----------- ---------- -------- ----------
$ 723,222 $ 146,797 $ 10,897 $ 859,122
=========== ========== ======== ==========
2007
----
Bonds and notes:
United States Government and agencies $ 54,148 $ 457 $ 404 $ 54,201
U.S. Government-Sponsored Enterprises 286,204 293 3,448 283,049
All other corporates 49,690 5,403 1,099 53,994
----------- ---------- -------- ----------
Total fixed maturities 390,042 6,153 4,951 391,244
----------- ---------- -------- ----------
Equity securities:
Common stocks:
Banks, trusts and insurance companies 99,716 33,863 1,133 132,446
Industrial, miscellaneous and all other 424,472 1,638,196 5,468 2,057,200
----------- ---------- -------- ----------
Total equity securities 524,188 1,672,059 6,601 2,189,646
----------- ---------- -------- ----------
$ 914,230 $1,678,212 $ 11,552 $2,580,890
=========== ========== ======== ==========
The amortized cost and estimated fair value of non-current investments
classified as available for sale at December 31, 2008, by contractual maturity,
are shown below. Expected maturities are likely to differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Estimated
Amortized Fair
Cost Value
---------- ---------
(In thousands)
Due after one year through five years $ 586 $ 674
Due after five years through ten years -- --
Due after ten years 4,062 3,827
---------- ----------
4,648 4,501
Mortgage-backed securities 296,535 293,190
---------- ----------
$ 301,183 $ 297,691
========== ==========
Net unrealized gains on investments were $24,000,000, $997,700,000 and
$37,800,000 at December 31, 2008, 2007 and 2006, respectively. Reclassification
adjustments included in comprehensive income (loss) for the three year period
ended December 31, 2008 are as follows (in thousands):
F-23
2008 2007 2006
---- ---- ----
Net unrealized holding gains (losses) arising during the period, net of
taxes of $536,981, $561,743 and $48,799 $ (938,930) $ 981,411 $ 86,004
Less: reclassification adjustment for net (gains) losses included in net
income (loss), net of taxes of $19,872, $12,328 and $14,650 (34,746) (21,539) (25,817)
----------- ----------- -----------
Net change in unrealized gains (losses) on investments, net of taxes
of $556,853, $549,415 and $34,149 $ (973,676) $ 959,872 $ 60,187
=========== =========== ===========
The following table shows the Company's investments' gross unrealized losses and
fair value, aggregated by investment category, all of which have been in a
continuous unrealized loss position for less than 12 months, at December 31,
2008 (in thousands):
Unrealized
Description of Securities Fair Value Losses
------------------------- ----------- ----------
Mortgage-backed securities $ 186,333 $ 2,903
Corporate bonds 38,891 654
Marketable equity securities 23,904 6,565
----------- ---------
Total temporarily impaired securities $ 249,128 $ 10,122
=========== =========
The unrealized losses on the mortgage-backed securities were considered to be
minor (approximately 1.6%). The unrealized losses on the mortgage-backed
securities (all of which are issued by U.S. Government agencies and U.S.
Government-Sponsored Enterprises) relate to 102 securities substantially all of
which were purchased between 2006 and 2008. The unrealized losses related to the
corporate bonds and marketable equity securities are not considered to be an
other than temporary impairment. This determination is based on a number of
factors including, but not limited to, the length of time and extent to which
the fair value has been less than cost, the financial condition and near term
prospects of the issuer, the reason for the decline in the fair value, changes
in fair value subsequent to the balance sheet date, the ability and intent to
hold investments to maturity, and other factors specific to the individual
investment.
At December 31, 2008, the Company's investments which have been in a continuous
unrealized loss position for 12 months or longer are comprised of 27 securities
which had aggregate gross unrealized losses of approximately $1,200,000 and an
aggregate fair value of approximately $41,300,000. These securities are
mortgage-backed securities (all of which are issued by U.S. Government agencies
and U.S. Government-Sponsored Enterprises).
At December 31, 2008 and 2007, the aggregate carrying amount of the Company's
investment in securities that are accounted for under the cost method totaled
$168,900,000 and $195,600,000, respectively. The December 31, 2007 amount
included $78,000,000 related to the Company's investment in the Inmet common
shares, which had a market value in excess of the carrying amount. The fair
value of the remaining cost method securities was not estimated as it was not
practicable to estimate the fair value of these investments.
Securities with book values of $8,100,000 and $12,500,000 at December 31, 2008
and 2007, respectively, collateralized certain swap agreements.
F-24
7. Trade, Notes and Other Receivables, Net:
---------------------------------------
A summary of current trade, notes and other receivables, net at December 31,
2008 and 2007 is as follows (in thousands):
2008 2007
---- ----
Trade receivables $ 79,462 $ 66,101
Accrued interest on FMG note 40,467 --
Receivables related to securities 4,512 13,678
Receivables related to associated companies 1,126 19,276
Receivables relating to real estate activities 1,000 5,934
Other 15,506 30,800
---------- ----------
142,073 135,789
Allowance for doubtful accounts (3,710) (2,024)
---------- ----------
Total current trade, notes and other receivables, net $ 138,363 $ 133,765
========== ==========
8. Inventory:
----------
A summary of inventory (which is included in the caption, prepaids and other
current assets) at December 31, 2008 is as follows (in thousands):
Raw materials $ 9,148
Work in process 15,436
Finished goods 52,319
---------
$ 76,903
=========
9. Intangible Assets, Net and Goodwill:
-----------------------------------
A summary of these assets at December 31, 2008 and 2007 is as follows (in
thousands):
2008 2007
---- ----
Intangibles:
Customer relationships, net of accumulated amortization of $27,473
and $19,472 $ 55,670 $ 52,362
Licenses, net of accumulated amortization of $991 and $361 10,947 11,527
Trademarks and tradename, net of accumulated amortization of $593
and $403 3,689 1,886
Patents, net of accumulated amortization of $611 and $453 1,749 1,907
Other, net of accumulated amortization of $2,344 and $2,048 3,477 3,673
Goodwill 9,316 8,151
----------- -----------
$ 84,848 $ 79,506
=========== ===========
During 2008, customer relationships, and trademarks and tradename increased by
$11,300,000 and $2,000,000, respectively, primarily due to acquisitions by STi
Prepaid. These intangible assets are being amortized on a straight line basis
over their estimated useful lives. The increase in goodwill during 2008 also
resulted from acquisitions by STi Prepaid. At December 31, 2007, all of the
goodwill in the above table related to Conwed Plastics.
Amortization expense on intangible assets was $9,300,000, $8,600,000 and
$7,700,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
The estimated aggregate future amortization expense for the intangible assets
for each of the next five years is as follows: 2009 - $10,400,000; 2010 -
$10,100,000; 2011 - $9,600,000; 2012 - $8,900,000; and 2013 - $8,600,000.
F-25
10. Other Assets:
-------------
A summary of non-current other assets at December 31, 2008 and 2007 is as
follows (in thousands):
2008 2007
---- ----
Real Estate $ 320,729 $ 225,409
Unamortized debt expense 26,915 33,447
Restricted cash 90,752 93,556
Prepaid mining interest 173,165 184,315
Other 8,229 7,705
---------- ----------
$ 619,790 $ 544,432
========== ==========
In October 2007, the Company entered into an agreement with the Panama City-Bay
County Airport and Industrial District of Panama City, Florida to purchase
approximately 708 acres of land which currently houses the Panama City-Bay
County International Airport. At December 31, 2008 and 2007, restricted cash
included $56,500,000 that has been placed into escrow pursuant to this
agreement; the transaction will close and title to the property will pass only
after the city completes construction of a new airport and moves the airport
operations to its new location within specified timeframes. In addition,
restricted cash at December 31, 2008 and 2007 includes $14,700,000 of escrowed
funds relating to the Premier noteholders' claims; see Note 19 for further
information.
The Company's prepaid mining interest relates to its investment in Fortescue,
which is more fully explained in Note 6.
11. Property, Equipment and Leasehold Improvements, Net:
----------------------------------------------------
A summary of property, equipment and leasehold improvements, net at December 31,
2008 and 2007 is as follows (in thousands):
Depreciable
Lives
(in years) 2008 2007
---------- ---- ----
Buildings and leasehold improvements 3-45 $ 403,186 $ 359,801
Machinery and equipment 3-40 180,836 157,692
Network equipment 5-15 16,597 32,294
Corporate aircraft 10 100,021 87,981
Computer equipment and software 2-5 17,009 14,455
Furniture and fixtures 2-10 25,383 23,549
Construction in progress N/A 3,836 10,498
Other 3-5 3,459 3,300
---------- -----------
750,327 689,570
Accumulated depreciation and amortization (215,687) (176,766)
---------- -----------
$ 534,640 $ 512,804
========== ===========
F-26
12. Trade Payables and Expense Accruals:
-----------------------------------
A summary of trade payables and expense accruals at December 31, 2008 and 2007
is as follows (in thousands):
2008 2007
---- ----
Trade payables $ 35,104 $ 41,877
Due to telecommunication carriers and accrued carrier costs 32,270 31,289
Payables related to securities 3,885 4,712
Accrued compensation, severance and other employee benefits 44,752 46,722
Accrued legal and professional fees 9,484 19,224
Accrued clinical trial expenses 2,003 6,648
Taxes other than income 7,363 3,481
Accrued interest payable 41,779 41,348
Other 29,230 34,259
--------- ---------
$ 205,870 $ 229,560
========= =========
13. Indebtedness:
-------------
The principal amount, stated interest rate and maturity date of outstanding debt
at December 31, 2008 and 2007 are as follows (dollars in thousands):
2008 2007
---- ----
Parent Company Debt:
Senior Notes:
Bank credit facility $ -- $ --
7 3/4% Senior Notes due 2013, less debt discount of $267 and $312 99,733 99,688
7% Senior Notes due 2013, net of debt premium of $673 and $793 375,673 375,793
7 1/8% Senior Notes due 2017 500,000 500,000
8 1/8% Senior Notes due 2015, less debt discount of $7,470 and $8,266 492,530 491,734
Subordinated Notes:
3 3/4% Convertible Senior Subordinated Notes due 2014 221,110 350,000
8.65% Junior Subordinated Deferrable Interest Debentures due 2027 98,200 98,200
Subsidiary Debt:
Repurchase agreements 151,088 124,977
Aircraft financing 37,108 39,221
Capital leases due 2009 through 2012 with a weighted average
interest rate of 8.1% 927 10,194
Other due 2009 through 2011 with a weighted average interest
rate of 3.3% 105,087 46,743
------------ ------------
Total debt 2,081,456 2,136,550
Less: current maturities (248,713) (132,405)
------------ ------------
Long-term debt $ 1,832,743 $ 2,004,145
============ ============
Parent Company Debt:
In June 2006, the Company entered into a new credit agreement with various bank
lenders for a $100,000,000 unsecured credit facility that expires in June 2011
and bears interest based on the Eurocurrency rate or the prime rate. At December
31, 2008, no amounts were outstanding under this bank credit facility.
In April 2004, the Company sold $350,000,000 principal amount of its 3 3/4%
Convertible Senior Subordinated Notes due 2014 in a private placement
transaction. The notes are convertible into the Company's common shares at
$22.97 per share at any time before their maturity, subject to certain
restrictions contained in the notes, at a conversion rate of 43.5414 shares per
each $1,000 principal amount of notes subject to adjustment (an aggregate of
15,239,490 shares). During 2008, the Company issued 5,611,913 common shares upon
the conversion of $128,887,000 principal amount of the notes, pursuant to
privately negotiated transactions to induce conversion. The number of common
shares issued was in accordance with the terms of the notes; however, the
Company paid the former noteholders $12,200,000 in addition to the shares. The
additional cash payments were expensed. Separately, another bondholder converted
$3,000 principal amount of the convertible notes into common shares.
F-27
The Company's senior note indentures contain covenants that restrict its ability
to incur more Indebtedness or issue Preferred Stock of Subsidiaries unless, at
the time of such incurrence or issuance, the Company meets a specified ratio of
Consolidated Debt to Consolidated Tangible Net Worth, limit the ability of the
Company and Material Subsidiaries to incur, in certain circumstances, Liens,
limit the ability of Material Subsidiaries to incur Funded Debt in certain
circumstances, and contain other terms and restrictions all as defined in the
senior note indentures. The Company has the ability to incur substantial
additional indebtedness or make distributions to its shareholders and still
remain in compliance with these restrictions. If the Company is unable to meet
the specified ratio, the Company would not be able to issue additional
Indebtedness or Preferred Stock, but the Company's inability to meet the
applicable ratio would not result in a default under its senior note indentures.
The Company's bank credit agreement also contains covenants and restrictions
which are generally more restrictive than the senior note indentures; however,
the Company has the ability to terminate the bank credit agreement if no amounts
are outstanding. As of December 31, 2008, cash dividends of approximately
$327,200,000 would be eligible to be paid under the bank credit agreement; the
senior note indentures do not restrict the payment of dividends.
Subsidiary Debt:
Debt due within one year includes $151,100,000 and $125,000,000 as of December
31, 2008 and 2007, respectively, relating to repurchase agreements. At December
31, 2008, these fixed rate repurchase agreements have a weighted average
interest rate of approximately 2.25%, mature in January 2009 and are
collateralized by non-current investments with a carrying value of $164,700,000.
During 2001, a subsidiary of the Company borrowed $53,100,000 collateralized by
certain of its corporate aircraft. This debt bears interest based on a floating
rate, requires monthly payments of principal and interest and matures in ten
years. The interest rate at December 31, 2008 was 5.9%. The subsidiary has
entered into an interest rate swap agreement for this financing, which fixed the
interest rate at approximately 5.7%. The subsidiary would have paid $3,300,000
and $1,500,000 at December 31, 2008 and 2007, respectively, if the swap were
terminated. Changes in interest rates in the future will change the amounts to
be received under the agreement, as well as interest to be paid under the
related variable debt obligation. The Parent company has guaranteed this
financing.
Capital leases at December 31, 2007 primarily consist of a sale-leaseback
transaction related to certain corporate aircraft. During 2008, the Company
exercised its purchase option to acquire the corporate aircraft and the capital
leases were terminated.
Other subsidiary debt at December 31, 2008 and 2007 principally includes
Premier's equipment financing ($14,700,000 and $18,700,000, respectively) and
debt secured by a real estate development project ($90,200,000 and $27,800,000,
respectively). With respect to the real estate development project, the
subsidiary entered into an interest rate swap agreement, which fixed the
interest rate at approximately 5.1%. The subsidiary would have paid $8,500,000
and $3,900,000 at December 31, 2008 and 2007, respectively, if the swap were
terminated. Changes in interest rates in the future will change the amounts to
be received under the agreement, as well as interest to be paid under the
related variable debt obligation.
At December 31, 2008, $374,600,000 of other assets (primarily investments, real
estate and property) are pledged for indebtedness aggregating $293,600,000.
Counterparties to interest rate and currency swap agreements are major financial
institutions, that management believes are able to fulfill their obligations.
Management believes any losses due to default by the counterparties are likely
to be immaterial.
The aggregate annual mandatory redemptions of debt during the five year period
ending December 31, 2013 are as follows: 2009 - $248,700,000; 2010 -
$12,600,000; 2011 - $32,900,000; 2012 - $0; and 2013 - $475,000,000.
The weighted average interest rate on short-term borrowings (consisting of
repurchase agreements) was 2.25% and 5.1% at December 31, 2008 and 2007,
respectively.
F-28
14. Common Shares, Stock Options and Preferred Shares:
-------------------------------------------------
During 2008, 5,612,043 shares of common stock were issued upon conversion of
$128,890,000 principal amount of the Company's 3 3/4% Convertible Notes. In
April 2008, the Company sold to Jefferies 10,000,000 of the Company's common
shares, and received 26,585,310 shares of common stock of Jefferies and
$100,021,000 in cash. In September 2007, the Company completed the issuance and
sale of 5,500,000 of its common shares at a net price of $45.50 per share. Net
proceeds after payment of underwriting fees were $242,000,000.
The Board of Directors from time to time has authorized acquisitions of the
Company's common shares. In March 2007, the Company's Board of Directors
increased to 12,000,000 the maximum number of shares that the Company is
authorized to purchase. During the three year period ended December 31, 2008,
the Company acquired 13,731 common shares at an average price of $34.34 per
common share, all in connection with stock option exercises. At December 31,
2008, the Company is authorized to repurchase 11,992,829 common shares.
Effective January 1, 2006, the Company adopted SFAS 123R using the modified
prospective method. As a result of the adoption of SFAS 123R, compensation cost
increased by $12,200,000, $11,200,000 and $15,200,000 for the years ended
December 31, 2008, 2007 and 2006, respectively, and net loss increased by
$12,200,000 for 2008 and net income decreased by $8,100,000 and $9,800,000 for
2007 and 2006, respectively. As of December 31, 2008, total unrecognized
compensation cost related to nonvested share-based compensation plans was
$18,900,000; this cost is expected to be recognized over a weighted-average
period of 1.4 years.
As of December 31, 2008, the Company has two share-based plans: a fixed stock
option plan and a senior executive warrant plan. The fixed stock option plan
provides for grants of options or rights to non-employee directors and certain
employees up to a maximum grant of 450,000 shares to any individual in a given
taxable year. The maximum number of common shares that may be acquired through
the exercise of options or rights under this plan cannot exceed 2,519,150. The
plan provides for the issuance of stock options and stock appreciation rights at
not less than the fair market value of the underlying stock at the date of
grant. Options granted to employees under this plan are intended to qualify as
incentive stock options to the extent permitted under the Internal Revenue Code
and become exercisable in five equal annual instalments starting one year from
date of grant. Options granted to non-employee directors become exercisable in
four equal annual instalments starting one year from date of grant. No stock
appreciation rights have been granted. As of December 31, 2008, 831,850 shares
were available for grant under the plan.
The senior executive warrant plan provides for the issuance, subject to
shareholder approval, of warrants to purchase up to 2,000,000 common shares to
each of the Company's Chairman and President at an exercise price equal to 105%
of the closing price per share of a common share on the date of grant. On March
6, 2006, the Company's Board of Directors approved, subject to shareholder
approval, the grant of warrants to purchase 2,000,000 common shares to each of
the Company's Chairman and President at an exercise price equal to $28.515 per
share (105% of the closing price per share of a common share on that date). In
May 2006, shareholder approval was received and the warrants were issued. The
warrants expire in 2011 and vest in five equal tranches with 20% vesting on the
date shareholder approval was received and an additional 20% vesting in each
subsequent year. At December 31, 2008, 4,000,000 warrants were outstanding and
2,400,000 were exercisable; since the exercise price exceeds the market price
the warrants have no aggregate intrinsic value. Both the outstanding and
exercisable warrants had a weighted-average remaining contractual term of 2.2
years. No warrants were exercised or forfeited during 2008.
A summary of activity with respect to the Company's stock options for the three
years ended December 31, 2008 is as follows:
F-29
Weighted-
Common Weighted- Average
Shares Average Remaining Aggregate
Subject Exercise Contractual Intrinsic
to Option Prices Term Value
--------- ------ ---------- --------------
Balance at December 31, 2005 1,955,260 $17.60
Granted 1,037,000 $27.42
Exercised (300,010) $12.79 $ 4,400,000
============
Cancelled (34,000) $23.40
-----------
Balance at December 31, 2006 2,658,250 $21.90
Granted 12,000 $33.50
Exercised (727,689) $15.72 $ 18,400,000
============
Cancelled (63,200) $23.52
-----------
Balance at December 31, 2007 1,879,361 $24.31
Granted 879,500 $28.23
Exercised (314,571) $20.04 $ 9,300,000
============
Cancelled (144,000) $25.94
-----------
Balance at December 31, 2008 2,300,290 $26.29 4.2 years $ 100,000
=========== ========= ============
Exercisable at December 31, 2008 330,390 $23.73 2.6 years $ 100,000
=========== ========= ============
The following summary presents the weighted-average assumptions used for
grants made during each of the three years in the period ended December 31,
2008:
2008 2007 2006
------------ ----------- --------------------------
Options Options Options Warrants
------- ------- ------- --------
Risk free interest rate 2.34% 4.57% 4.47% 4.95%
Expected volatility 38.46% 21.71% 22.85% 23.05%
Expected dividend yield .45% .75% .90% .41%
Expected life 4.0 years 4.3 years 4.0 years 4.3 years
Weighted-average fair value per grant $8.94 $8.03 $6.25 $9.39
The expected life assumptions were based on historical behavior and incorporated
post-vesting forfeitures for each type of award and population identified. The
expected volatility was based on the historical behavior of the Company's stock
price.
At December 31, 2008 and 2007, 3,132,140 and 3,446,711, respectively, of the
Company's common shares were reserved for stock options, 9,627,447 and
15,239,490, respectively, of the Company's common shares were reserved for the
3 3/4% Convertible Senior Subordinated Notes and 4,000,000 of the Company's
common shares were reserved for warrants.
At December 31, 2008 and 2007, 6,000,000 of preferred shares (redeemable and
non-redeemable), par value $1 per share, were authorized and not issued.
F-30
15. Net Securities Gains (Losses):
----------------------------
The following summarizes net securities gains (losses) for each of the three
years in the period ended December 31, 2008 (in thousands):
2008 2007 2006
---- ---- ----
Net realized gains on securities $ 23,383 $ 109,356 $ 129,734
Write-down of investments (a) (143,417) (36,834) (12,940)
Net unrealized gains (losses) on trading securities (24,508) 23,119 365
----------- --------- ---------
$ (144,542) $ 95,641 $ 117,159
=========== ========= =========
(a) Consists of provisions to write down investments in certain debt and equity
securities resulting from declines in fair values of securities believed to
be other than temporary.
During 2007, the Company sold all of its common stock holdings in Eastman
Chemical Company and recognized a net security gain of $37,800,000. During 2006,
the Company sold all of its shares of Level 3 common stock received in
connection with the sale of WilTel for total proceeds of $376,600,000 and
recorded a pre-tax gain of $37,400,000.
Proceeds from sales of investments classified as available for sale were
$4,485,200,000, $5,286,100,000 and $2,932,800,000 during 2008, 2007 and 2006,
respectively. Gross gains of $22,400,000, $99,000,000 and $134,200,000 and gross
losses of $44,000,000, $5,500,000 and $3,200,000 were realized on these sales
during 2008, 2007 and 2006, respectively.
16. Other Results of Operations Information:
----------------------------------------
Investment and other income for each of the three years in the period ended
December 31, 2008 consists of the following (in thousands):
2008 2007 2006
---- ---- ----
Interest on short-term investments $ 4,053 $ 18,121 $ 10,909
Dividend income 8,180 13,290 12,019
Interest on fixed maturity investments 41,555 64,787 91,634
Other investment income 3,974 4,075 4,630
Income related to Fortescue's Pilbara project 40,467 -- --
Gains on sale of real estate and other assets, net of costs 3,395 11,607 75,729
Reimbursement for minority interest losses 5,551 -- --
Income related to settlement of insurance claims 11,546 -- --
Income related to sale of associated companies -- 11,441 34,673
Recovery of bankruptcy claims -- -- 7,371
Income on termination of joint development agreement -- 8,490 --
Rental income 8,617 5,723 7,023
Winery revenues 22,102 20,091 20,822
Other 39,611 23,840 29,868
---------- ---------- ----------
$ 189,051 $ 181,465 $ 294,678
========== ========== ==========
See Note 6 for information concerning the income related to Fortescue's Pilbara
project.
For 2008, other income for the gaming entertainment segment includes a
$7,300,000 gain from the settlement of an insurance claim and $5,600,000
resulting from capital contributions from the minority interest. In prior
periods, the Company recorded 100% of the losses from this segment after
cumulative loss allocations to the minority interest had reduced the minority
interest liability to zero. Since the minority interest liability remains at
zero after considering the capital contributions, the entire capital
contribution was recorded as income, effectively reimbursing the Company for a
portion of the minority interest losses that were not previously allocated to
the minority interest. For 2008, manufacturing other income includes a
$4,200,000 gain from the settlement of an insurance claim relating to Idaho
Timber.
F-31
In February 2006, 711 Developer, LLC ("Square 711"), a 90% owned subsidiary of
the Company, completed the sale of 8 acres of unimproved land in Washington,
D.C. for aggregate cash consideration of $121,900,000. The land was acquired by
Square 711 in September 2003 for cash consideration of $53,800,000. After
satisfaction of mortgage indebtedness on the property of $32,000,000 and other
closing payments, the Company received net cash proceeds of $75,700,000, and
recorded a pre-tax gain of $48,900,000.
Taxes, other than income or payroll, amounted to $21,300,000, $10,400,000 and
$3,900,000 for the years ended December 31, 2008, 2007 and 2006, respectively.
Advertising costs amounted to $25,000,000, $9,700,000 and $900,000 for the years
ended December 31, 2008, 2007 and 2006, respectively.
Research and development costs charged to expense were $14,000,000, $22,300,000
and $16,500,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.
17. Income Taxes:
-------------
The principal components of deferred taxes at December 31, 2008 and 2007 are as
follows (in thousands):
2008 2007
---- ----
Deferred Tax Asset:
Securities valuation reserves $ 235,498 $ 40,473
Other assets 61,696 45,089
NOL carryover 2,090,031 1,972,901
Other liabilities 47,850 48,829
------------ ------------
2,435,075 2,107,292
Valuation allowance (2,307,281) (299,775)
------------ ------------
127,794 1,807,517
------------ ------------
Deferred Tax Liability:
Unrealized gains on investments (51,799) (626,364)
Depreciation (12,715) (18,536)
Other (23,045) (24,535)
------------ ------------
(87,559) (669,435)
------------ ------------
Net deferred tax asset $ 40,235 $ 1,138,082
============ ============
As of December 31, 2008, the Company had consolidated federal NOLs of
$1,002,600,000, none of which expire prior to 2023, that may be used to offset
the taxable income of any member of the Company's consolidated tax group. In
addition, the Company has $4,743,000,000 of federal NOLs that are only available
to offset the taxable income of certain subsidiaries. Except for $3,941,000 that
expire in 2012, none of the other NOLs expire prior to 2017. The Company also
has various state NOLs that expire at different times, which are reflected in
the above table to the extent the Company estimates its future taxable income
will be apportioned to those states. Uncertainties that may affect the
utilization of the Company's tax attributes include future operating results,
tax law changes, rulings by taxing authorities regarding whether certain
transactions are taxable or deductible and expiration of carryforward periods.
As more fully discussed in Note 2, during 2008 the Company concluded that a
valuation allowance was required against substantially all of the net deferred
tax asset, and increased its valuation allowance by $1,672,100,000 with a
corresponding charge to income tax expense. During 2007, the Company concluded
that it was more likely than not that it would have future taxable income
sufficient to realize a portion of the Company's net deferred tax asset;
accordingly, $542,700,000 of the deferred tax valuation allowance was reversed
as a credit to income tax expense.
F-32
Under certain circumstances, the ability to use the NOLs and future deductions
could be substantially reduced if certain changes in ownership were to occur. In
order to reduce this possibility, the Company's certificate of incorporation
includes a charter restriction that prohibits transfers of the Company's common
stock under certain circumstances.
The provision (benefit) for income taxes for each of the three years in the
period ended December 31, 2008 was as follows, excluding amounts allocated to
income (losses) related to associated companies and discontinued operations (in
thousands):
2008 2007 2006
---- ------ ----
State income taxes $ 3,266 $ 4,176 $ 3,682
Resolution of state tax contingencies (254) (1,475) (8,000)
Federal income taxes:
Current (116) (1,958) 1,721
Deferred (1,420) (17,925) 44,203
Increase (decrease) in valuation allowance 1,672,138 (542,686) --
Currently payable foreign income taxes 61 97 165
----------- ---------- ----------
$ 1,673,675 $ (559,771) $ 41,771
=========== ========== ==========
The table below reconciles the expected statutory federal income tax to the
actual income tax provision (benefit) (in thousands):
2008 2007 2006
---- ------ ----
Expected federal income tax $ (128,299) $ (19,981) $ 46,837
State income taxes, net of federal income tax benefit 3,266 2,714 2,393
Increase (decrease) in valuation allowance 1,672,138 (542,686) --
Tax benefit of current year losses fully reserved in valuation allowance 128,591 -- --
Resolution of tax contingencies (1,669) (1,475) (8,000)
Permanent differences (292) 824 434
Other (60) 833 107
----------- ---------- ----------
Actual income tax provision (benefit) $ 1,673,675 $ (559,771) $ 41,771
=========== ========== ==========
Reflected above as resolution of tax contingencies are reductions to the
Company's income tax provision for the expiration of the applicable statute of
limitations and the favorable resolution of certain federal and state income tax
contingencies.
Effective January 1, 2007, the Company adopted Financial Accounting Standards
Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" ("FIN 48"), which prescribes the
accounting for and disclosure of uncertainty in income tax positions. FIN 48
specifies a recognition threshold that must be met before any part of the
benefit of a tax position can be recognized in the financial statements,
specifies measurement criteria and provides guidance for classification and
disclosure. The Company was not required to record an adjustment to its
financial statements upon the adoption of FIN 48.
The following table reconciles the total amount of unrecognized tax benefits as
of the beginning and end of the periods presented (in thousands):
F-33
Unrecognized
Tax Benefits Interest Total
------------ -------- -----
As of January 1, 2007, date of adoption of FIN 48 $ 10,500 $ 3,500 $ 14,000
Additions to unrecognized tax benefits 400 100 500
Additional interest expense recognized -- 800 800
Audit payments (300) (200) (500)
Reductions as a result of the lapse of the statute of limitations
and completion of audits (1,000) (500) (1,500)
--------- ------- ---------
Balance, December 31, 2007 9,600 3,700 13,300
Additions to unrecognized tax benefits 1,200 -- 1,200
Additional interest expense recognized -- 800 800
Audit payments -- -- --
Reductions as a result of the lapse of the statute of limitations
and completion of audits (2,900) (1,300) (4,200)
--------- ------- ---------
Balance, December 31, 2008 $ 7,900 $ 3,200 $ 11,100
========= ======= =========
If recognized, the total amount of unrecognized tax benefits reflected in the
table above would lower the Company's effective income tax rate. Over the next
twelve months, the Company does not expect that the aggregate amount of
unrecognized tax benefits will change by a material amount. The statute of
limitations with respect to the Company's federal income tax returns has expired
for all years through 2004. The Company's New York State and New York City
income tax returns are currently being audited for the 2003 to 2005 period.
Prior to May 2001, WilTel was included in the consolidated federal income tax
return of its former parent, The Williams Companies Inc. ("Williams"). Pursuant
to a tax settlement agreement between WilTel and Williams, the Company has no
liability for any audit adjustments made to Williams' consolidated tax returns;
however, adjustments to Williams' prior years tax returns could affect certain
of the Company's tax attributes that impact the calculation of alternative
minimum taxable income.
18. Pension Plans and Postretirement Benefits:
-----------------------------------------
The information presented below for defined benefit pension plans is presented
separately for the Company's plans and the plans formerly administered by
WilTel. Pursuant to the WilTel sale agreement the responsibility for WilTel's
defined benefit pension plans was retained by the Company. The Company presents
the information separately since the WilTel plan's investment strategies,
assumptions and results are significantly different than those of the Company.
The Company:
Prior to 1999, the Company maintained defined benefit pension plans covering
employees of certain units who also met age and service requirements. Effective
December 31, 1998, the Company froze its defined benefit pension plans. A
summary of activity with respect to the Company's defined benefit pension plan
for 2008 and 2007 is as follows (in thousands):
F-34
2008 2007
---- ----
Projected Benefit Obligation:
Projected benefit obligation at January 1, $ 51,759 $ 54,876
Interest cost (a) 2,555 2,565
Actuarial gain (53) (1,587)
Benefits paid (3,633) (4,095)
---------- ----------
Projected benefit obligation at December 31, $ 50,628 $ 51,759
========== ==========
Change in Plan Assets:
Fair value of plan assets at January 1, $ 47,203 $ 47,653
Actual return on plan assets 4,706 3,786
Employer contributions -- --
Benefits paid (3,633) (4,095)
Administrative expenses (271) (141)
---------- ----------
Fair value of plan assets at December 31, $ 48,005 $ 47,203
========== ==========
Funded Status at end of year $ (2,623) $ (4,556)
========== ==========
(a) Includes charges to expense of $700,000 for each of 2008 and 2007 relating
to discontinued operations obligations.
As of December 31, 2008 and 2007, $11,300,000 and $14,500,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income (loss) and $2,600,000 and
$4,600,000, respectively, was reflected as accrued pension cost. The Company is
currently evaluating whether to make any contributions to the Company's defined
benefit pension plan in 2009.
Pension expense related to the defined benefit pension plan charged to
operations included the following components (in thousands):
2008 2007 2006
---- ---- ----
Interest cost $ 1,836 $ 1,838 $ 1,916
Expected return on plan assets (1,470) (1,238) (1,052)
Actuarial loss 563 813 905
Amortization of prior service cost 3 3 3
--------- --------- ---------
Net pension expense $ 932 $ 1,416 $ 1,772
========= ========= =========
At December 31, 2008, the plan's assets consisted of U.S. Government and
agencies bonds (19%), U.S. Government-Sponsored Enterprises (49%), investment
grade bonds (30%) and cash equivalents (2%). At December 31, 2007, the plan's
assets consisted of U.S. Government and agencies bonds (12%), U.S.
Government-Sponsored Enterprises (55%), investment grade bonds (27%) and cash
equivalents (6%).
The defined benefit pension plan assets are invested in short-term investment
grade fixed income investments in order to maximize the value of its invested
assets by minimizing exposure to changes in market interest rates. This
investment strategy provides the Company with more flexibility in managing the
plan should interest rates rise and result in a decrease in the discounted value
of benefit obligations. The current investment strategy substantially requires
investments in investment grade securities, and a final average maturity target
for the portfolio of one and one-half years and a one year maximum duration.
F-35
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 2.1% real rate of return for risk-free investments
(primarily U.S. government and agency bonds) for the target duration, .3%
inflation risk premium and .2% default risk premium for the portion of the
portfolio invested in non-U.S. government and agency bonds. The combination of
these underlying assumptions resulted in the selection of the 5.1% expected
long-term rate of return assumption for 2008. Because pension expense includes
the cost of expected plan administrative expenses, the 5.1% assumption is not
reduced for such expenses.
Several subsidiaries provide certain health care and other benefits to certain
retired employees under plans which are currently unfunded. The Company pays the
cost of postretirement benefits as they are incurred. Amounts charged to expense
were not material in each of the three years ended December 31, 2008.
A summary of activity with respect to the Company's postretirement plans for
2008 and 2007 is as follows (in thousands):
2008 2007
---- ----
Accumulated postretirement benefit obligation at January 1, $ 4,083 $ 4,281
Interest cost 239 236
Contributions by plan participants 120 162
Actuarial (gain) loss 14 (111)
Benefits paid (519) (485)
------- -------
Accumulated postretirement benefit obligation at December 31, $ 3,937 $ 4,083
======= =======
The Company expects to spend $400,000 on postretirement benefits during 2009. At
December 31, 2008, the assumed health care cost trend rate for 2009 used in
measuring the accumulated postretirement benefit obligation is 9.0% and, at
December 31, 2007, such rate for 2008 was 9.5%. At December 31, 2008 and 2007,
the assumed health care cost trend rates were assumed to decline to an ultimate
rate of 5% by 2018. If the health care cost trend rates were increased or
decreased by 1%, the accumulated postretirement obligation as of December 31,
2008 would have increased by $300,000 or decreased by $200,000. The effect of
these changes on interest cost for 2008 would be immaterial.
At December 31, 2008 and 2007, the amounts in accumulated other comprehensive
income (loss) relating to the Company's defined benefit pension plan and other
benefits plans that have not yet been recognized in net periodic benefit cost
are as follows (in thousands):
2008 2007
--------------------------------- ----------------------------------
Other Other
Pension Plan Benefits Plans Pension Plan Benefits Plans
------------ -------------- ------------ --------------
Net loss (gain) $ 11,278 $ (862) $ 14,425 $ (947)
Prior service cost (credit) 40 (205) 43 (264)
--------- --------- --------- ---------
$ 11,318 $ (1,067) $ 14,468 $ (1,211)
========= ========= ========= =========
Changes in the Company's plan assets and benefit obligations recognized in other
comprehensive income (loss) for the years ended December 31, 2008 and 2007 are
as follows (in thousands):
F-36
2008 2007
--------------------------------- ---------------------------------
Other Other
Pension Plan Benefits Plans Pension Plan Benefits Plans
------------ -------------- ------------ --------------
Net gain (loss) arising during period $ 2,364 $ (13) $ 3,447 $ 112
Recognition of amortization in
net periodic benefit cost:
Prior service cost (credit) 3 (59) 3 (59)
Actuarial loss (gain) 783 (71) 1,134 (68)
-------- ------- --------- ------
Total $ 3,150 $ (143) $ 4,584 $ (15)
======== ======= ========= ======
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income (loss) into net periodic
benefit cost in 2009 is $500,000; such amount for the prior service cost is not
material. The estimated net gain and prior service credit for the other benefits
plans that will be amortized from accumulated other comprehensive income (loss)
into net periodic benefit cost in 2009 are $100,000 and $100,000, respectively.
The Company uses a December 31 measurement date for its plans. The assumptions
used relating to the defined benefit plan and postretirement plans are as
follows:
Pension Benefits Other Benefits
------------------ ---------------------
2008 2007 2008 2007
---- ---- ---- ----
Discount rate used to determine benefit
obligation at December 31, 5.25% 5.20% 6.30% 6.10%
Weighted-average assumptions used to determine
net cost for years ended December 31,:
Discount rate 5.20% 4.90% 6.10% 5.75%
Expected long-term return on plan assets 5.10% 4.25% N/A N/A
The discount rate for pension benefits was selected to result in an estimated
projected benefit obligation on a plan termination basis, using current rates
for annuity settlements and lump sum payments weighted for the assumed elections
of participants. The discount rate for other benefits was based on the expected
future benefit payments in conjunction with the Citigroup Pension Discount
Curve.
The following benefit payments are expected to be paid (in thousands):
Pension Benefits Other Benefits
---------------- --------------
2009 $ 4,689 $ 429
2010 3,916 416
2011 3,885 407
2012 3,905 379
2013 3,894 369
2014 - 2018 20,163 1,628
F-37
WilTel:
Effective on the date of sale, the Company froze WilTel's defined benefit
pension plans. A summary of activity with respect to the plans for 2008 and 2007
is as follows (in thousands):
2008 2007
---- ----
Projected Benefit Obligation:
Projected benefit obligation at beginning of period $ 168,541 $ 176,724
Interest cost 10,492 10,163
Actuarial (gain) loss 2,301 (12,573)
Settlement payment (4,250) --
Benefits paid (4,471) (5,773)
---------- ----------
Projected benefit obligation at December 31, $ 172,613 $ 168,541
========== ==========
Change in Plan Assets:
Fair value of plan assets at beginning of period $ 150,738 $ 143,590
Actual return on plan assets (31,584) 14,490
Employer contributions 4,365 68
Settlement payment (4,250) --
Benefits paid (4,471) (5,773)
Administrative expenses (1,811) (1,637)
---------- ----------
Fair value of plan assets at December 31, $ 112,987 $ 150,738
========== ==========
Funded Status at end of year $ (59,626) $ (17,803)
========== ==========
As of December 31, 2008 and 2007, $49,900,000 and $7,100,000, respectively, of
the net amount recognized in the consolidated balance sheet was reflected as a
charge to accumulated other comprehensive income (loss) and $59,600,000 and
$17,800,000, respectively, was reflected as accrued pension cost.
The Company funded and distributed the benefits of WilTel's supplemental
employee retirement plan in 2008 and recognized a settlement loss of $1,900,000.
At December 31, 2007, the Company had classified the anticipated distribution
($3,900,000) as a current liability.
Employer contributions expected to be paid to the WilTel plan in 2009 are
$4,200,000.
Pension expense for the WilTel plans charged to results of continuing operations
included the following components (in thousands):
2008 2007 2006
---- ---- ----
Interest cost $ 10,492 $ 10,163 $ 9,856
Expected return on plan assets (9,177) (9,363) (6,954)
Actuarial loss 110 1,136 1,579
---------- ---------- ----------
Net pension expense $ 1,425 $ 1,936 $ 4,481
========== ========== ==========
At December 31, 2008, the plans' assets consisted of equity securities (43%),
debt securities (51%) and cash equivalents (6%). At December 31, 2007, the
plans' assets consisted of equity securities (58%), debt securities (39%) and
cash equivalents (3%). Historically, the investment objectives of the plans have
emphasized long-term capital appreciation as a primary source of return and
current income as a supplementary source. However, the Company is reviewing the
target allocations and investment objectives of the plan, which currently are as
follows:
F-38
Target
------
Equity securities:
Large cap stocks 25%
Small cap stocks 4%
International stocks 11%
-----
Total equity securities 40%
Fixed income/bonds 60%
-----
Total 100%
=====
Investment performance objectives are based upon a benchmark index or mix of
indices over a market cycle. The investment strategy designates certain
investment restrictions for domestic equities, international equities and fixed
income securities. These restrictions include the following:
o For domestic equities, there will generally be no more than 5% of any
manager's portfolio at market in any one company and no more than 150% of
any one sector of the appropriate index for any manager's portfolio.
Restrictions are also designated on outstanding market value of any one
company at 5% for large to medium equities and 8% for small to medium
equities.
o For international equities, there will be no more than 8% in any one
company in a manager's portfolio, no fewer than three countries in a
manager's portfolio, no more than 10% of the portfolio in countries not
represented in the EAFE index, no more than 150% of any one sector of the
appropriate index and no currency hedging is permitted.
o Fixed income securities will all be rated BBB- or better at the time of
purchase, there will be no more than 8% at market in any one security (U.S.
government and agency positions excluded), no more than a 30-year maturity
in any one security and investments in standard collateralized mortgage
obligations are limited to securities that are currently paying interest,
receiving principal, do not contain leverage and are limited to 10% of the
market value of the portfolio.
To develop the assumption for the expected long-term rate of return on plan
assets, the Company considered the following underlying assumptions: 2.5%
current expected inflation, 1.5% real rate of return for short duration
risk-free investments, .2% inflation risk premium, .6% default risk premium for
the portion of the portfolio invested in corporate bonds, and 3.2% to 3.6% in
equity risk premium (depending on asset class) in excess of short duration
corporate bond returns. The Company then weighted these assumptions by the
long-term target allocations and assumed that investment expenses were offset by
expected returns in excess of benchmarks, which resulted in the selection of the
6.85% expected long-term rate of return assumption for 2008.
At December 31, 2008 and 2007, the accumulated other comprehensive income (loss)
relating to WilTel's plans that has not yet been recognized in net periodic
benefit cost consists of cumulative losses of $49,900,000 and $7,100,000,
respectively.
Changes in plan assets and benefit obligations recognized in other comprehensive
income (loss) related to WilTel's pension plans for the years ended December 31,
2008 and 2007 are as follows (in thousands):
2008 2007
---- ----
Net gain (loss) arising during period $ (44,873) $ 16,064
Recognition of amortization of actuarial loss in
net periodic benefit cost 2,048 1,135
---------- ----------
Total $ (42,825) $ 17,199
========== ==========
The estimated net loss for the defined benefit pension plan that will be
amortized from accumulated other comprehensive income (loss) into net periodic
benefit cost in 2009 is $2,700,000.
F-39
The measurement date for WilTel's plans is December 31. The assumptions used for
2008 and 2007 are as follows:
Pension Benefits
--------------------
2008 2007
---- ----
Weighted-average assumptions used to determine benefit
obligation at December 31,:
Discount rate 6.20% 6.30%
Weighted-average assumptions used to determine
net cost for the period ended December 31,:
Discount rate 6.30% 5.70%
Expected long-term return on plan assets 6.85% 7.50%
The timing of expected future benefit payments was used in conjunction with the
Citigroup Pension Discount Curve to develop a discount rate that is
representative of the high quality corporate bond market.
The following pension benefit payments are expected to be paid (in thousands):
2009 $ 3,371
2010 2,872
2011 3,607
2012 3,929
2013 4,550
2014 - 2018 43,566
The Company and its consolidated subsidiaries have defined contribution pension
plans covering certain employees. Contributions and costs are a percent of each
covered employee's salary. Amounts charged to expense related to such plans were
$3,700,000, $2,900,000 and $2,000,000 for the years ended December 31, 2008,
2007 and 2006, respectively.
19. Commitments and Contingencies:
-----------------------------
The Company and its subsidiaries rent office space and office equipment under
noncancellable operating leases with terms varying principally from one to
thirty years. Rental expense (net of sublease rental income) was $21,900,000 in
2008, $12,900,000 in 2007 and $5,700,000 in 2006. Future minimum annual rentals
(exclusive of month-to-month leases, real estate taxes, maintenance and certain
other charges) under these leases at December 31, 2008 are as follows (in
thousands):
2009 $ 15,978
2010 13,401
2011 12,727
2012 11,923
2013 9,866
Thereafter 86,861
---------
150,756
Less: sublease income (1,393)
---------
$ 149,363
=========
In connection with the sale of certain subsidiaries and certain non-recourse
financings, the Company has made or guaranteed the accuracy of certain
representations. No material loss is expected in connection with such matters.
F-40
Pursuant to an agreement that was entered into before the Company sold CDS to
HomeFed in 2002, the Company agreed to obtain project improvement bonds for the
San Elijo Hills project. These bonds, which are for the benefit of the City of
San Marcos, California and other government agencies, are required prior to the
commencement of any development at the project. CDS is responsible for paying
all third party fees related to obtaining the bonds. Should the City or others
draw on the bonds for any reason, CDS and one of its subsidiaries would be
obligated to reimburse the Company for the amount drawn. At December 31, 2008,
$5,000,000 was outstanding under these bonds, $1,800,000 of which expires in
2009 and the remainder thereafter.
As more fully discussed in Note 4, CLC has entered into an agreement with third
party lenders consisting of a ten year senior secured credit facility of up to
$240,000,000 and a senior secured bridge credit facility of up to
(euro)69,000,000. The Company has guaranteed 30% of the obligations outstanding
under both facilities until completion of the project as defined in the project
financing agreement. At December 31, 2008, approximately $215,000,000 was
outstanding under the senior secured credit facility and (euro)47,000,000 was
outstanding under the senior secured bridge credit facility; as a result, the
Company's outstanding guaranty at that date was $64,500,000 and (euro)14,100,000
($18,100,000 at exchange rates in effect on February 20, 2009), respectively.
There is no more borrowing capacity under either facility. The Company and Inmet
have also committed to provide financing to CLC which is currently estimated to
be (euro)340,000,000 ($436,100,000 at exchange rates in effect on February 20,
2009), of which the Company's share will be 30% ((euro)77,600,000 of which has
been loaned as of December 31, 2008).
The former holders of the Premier Notes argued that they were entitled to
liquidated damages under the indenture governing the Premier Notes, and as such
are entitled to more than the principal amount of the notes plus accrued
interest that was paid to them at emergence. Although the Company does not agree
with the position taken by the Premier noteholders, in order to have Premier's
bankruptcy plan confirmed so that Premier could complete reconstruction of its
property and open its business without further delay, the Company agreed to fund
an escrow account to cover the Premier noteholders' claim for additional damages
in the amount of $13,700,000, and a second escrow account for the trustee's
reasonable legal fees and expenses in the amount of $1,000,000. Entitlement to
the escrows has yet to be determined by the bankruptcy court as an appeal to the
plan confirmation was filed by certain of the Premier noteholders. A hearing on
the appeal was held on February 2, 2009 before the United States Court of
Appeals for the Fifth Circuit; a decision on the appeal may be made within 60
days. The Company believes it is probable that the court will approve payment of
legal fees and expenses and has fully reserved for that contingency. The Company
believes it is reasonably possible that the bankruptcy court will find in favor
of the Premier noteholders with respect to the additional damages escrow;
however, any potential loss can not be reasonably estimated. Accordingly, the
Company has not accrued a loss for the additional damages contingency.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino, which was
a facility built on floating barges, and caused significant damage to the hotel
and related structures. The new casino was constructed over water on concrete
pilings that greatly improved the structural integrity of the facility; however,
the threat of hurricanes remains a risk to the repaired and rebuilt facilities.
Premier's current insurance policy provides up to $253,000,000 in coverage for
damage to real and personal property including business interruption coverage.
The coverage is led by Lloyds of London and is comprised of a $50,000,000
primary layer and five excess layers. The coverage is syndicated through several
insurance carriers, each with an A.M. Best Rating of A- (Excellent) or better.
Although the insurance policy is an all risk policy, any loss resulting from a
weather catastrophe occurrence, which is defined to include damage caused by a
named storm, is sublimited to $100,000,000 with a deductible of $5,000,000.
20. Litigation:
----------
The Company and its subsidiaries are parties to legal proceedings that are
considered to be either ordinary, routine litigation incidental to their
business or not material to the Company's consolidated financial position. The
Company does not believe that any of the foregoing actions will have a material
adverse effect on its consolidated financial position or liquidity, but any
amounts paid could be material to results of operations for the period.
F-41
IDT Telecom, Inc. and Union Telecard Alliance, LLC filed a federal court action
pending in the District of New Jersey entitled, IDT Telecom and Union Telecard
Alliance, LLC v. CVT Prepaid Solutions, Inc., et al., alleging that STi Prepaid
unlawfully violated the consumer protection laws of several states as a result
of their alleged participation in allegedly fraudulent marketing activities of
the Telco Group, from which STi Prepaid acquired the assets of the business now
conducted by STi Prepaid, as well as alleging that STi Prepaid's current
business practices violate the federal Lanham Act and consumer protection laws.
Plaintiffs are seeking equitable relief and monetary damages in an unspecified
amount from STi Prepaid for allegedly wrongful conduct from March 8, 2007 (the
date STi Prepaid commenced business operations), as well as on a theory of
successor liability for the conduct of the Telco Group prior to March 8, 2007.
The trial is currently scheduled to commence on April 21, 2009. The Company
believes that the material allegations of the complaint are without merit and
intends to defend the action vigorously. The Company believes that it is
reasonably possible that a loss that could be material could be incurred;
however, any potential loss can not be reasonably estimated.
Additionally, three purported class actions arising out of similar conduct are
also currently pending against STi Prepaid: Soto v. STi Prepaid, LLC et al.;
Adighibe et al. v. Telco Group, Inc. et al; Ramirez et al. v. STi Prepaid, LLC
et al. (where the Company is also a defendant). The Company believes that the
material allegations in these actions are without merit and intends to defend
these actions vigorously. The Company believes that it is reasonably possible
that a loss that could be material could be incurred; however, any potential
loss can not be reasonably estimated.
21. Earnings (Loss) Per Common Share:
--------------------------------
For the year ended December 31, 2008, the numerators for basic and diluted per
share computations for loss from continuing operations were $2,579,300,000. For
the year ended December 31, 2007, the numerators for basic and diluted per share
computations for income from continuing operations were $480,800,000 and
$489,600,000, respectively. For the year ended December 31, 2006, the numerators
for basic and diluted per share computations for income from continuing
operations were $129,800,000 and $138,600,000, respectively. The calculations
for diluted earnings (loss) per share assumes the 3 3/4% Convertible Notes had
been converted into common shares for the periods they were outstanding and
earnings increased for the interest on such notes, net of the income tax effect,
unless the effect is antidilutive.
The denominators for basic per share computations were 230,494,000, 218,361,000
and 216,233,000 for 2008, 2007 and 2006, respectively. For 2008, 1,209,000
options and warrants and 14,429,000 shares related to the 3 3/4% Convertible
Notes were not included in the computation of diluted loss per share as the
effect was antidilutive. The denominators for diluted per share computations
reflect the dilutive effect of 1,053,000 and 412,000 options and warrants for
2007 and 2006, respectively (the treasury stock method was used for these
calculations), and 15,239,000 shares for each of 2007 and 2006 related to the
3 3/4% Convertible Notes.
22. Fair Value of Financial Instruments:
-----------------------------------
Aggregate information concerning assets and liabilities at December 31, 2008
that are measured at fair value on a recurring basis is presented below (dollars
in thousands):
Fair Value Measurements Using (d)
------------------------------------------
Quoted Prices in
Active Markets for
Identical Assets or Significant Other
Total Fair Value Liabilities Observable Inputs
Measurements (Level 1) (Level 2)
----------------- ------------------ -----------------
Current investments :
Investments available for sale $ 362,628 $ 329,317 $ 33,311
Non-current investments:
Investments available for sale 859,122 564,903 294,219
Investments in associated companies (a) 933,057 933,057 --
------------- ------------- ----------
Total $ 2,154,807 $ 1,827,277 $ 327,530
============= ============= ==========
Other current liabilities (b) $ (259) $ (259) $ --
Other non-current liabilities (c) (13,132) -- (13,132)
------------- ------------- ----------
Total $ (13,391) $ (259) $ (13,132)
============= ============= ==========
F-42
(a) During the year ended December 31, 2008, changes in fair value of
$(266,500,000) are reflected in income (losses) related to associated
companies in the consolidated statements of operations. This is the
aggregate change in the fair values of ACF and Jefferies, the only eligible
items identified in SFAS 159 for which the Company has elected the fair
value option.
(b) During the year ended December 31, 2008, changes in fair value of $100,000
are reflected in net securities gains (losses) in the consolidated
statements of operations.
(c) Comprised of currency swap and interest rate swap derivative financial
instruments. During the year ended December 31, 2008, changes in fair value
of $(6,400,000) are reflected in investment and other income in the
consolidated statements of operations.
(d) At December 31, 2008, the Company did not have material fair value
measurements using unobservable inputs (Level 3).
The following table presents fair value information about certain financial
instruments, whether or not recognized on the balance sheet. Fair values are
determined as described below. These techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. The fair value amounts presented do not purport to represent and should
not be considered representative of the underlying "market" or franchise value
of the Company. The methods and assumptions used to estimate the fair values of
each class of the financial instruments described below are as follows:
(a) Investments: The fair values of marketable equity securities, fixed maturity
securities and investments held for trading purposes (which include securities
sold not owned) are substantially based on quoted market prices, as disclosed in
Note 6. The fair value of the Company's investment in the Inmet common shares,
all of which are restricted as discussed in Note 6, is based on quoted market
prices. The fair values of the Company's other securities that are accounted for
under the cost method (aggregating $168,900,000 and $117,600,000 at December 31,
2008 and 2007, respectively) were not practicable to estimate; the fair values
were assumed to be the carrying amount.
(b) Cash and cash equivalents: For cash equivalents, the carrying amount
approximates fair value.
(c) Notes receivables: The fair values of variable rate notes receivable are
estimated to be the carrying amount. The fair value of fixed rate convertible
debt is based on the market value of the common stock that would be received
assuming conversion.
(d) Long-term and other indebtedness: The fair values of non-variable rate debt
are estimated using quoted market prices and estimated rates that would be
available to the Company for debt with similar terms. The fair value of variable
rate debt is estimated to be the carrying amount.
(e) Swap agreements: The fair values of the interest rate swap and currency rate
swap agreements are based on rates currently available for similar agreements.
The carrying amounts and estimated fair values of the Company's financial
instruments at December 31, 2008 and 2007 are as follows (in thousands):
F-43
2008 2007
------------------------------- ------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ -------- ---------- ----------
Financial Assets:
Investments:
Current $ 366,464 $ 366,464 $ 983,199 $ 983,199
Non-current 1,028,012 1,028,012 2,776,521 3,150,321
Cash and cash equivalents 237,503 237,503 456,970 456,970
Notes receivable:
Current 65 65 2,053 2,053
Non-current 6,100 7,129 200 200
Financial Liabilities:
Debt:
Current 248,713 248,716 132,405 133,364
Non-current 1,832,743 1,459,892 2,004,145 2,398,592
Securities sold not owned 259 259 2,603 2,603
Swap agreements:
Interest rate swaps (11,708) (11,708) (5,380) (5,380)
Foreign currency swaps (1,424) (1,424) (2,862) (2,862)
23. Segment Information:
-------------------
The Company's reportable segments consist of its operating units, which offer
different products and services and are managed separately. Idaho Timber
primarily remanufactures, manufactures and/or distributes wood products. Conwed
Plastics manufactures and markets lightweight plastic netting used for a variety
of purposes. The Company's telecommunications segment is conducted through STi
Prepaid, a provider of international prepaid phone cards and other
telecommunication services in the U.S. The property management and services
business is conducted through ResortQuest, which offers management services to
vacation properties in beach and mountain resort locations in the continental
United States, as well as real estate brokerage services and other rental and
property owner services. The Company's gaming entertainment segment is conducted
through Premier, which owns the Hard Rock Biloxi. The Company's domestic real
estate operations consist of a variety of commercial properties, residential
land development projects and other unimproved land, all in various stages of
development. The Company's medical product development segment is conducted
through Sangart. Other operations primarily consist of the Company's wineries
and energy projects.
At acquisition in 2006, the Company's investment in Premier was reported as a
consolidated subsidiary in the other operations segment; however, it was
deconsolidated and classified as an investment in an associated company upon its
filing of voluntary petitions for reorganization under chapter 11 of title 11 of
the United States Bankruptcy Code in September 2006. While in bankruptcy,
Premier was classified as an investment in an associated company and its
operating results were not reported as the gaming entertainment segment. Upon
its emergence from bankruptcy in August 2007, Premier was once again
consolidated by the Company and has been reported as an operating segment since
that date.
Associated companies include equity interests in other entities that the Company
accounts for on the equity method of accounting. Investments in associated
companies that are accounted for under the equity method of accounting include
HomeFed, JHYH, Goober Drilling and CLC. At December 31, 2008, the Company has
non-controlling investments in entities that are engaged in investing and/or
securities transactions activities which are accounted for on the equity method
of accounting including Pershing Square, Shortplus, EagleRock and Wintergreen.
Associated companies also include the Company's investments in ACF and
Jefferies, which are accounted for at fair value rather than the equity method
of accounting.
F-44
Corporate assets primarily consist of investments and cash and cash equivalents
and corporate revenues primarily consist of investment and other income and
securities gains and losses. Corporate assets include the Company's investment
in Fortescue. Corporate assets, revenues, overhead expenses and interest expense
are not allocated to the operating units.
Conwed Plastics has manufacturing facilities located in Belgium and Mexico and
STi Prepaid has a customer care unit located in the Dominican Republic. These
are the only foreign operations with non-U.S. revenue or assets that the Company
consolidates, and are not material. Unconsolidated non-U.S. based investments
include 38% of Light and Power Holdings Ltd., the parent company of the
principal electric utility in Barbados, a small Caribbean-based
telecommunications provider, the 30% ownership interest in CLC and the
investments in Fortescue and Inmet. From time to time the Company invests in the
securities of non-U.S. entities or in investment partnerships that invest in
non-U.S. securities.
Certain information concerning the Company's segments is presented in the
following table. Consolidated subsidiaries are reflected as of the date of
acquisition, which was June 2007 for ResortQuest and March 2007 for STi Prepaid.
As discussed above, Premier is reflected as a consolidated subsidiary from May
2006 until it was deconsolidated in September 2006; Premier once again became a
consolidated subsidiary in August 2007. Associated Companies are only reflected
in the table below under identifiable assets employed.
F-45
2008 2007 2006
---- ---- ----
(In millions)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 235.3 $ 292.2 $ 345.7
Conwed Plastics 106.0 105.4 106.4
Telecommunications 452.4 363.2 --
Property Management and Services 142.0 81.5 --
Gaming Entertainment 119.1 38.5 --
Domestic Real Estate 15.1 13.4 86.7
Medical Product Development .7 2.1 .7
Other Operations (b) 53.4 53.6 42.8
Corporate (c) (43.3) 205.0 280.4
--------- --------- ---------
Total consolidated revenues and other income $ 1,080.7 $ 1,154.9 $ 862.7
========= ========= =========
Income (loss) from continuing operations before income taxes and income (losses)
related to associated companies:
Manufacturing:
Idaho Timber $ .8 $ 9.1 $ 12.0
Conwed Plastics 14.0 17.4 17.9
Telecommunications 11.9 18.4 --
Property Management and Services (1.9) (6.5) --
Gaming Entertainment 1.0 (9.3) --
Domestic Real Estate (14.4) (8.2) 44.0
Medical Product Development (32.3) (31.5) (21.1)
Other Operations (b) (41.6) (17.2) (14.4)
Corporate (c) (304.1) (29.3) 95.4
--------- --------- ---------
Total consolidated income (loss) from continuing operations before income
taxes and income (losses) related to associated companies $ (366.6) $ (57.1) $ 133.8
========= ========= =========
Identifiable assets employed:
Manufacturing:
Idaho Timber $ 118.3 $ 129.5 $ 132.3
Conwed Plastics 78.5 88.8 83.6
Telecommunications 107.7 81.9 --
Property Management and Services 55.2 62.8 --
Gaming Entertainment 281.6 300.6 --
Domestic Real Estate 409.7 306.3 198.1
Medical Product Development 21.2 36.5 12.2
Other Operations 290.1 255.5 257.8
Investments in Associated Companies 2,006.6 1,362.9 773.0
Corporate (d) 1,829.6 5,501.8 3,846.8
--------- --------- ---------
Total consolidated assets $ 5,198.5 $ 8,126.6 $ 5,303.8
========= ========= =========
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains (losses) in the
Company's consolidated statements of operations.
(b) Other operations includes pre-tax losses of $33,600,000, $12,500,000 and
$8,300,00 for the years ended December 31, 2008, 2007 and 2006,
respectively, for investigation and evaluation of various energy related
projects. There were no material operating revenues or identifiable assets
associated with these activities in any period; however, other income
includes $8,500,000 in 2007 related to the termination of a joint
development agreement with another party.
F-46
(c) Net securities gains (losses) for Corporate aggregated $(144,500,000),
$92,700,000 and $116,600,000 during 2008, 2007 and 2006, respectively.
Corporate net securities gains (losses) are net of impairment charges of
$143,400,000, $36,800,000 and $12,900,000 during 2008, 2007 and 2006,
respectively. The impaired securities include the Company's investment in
various debt and equity securities and in 2008 reflect the significant
decline in value of worldwide securities markets during 2008. The
impairment charges result from declines in fair values of securities
believed to be other than temporary, principally for securities classified
as available for sale securities. In 2007, security gains include a gain of
$37,800,000 from the sale of Eastman Chemical Company. In 2006, security
gains include a gain of $37,400,000 from the sale of 115,000,000 common
shares of Level 3, which were received in December 2005 in connection with
Level 3's purchase of WilTel.
(d) As more fully discussed above, during 2008 the Company increased its
deferred tax valuation allowance by $1,672,100,000 to reserve for
substantially all of the net deferred tax asset.
(e) For the years ended December 31, 2008, 2007 and 2006, income (loss) from
continuing operations reflects depreciation and amortization expenses of
$77,300,000, $54,200,000 and $39,500,000, respectively; such amounts are
primarily comprised of Corporate ($20,400,000, $12,700,000 and $11,600,000,
respectively), manufacturing ($17,300,000, $18,000,000 and $17,500,000,
respectively), gaming entertainment ($17,000,000, $6,300,000 and $900,000,
respectively), domestic real estate ($7,600,000, $3,800,000 and $3,300,000,
respectively), property management and services ($4,600,000 and $3,100,000
in 2008 and 2007, respectively) and other operations ($8,300,000,
$9,000,000 and $5,600,000, respectively). Depreciation and amortization
expenses for other segments are not material.
(f) For the years ended December 31, 2008, 2007 and 2006, income (loss) from
continuing operations reflects interest expense of $145,500,000,
$111,500,000 and $79,400,000, respectively; such amounts are primarily
comprised of Corporate ($140,000,000, $110,800,000 and $70,900,000,
respectively), domestic real estate ($4,400,000 in 2008) and gaming
entertainment ($900,000, $500,000 and $8,000,000, respectively). Interest
expense for other segments is not material.
F-47
24. Selected Quarterly Financial Data (Unaudited):
---------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2008
----
Revenues and other income $ 324,849 $ 337,554 $ 251,616 $ 166,634
========== =========== =========== ===========
Income (loss) from continuing operations $ (95,824) $ 186,778 $ 89,462 $(2,759,727)
========== =========== =========== ===========
Income from discontinued operations, net of taxes $ -- $ -- $ -- $ 44,904
========== =========== =========== ===========
Loss on disposal of discontinued operations, net of taxes $ -- $ -- $ -- $ (1,018)
========== =========== =========== ===========
Net income (loss) $ (95,824) $ 186,778 $ 89,462 $(2,715,841)
========== =========== =========== ===========
Basic earnings (loss) per common share:
Income (loss) from continuing operations $ (.43) $ .81 $ .38 $(11.72)
Income from discontinued operations -- -- -- .19
Loss on disposal of discontinued operations -- -- -- --
------ ----- ------- -------
Net income (loss) $ (.43) $ .81 $ .38 $(11.53)
====== ===== ======= =======
Number of shares used in calculation 222,584 230,235 232,849 235,521
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income (loss) from continuing operations $ (.43) $ .76 $ .37 $(11.72)
Income from discontinued operations -- -- -- .19
Loss on disposal of discontinued operations -- -- -- --
------ ----- ------ -------
Net income (loss) $ (.43) $ .76 $ .37 $(11.53)
====== ===== ====== =======
Number of shares used in calculation 222,584 247,234 249,452 235,521
======= ======= ======= =======
2007
----
Revenues and other income $ 197,185 $ 344,004 $ 331,149 $ 282,557
========== =========== =========== ===========
Income from continuing operations $ 7,861 $ 26,315 $ 2,087 $ 444,545
========== =========== =========== ===========
Income (loss) from discontinued operations, net of taxes $ 222 $ (13) $ 98 $ (148)
========== =========== =========== ===========
Gain (loss) on disposal of discontinued operations, net of taxes $ 291 $ (3) $ 1,703 $ 1,336
========== =========== =========== ===========
Net income $ 8,374 $ 26,299 $ 3,888 $ 445,733
========== =========== =========== ===========
Basic earnings (loss) per common share:
Income from continuing operations $ .04 $ .12 $ .01 $ 2.00
Income (loss) from discontinued operations -- -- -- --
Gain (loss) on disposal of discontinued operations -- -- .01 --
------ ------ ------ ------
Net income $ .04 $ .12 $ .02 $ 2.00
====== ====== ====== ======
Number of shares used in calculation 216,409 216,596 218,071 222,494
======= ======= ======= =======
Diluted earnings (loss) per common share:
Income from continuing operations $ .04 $ .12 $ .01 $ 1.87
Income (loss) from discontinued operations -- -- -- --
Gain (loss) on disposal of discontinued operations -- -- .01 --
------ ------ ------ ------
Net income $ .04 $ .12 $ .02 $ 1.87
====== ====== ====== ======
Number of shares used in calculation 216,779 217,229 219,411 239,483
======= ======= ======= =======
Income (loss) from continuing operations includes a charge to income tax expense
in the fourth quarter of 2008 in order to reserve for substantially all of the
net deferred tax asset. Income (loss) from continuing operations includes a
credit to income tax expense of $222,200,000 in the second quarter of 2008 and
$542,700,000 in the fourth quarter of 2007, resulting from the reversal of a
portion of the deferred tax valuation allowance. Income (loss) from continuing
operations also includes a credit to income tax expense of $12,500,000 in the
second quarter of 2008, resulting from the recognition of additional state and
local net operating loss carryforwards. See Note 2 for more information.
In 2008 and 2007, the totals of quarterly per share amounts do not equal annual
per share amounts because of changes in outstanding shares during the year.
F-48
Schedule II - Valuation and Qualifying Accounts
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
For the years ended December 31, 2008, 2007 and 2006
(In thousands)
Additions Deductions
--------------------------------------- ---------------------------------------------
Charged
Balance at to Costs Balance
Beginning and Write Sale of at End
Description of Period Expenses Recoveries Other Offs Receivables Other of Period
----------- --------- -------- ---------- ----- ----- ------------ ----- ---------
2008
----
Allowance for
doubtful accounts $ 2,079 $ 2,386 $ 355 $ -- $ 1,088 $ -- $ -- $ 3,732
========== ========== ======== ========== ========= ======= =========== ==========
Deferred tax asset
valuation allowance $ 299,775 $1,672,138(a) $ -- $ 335,368(b) $ -- $ -- $ -- $2,307,281
========== ========== ======== ========== ========= ======= =========== ==========
2007
----
Allowance for
doubtful accounts $ 1,773 $ 566 $ 147 $ -- $ 407 $ -- $ -- $ 2,079
========== ========== ======== ========== ========= ======== =========== ==========
Deferred tax asset
valuation allowance $ 911,777 $ -- $ -- $ 29,311(c) $ -- $ -- $ 641,313(d) $ 299,775
========== ========== ======== ========== ========= ======= =========== ==========
2006
----
Allowance for
doubtful accounts $ 15,432 $ 1,089 $ 194 $ -- $ 6,525 $ 8,417 $ -- $ 1,773
========== ========== ======== ========== ========= ======= =========== ==========
Deferred tax asset
valuation allowance $ 804,829 $ -- $ -- $ 106,948(e) $ -- $ -- $ -- $ 911,777
========== ========== ======== ========== ========= ======= ========== ==========
(a) During 2008 the Company concluded that a valuation allowance was
required against substantially all of the net deferred tax asset, and
increased its valuation allowance by $1,672,100,000 with a
corresponding charge to income tax expense. See Note 2 of Notes to
Consolidated Financial Statements for more information.
(b) Represents the tax effect of losses during 2008, which were reserved
for in the deferred tax asset valuation allowance.
(c) In connection with the filing of the 2006 income tax return and with a
subsidiary joining the Company's consolidated income tax return during
2007, additional deferred tax assets were recognized but were fully
reserved.
(d) During 2007, the Company's revised projections of future taxable income
enabled it to conclude that it was more likely than not that it will
have future taxable income sufficient to realize a portion of the
Company's net deferred tax asset; accordingly, $542,700,000 of the
deferred tax valuation allowance was reversed as a credit to income tax
expense. Also reflects the allocation of the purchase price for STi
Prepaid in the amount of $98,600,000.
(e) The increase in the valuation allowance is principally due to the
utilization of previously unrecognized capital losses in the Company's
2005 federal income tax return, which resulted in a larger NOL than
previously estimated.
(f) Amounts in the schedule include activity related to discontinued
operations.
F-49