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ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL SUMMARY - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
See the information under the caption "Management's Discussion and Analysis" on pages 24-35.
ITEM 8. | 315189 | 1993 |
Item 6. Selected Financial Data
Starrett Housing Corporation and Subsidiaries
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
1993 Compared to 1992
During the year ended December 31, 1993 the Company had income from operations of $2,140,000 ($.34 per share) compared to $284,000 ($.04 per share) for the year ended December 31, 1992. In addition, during the year ended December 31, 1992, the Company reported an extraordinary gain net of tax of $824,000 and an accounting change of $1,287,000 or $.13 and $.20 per share, respectively, which when combined with the income from operations increased net income to $2,395,000 ($.37 per share). Earnings per share were based on average shares outstanding of 6,356,000 and 6,417,000 in 1993 and 1992, respectively.
The Company's revenues increased $10,327,000 compared with the similar period in 1992. This increase was primarily attributable to an increase in revenues from the Company's Levitt division resulting from an increase in the number of houses delivered in the Company's Puerto Rico region. The increase in revenues from Levitt was offset by a decrease in revenues in the Company's development and construction management divisions in 1993. In 1992 revenues also included Levitt's Joint Venture share of the gain on the sale of a rental apartment project. Levitt's backlog of homes contracted for sale at December 31, 1993 was $32,320,000 compared to $33,765,000 at December 31, 1992. The backlog at February 28, 1994 was $63,179,000 as compared to $42,943,000 at February 28, 1993.
General and administrative expenses (which were reduced for all divisions other than Grenadier which showed an overhead increase for the year) declined by $3,044,000 in 1993 following a $2,200,000 reduction in 1992 as a result of continuing cost reduction programs. Interest expense decreased by $655,000 for 1993 as compared to 1992 primarily as a result of both a decrease in borrowings and a decline in interest rates.
Levitt's interest, real estate taxes and sales costs incurred with certain properties are capitalized in order to achieve better matching of costs with revenues. The Company's interest incurred on loans was $3,893,000 in 1993 and $5,964,000 in 1992, of which $2,959,000 in 1993 and $4,150,000 in 1992 was capitalized by Levitt in its operations. Levitt amortized capitalized interest of $5,802,000 in 1993 and $5,177,000 in 1992 to construction and related costs.
HRH's estimated backlog of fees for development work and uncompleted construction in connection with construction projects, including fees for projects where development work has begun but contracts have not yet been executed, was $8,151,000 at December 31, 1993 as compared to $8,158,000 and $9,409,000 at the end of 1992 and 1991, respectively. HRH is actively seeking to increase its backlog of business, particularly in the governmental and institutional sectors, while at the same time continuing to reduce its overhead (overhead was reduced 21%, 25% and 20% in 1993, 1992 and 1991, respectively) to reflect the lower level of business activity.
Grenadier continued its steady profitability in 1993 and has expanded its management services to private owners and institutional property owners as well as banks and thrift institutions.
The Company has three projects located on the Upper West Side of Manhattan, in which it has a 50% residual partnership interest, with respect to which the Company has made application for incentives under the Low Income Housing Preservation and Resident Homeownership Act ("LIHPRHA"). On April 28, 1993, HUD provided the Partnership with a Value Determination Letter for the first of its projects establishing a substantial value for the project, and in August and October 1993 HUD provided technical comments on the Plan of Action necessary to complete the processing. HUD has notified the Company that it is reversing its prior Value Determination and consequently will require the Partnership to reprocess the project, using a different formula for valuation, presently being developed by HUD. Under HUD's revised formula, the project may have a substantially diminished value. The Company disagrees with the reversal of HUD's prior Value Determination position, has so notified HUD and discussions are in process regarding this matter. In light of the foregoing, the amount of cash proceeds and profits, if any, the Company could receive for its 50% residual interest in the project as well as the time required to complete the processing is uncertain. The revised HUD position also affects processing under LIHPRHA for the two similar projects in which the Company owns a 50% residual interest located on the Upper West Side of Manhattan. If sustained, the revised HUD position will affect all New York projects of a similar nature. See "Business - Ownership of Partnership Interests," page 6.
1992 Compared to 1991
During the year ended December 31, 1992 the Company had net income of $2,395,000 ($.37 per share) as compared with $1,384,000 ($.21 per share) in 1991. The accounting change and the extraordinary item described below added $1,287,000 and $824,000 or $.20 and $.13 per share, respectively, to net income for the year ended December 31, 1992. Earnings per share were based on average shares outstanding of 6,417,000 for 1992 and 6,495,000 for 1991.
Effective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes, which requires the Company to adjust deferred taxes for the temporary differences between the tax bases of its assets and liabilities and the amounts reported in the financial statements at enacted statutory tax rates.
In September 1992, the Company repurchased a $2,600,000 outstanding mortgage loan (including accrued interest) for approximately $1,300,000, including transaction costs. The extraordinary gain, net of income tax effect, was $824,000.
In October 1992, Roosevelt Island Associates ("RIA"), a partnership in which a Company subsidiary is one of several partners, defaulted on its mortgage payment obligations to the New York City Housing Development Corporation. The default was cured on January 15, 1993, by RIA entering into a bond refunding transaction with respect to its FHA insured $157,500,000 mortgage loan. This transaction resulted in an interest rate reduction to approximately 6.66%, from a prior rate of approximately 9.7%. The refinancing reduced RIA's debt service by $4,200,000 annually, thereby substantially reducing RIA's operating deficits which the Company, as a joint venture partner, has a continuing obligation to fund. As part of the refunding transaction, the Company provided cash flow guarantees to the investor partner.
HRH reported a small profit for 1992. Its fee backlog decreased to $8,158,000 at December 31, 1992 as compared with $9,409,000 at the end of 1991.
The Company's development activities also contributed to profits during 1992 with the recognition of $1,000,000 of income from its Livingston Plaza project, and the successful development, construction and sale by its Levitt division of a rental apartment project to a major institutional investor at a $1,800,000 profit.
Grenadier continued its steady profitability in 1992. Grenadier is now providing management services to private owners and to institutional property owners as well as banks and thrift institutions.
The Company's Levitt subsidiary reported income before taxes for 1992 of $864,000 as compared with a loss before taxes of $4,575,000 in 1991. The income in 1992 was before giving effect to the extraordinary gain on the repurchase of debt or the accounting change previously described. Sales in Puerto Rico increased to $48,616,000 for the year compared with $35,598,000 in 1991 and Levitt's company-wide backlog was $33,765,000 at December 31, 1992 compared with $27,043,000 for 1991. Domestically, Levitt's profitability was adversely affected by slow sales in certain of its projects. Levitt continued with its aggressive land disposition program, and in 1993 largely completed the liquidation of certain of its domestic land positions by selling and building homes at reduced prices. As a result of this program, in 1992 the Company increased its non-cash reserve by $1,810,000 to reduce the carrying value of its real estate inventory to its estimated net realizable value.
Revenues increased $766,000 for the year 1992 compared with the similar period in 1991 as a result of an increase in revenues from Levitt of $10,327,000, offset principally by a decrease in revenues recognized upon the completion of a large project, Livingston Plaza in 1991, which was built and sold to The New York City Transit Authority, as well as a decrease in revenues of the Company's HRH division.
General and administrative expenses (which were reduced for all divisions other than Grenadier which showed an overhead increase for the year) were reduced $2,200,000 in 1992 following a $3,000,000 reduction in 1991 as a result of continuing cost reduction programs. Interest expense decreased by $1,000,000 for 1992 as compared to 1991 primarily as a result of both a decrease in borrowings and a decline in interest rates.
Levitt's interest, real estate taxes and sales costs incurred with certain properties are capitalized in order to achieve better matching of costs with revenues. The Company's interest incurred on loans was $5,964,000 in 1992 and $8,264,000 in 1991, of which $4,150,000 in 1992 and $5,314,000 in 1991 was capitalized by Levitt in its operations. Levitt amortized capitalized interest of $5,177,000 in 1992 and $4,909,000 in 1991 to construction and related costs.
Cash Flow and Liquidity
While the Company presently has various banking relationships, it does not have any formal lines of credit other than in connection with its Levitt subsidiary as described below.
Levitt's business and earnings are substantially dependent on its ability to obtain financing on acceptable terms for it's activities. The Company has a $18,400,000 balance on a term loan, previously a revolving credit loan which was converted to a term loan in November 1991. As of December 31, 1993, the loan agreement provides for semi-annual principal payments of $1,000,000 in January and July in 1994 and 1995, a $3,000,000 payment in January 1996, a $1,000,000 payment in July 1996, a $3,000,000 payment in January 1997 and a final payment of $7,400,000 in July 1997.
Levitt's Puerto Rico operations are partially financed by an unsecured $15,000,000 revolving credit facility with a Puerto Rico bank. As a result of greater than anticipated house sales in Levitt's Puerto Rico Encantada planned community in 1992 and a resultant increase in capital needed to complete such homes, Levitt obtained a short-term secured loan for $6,000,000 in June 1992. This facility was repaid in full in March 1993. In September 1993, the Puerto Rico mortgage branch operations entered into a $3,000,000 revolving credit agreement, with a Puerto Rico bank to finance the warehousing of mortgage note receivables originated by the mortgage operation. As of December 31, 1993, no amount was outstanding on its warehousing line of credit.
Levitt also finances the acquisition of property for its operations on deferred payment terms provided by sellers of such property. Levitt anticipates that funds generated by operations, together with its existing credit relationships, will provide it with adequate financial resources to satisfy its operating needs and to meet its anticipated capital requirements for new projects.
The timing of introducing Levitt's new projects to the market, weather conditions in certain of Levitt's regions, and traditional periods of greater customer activity have tended to create seasonal trends in Levitt's residential home building activities. Historically, the number of homes delivered has been greater in the second half of the calendar year.
Net Operating Loss Carryforwards
At December 31, 1993 the Company had net tax operating loss carryforwards which can be utilized against future taxable income of approximately $12,957,000 expiring in 2001 through 2008. Under current tax laws, if the aggregate voting stock owned by the Company's 5% shareholders increases over the lowest percentage owned by such shareholders during a three-year period by an amount exceeding 50% of Starrett's total voting stock, then Starrett's utilization of the net tax operating loss carryforwards could be limited to an amount per year equal to the market value of all Starrett equity securities multiplied by an adjusted federal long-term interest rate. In general, all non-5% shareholders are treated as a single 5% shareholder for the purpose of such calculations. Such an ownership change might be caused by sales of shares by the Company's shareholders, repurchases of shares by the Company, certain reorganizations, or certain other transactions.
Inflation
The Company believes that inflation has not had a material adverse effect upon its construction, development and management business. Levitt has from time to time been
adversely affected by high interest costs and increases in material and labor costs which it has not been able to pass through entirely to home purchasers.
Item 8. | 93675 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Reference is made to Selected Consolidated Financial Data on pages 22 through 26 of the 1993 Annual Report to Shareholders, which section is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Reference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 27 through 63 of the 1993 Annual Report to Shareholders, which section is incorporated herein by reference.
PART II
ITEM 8. | 847322 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected consolidated financial data of the Company as of and for the years ended December 31, 1993, 1992, 1991, 1990 and 1989. This financial data was derived from the historical consolidated financial statements of the Company. The financial data reflects the elimination of all intercompany accounts, transactions and profits among the Holding Company, Dr Pepper, Seven-Up and DP/7UP. The financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the historical consolidated financial statements of the Company and the related notes thereto. See "Index to Consolidated Financial Statements and Schedules".
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS -- YEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992
Net sales for the year ended December 31, 1993 increased 7.4% to $707.4 million compared to $658.7 million for the year ended December 31, 1992. All of the Company's operating units recorded net sales increases in 1993 compared to 1992, except for the International Division which was unchanged. These sales increases were primarily the result of volume increases for the Company's DR PEPPER, Diet DR PEPPER, 7UP and I.B.C. brands over the comparable period in 1992, as well as price increases on DR PEPPER, 7UP and certain other products.
Cost of sales for 1993 decreased 8.0% to $116.0 million compared to $126.0 million in 1992. This decrease was primarily due to a decrease in sweetener costs somewhat offset by an increase in concentrate and syrup sales volume. Gross profit as a percentage of net sales increased from 80.9% in 1992 to 83.6% in 1993.
Total operating expenses, which include marketing expense, general and administrative expense and amortization of intangible assets, increased by 9.7% to $408.4 million compared to $372.1 million in 1992. The increase was primarily due to increased marketing expenses in response to improved sales volume. The Company's general and administrative expenses increased 12.8% to $30.8 million primarily as the result of higher legal costs. Excluding this increase, general and administrative expenses as a percentage of net sales would have remained at 4.1%.
The American Institute of Certified Public Accountants has recently issued Statement of Position ("SOP") 93-7 on Reporting on Advertising Costs. The SOP is effective for years beginning after June 15, 1994. The Company's adoption of the SOP is not expected to have a material effect on its operating results.
As a result of the above factors, operating profit for the year ended December 31, 1993 increased 14.0% to $183.0 million compared to $160.6 million in 1992. Operating profit as a percentage of net sales increased to 25.9% in 1993 from 24.4% in 1992.
Interest expense for 1993 decreased 43.1% to $85.6 million compared to $150.2 million in 1992. The decrease was due to the consummation of the 1992 Recapitalization and the Offering which together reduced outstanding borrowings and resulted in lower interest rates on borrowings.
Income tax expense of $2.1 million for the year ended December 31, 1993 consists of current Federal tax expense of $1.1 million, current state tax expense of $4.0 million and a deferred Federal tax benefit of $3.0 million.
In connection with the Offering, a $14.9 million extraordinary charge was recorded in 1993 which included (i) a write-off of a portion of the unamortized balance of deferred debt issuance costs related to the Credit Agreement borrowings and the Discount Notes ($6.8 million) and (ii) the premium related to the redemption of a portion of the Discount Notes ($8.1 million). In addition, a $2.0 million extraordinary charge was recorded in 1993 reflecting a write-off of a portion of the unamortized balance of deferred debt issuance costs related to the Credit Agreement borrowings. The write-off was the result of repayments of the Term Loan Facility in advance of scheduled requirements. These extraordinary items were recorded net of applicable taxes.
See the following section "Results of Operations -- Year Ended December 31, 1992 Compared to Year Ended December 31, 1991" for a discussion of income taxes, extraordinary item and cumulative effect of accounting change recorded in 1992.
As a result of the above factors, the Company earned $77.9 million of net income in 1993 compared to a $140.1 million net loss incurred in 1992.
RESULTS OF OPERATIONS -- YEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991
Net sales for the year ended December 31, 1992 increased 9.6% to $658.7 million compared to $600.9 million for the year ended December 31, 1991. All of the Company's operating units recorded sales increases in 1992 compared to 1991. These increases were primarily the result of volume increases for the Company's DR PEPPER, Diet DR PEPPER, WELCH's, 7UP, Diet 7UP, CHERRY 7UP, Diet CHERRY 7UP, and I.B.C. brands over the comparable period in 1991, as well as selected price increases.
Cost of sales for 1992 increased 6.1% to $126.0 million compared to $118.8 million in 1991. This increase was primarily due to an increase in concentrate and syrup sales volume. Gross profit as a percentage of net sales increased from 80.2% in 1991 to 80.9% in 1992.
Total operating expenses, which include marketing expense, general and administrative expense and amortization of intangible assets, increased by 8.2% to $372.1 million compared to $344.0 million in 1991. The increase was primarily due to increased marketing expenses in response to improved sales volume. General and administrative expenses as a percentage of net sales decreased to 4.1% in 1992 from 4.4% in 1991. The Company's general and administrative expenses are comprised primarily of fixed costs. As sales volumes increase, these expenses generally represent a declining percentage of net sales.
As a result of the above factors, operating profit for the year ended December 31, 1992 increased 16.2% to $160.6 million compared to $138.2 million in 1991. Operating profit as a percentage of net sales increased to 24.4% in 1992 from 23.0% in 1991.
Interest expense for 1992 increased 1.5% to $150.2 million compared to $148.0 million in 1991. The increase was due to the higher accreted value of certain subordinated debt and issuance of senior notes and term loans of Dr Pepper in August 1991, somewhat offset by lower outstanding borrowings under the credit agreement of Seven-Up and lower interest rates on the Company's floating rate borrowings.
Other expense for the year ended December 31, 1992 includes $6.0 million of costs associated with the Company's withdrawal of its planned public offering in July 1992.
Income tax expense for the year ended December 31, 1991 consists of state and local taxes and includes a charge in lieu of taxes of $1.0 million which is offset by utilization of net operating loss carryforwards.
In February 1992, the Financial Accounting Standards Board issued Statement 109, "Accounting for Income Taxes" ("Statement 109") which requires a change from the deferred method of accounting for income taxes of APB Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of Statement 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company adopted Statement 109 in the fourth quarter of 1992 and has applied the provisions of Statement 109 retroactively to January 1, 1992. The cumulative effect as of January 1, 1992 of the change in the method of accounting for income taxes is a charge to earnings of $74.8 million and has been reported separately in the 1992 consolidated statement of operations. Financial statements for periods prior to January 1, 1992 have not been restated for Statement 109.
Pursuant to the deferred method under APB Opinion 11, which was applied in 1991 and prior years, deferred income taxes are recognized for income and expense items that are reported in different years for financial reporting purposes and income tax purposes using the tax rate applicable for the year of the calculation. Under the deferred method, deferred taxes are not adjusted for subsequent changes in tax rates.
Income tax benefit of $182,000 for the year ended December 31, 1992 consists of current state tax expense of $424,000 and a deferred Federal income tax benefit of $606,000. The deferred income tax benefit includes a charge in lieu of taxes resulting from initial recognition of acquired tax benefits of $1.1 million.
In connection with the 1992 Recapitalization, the Company recorded an extraordinary charge of $56.9 million consisting of a write-off of the unamortized balance of deferred debt issuance costs related to the debt retirements ($24.6 million) and premiums and fees in respect of the debt retirements ($32.3 million).
In connection with the refinancing that occurred in 1991, an $18.6 million extraordinary charge was recorded representing incentive payments made to holders of the Dr Pepper Subordinated Debentures ($8.2 million), write-off of the unamortized balance of deferred debt issuance costs related to the credit agreement of Dr Pepper ($5.0 million) and the present value (assuming a discount rate of 12 3/4%) of the increase in the annual interest rate of the Dr Pepper Subordinated Debentures from 13 1/4% to 13 3/4% ($5.4 million).
As a result of the above factors, the Company incurred a $140.1 million net loss in 1992 as compared to a $37.5 million net loss incurred in 1991.
LIQUIDITY AND CAPITAL RESOURCES
The Company believes that cash provided by operations, together with borrowings under the Revolving Facility, will be sufficient to fund its working capital requirements, capital expenditures and principal, interest and dividend requirements described below.
As a result of the consummation of the 1992 Recapitalization, the Holding Company conducts its business through DP/7UP and the primary asset of the Holding Company is the common stock of
DP/7UP. The Holding Company has no material operations of its own. Accordingly, the Holding Company is dependent on the cash flow of DP/7UP to meet its obligations. The Holding Company has no material obligations other than those under the Discount Notes and certain contingent obligations under the Holding Company's guarantee of DP/7UP's obligations under the Credit Agreement. Accordingly, the Holding Company is not expected to have any material need for cash until interest on the Discount Notes becomes payable in cash on May 1, 1998. The Holding Company will be required to make sinking fund payments equal to 25% of the then outstanding principal amount of the Discount Notes in each of 2000 and 2001. The Discount Notes will mature in 2002. The Credit Agreement imposes significant restrictions on the payment of dividends and the making of loans by DP/7UP to the Holding Company. The Credit Agreement does, however, allow DP/7UP to pay dividends to the Holding Company in an amount necessary to make cash interest payments on the Discount Notes, provided that such interest payments are permitted to be made at such time in accordance with the subordination provisions relating to the Discount Notes and so long as no payment default or bankruptcy default then exists under the Credit Agreement with respect to the Holding Company or DP/7UP. The Holding Company's access to the cash flow of DP/7UP is further restricted because DP/7UP may not make any dividend payments to the Holding Company unless all accumulated and unpaid dividends on the outstanding shares of the $1.375 Senior Exchangeable Preferred Stock of Dr Pepper (the "DP/7UP Preferred Stock") (and any DP/7UP preferred stock that may be issued in the future) are paid in full. In addition, the indenture governing the exchange debentures into which the DP/7UP Preferred Stock is exchangeable will limit the payment of dividends and the making of loans by DP/7UP to the Holding Company. The indenture governing the Discount Notes also imposes limits on the payment of dividends by the Holding Company.
The operations of DP/7UP do not require significant outlays for capital expenditures, and its working capital requirements have historically been funded with internally generated funds. Marketing expenditures have historically been, and are expected to remain, the principal recurring use of funds for the foreseeable future. Such expenditures are, to an extent, controllable by management and are generally based on a percentage of unit sales volume. DP/7UP's other principal use of funds in the future will be the payment of principal and interest under the Credit Agreement, the payment of dividends on the outstanding shares of DP/7UP Preferred Stock and the payment of dividends to the Holding Company for purposes of making principal and interest payments on the Discount Notes.
During 1993, the Company used funds provided by operations to repay $123.6 million of the principal balance under the Term Loan Facility. This amount satisfied the total required repayment for 1993 of $67.0 million with the remaining $56.6 million applied prorata toward all future required repayments. On December 28, 1993, the Company modified the Credit Agreement resulting in a reduction in interest rates of approximately 1 1/2%. The amended credit line is $675.0 million, consisting of a $525.0 million Term Loan Facility and a $150.0 million Revolving Facility. As of December 31, 1993, DP/7UP is required to repay the principal of $525.0 million under the Term Loan Facility as follows: $85.0 million in 1994, $100.0 million in 1995, $110.0 million in 1996, and $115.0 million in each of 1997 and 1998. The Revolving Facility includes an amount for letters of credit in an aggregate face amount of up to $15.0 million. At December 31, 1993, the outstanding balance of revolving loans and the aggregate face amount of letters of credit issued under the Revolving Facility were $49.0 million and $0.6 million, respectively. A total of $15.6 million of the available credit under the Revolving Facility is reserved for use to repurchase or redeem shares of DP/7UP Preferred Stock and, if not so used by September 1, 1994, is required to be used to repay borrowings under the Term Loan Facility. The Revolving Facility will mature on the earlier to occur of (i) December 31, 1998 or (ii) the date on which there are no amounts outstanding under the Term Loan Facility.
The Company has entered into interest rate swap and interest rate cap agreements to satisfy certain terms of the Credit Agreement. At December 31, 1993, LIBOR-based interest rate swap agreements covered notional amounts of $350.0 million and $300.0 million expiring on December 1, 1994 and December 1, 1995, respectively. The interest rate differential to be received or paid is recognized as an adjustment to interest expense.
The Company had working capital deficits of $67.2 million at December 31, 1993 and $102.2 million at December 31, 1992. The Company generally operates with a working capital deficit due to its low inventory investment and because it has a significant amount of accrued marketing expenses in current liabilities. The deficit at December 31, 1992 was significantly impacted by the use of cash on hand in connection with, and the increase in the current portion of long-term debt as a result of, the consummation of the 1992 Recapitalization. The deficit at December 31, 1993 was improved from the December 31, 1992 deficit due to the recognition of the deferred tax asset and the net increase in other working capital components as a result of the timing of cash receipts and disbursements and the seasonal nature of the business. The Company does not believe that such deficits will have a material adverse effect on the liquidity or operations of the Company.
Capital expenditures totaled $1.9 million in 1992 and $3.8 million in 1993.
The Credit Agreement contains numerous financial and operating covenants and prohibitions that impose limitations on the Company's liquidity, including the satisfaction of certain financial ratios and limitations on the incurrence of additional indebtedness. Through December 31, 1993, the Company has satisfied all required financial ratios. The indenture governing the Discount Notes also contains covenants that impose limitations on the Company's liquidity, including a limitation on the incurrence of additional indebtedness. The ability of the Company to meet its debt service requirements and to comply with the financial covenants in the Credit Agreement and the indenture will be dependent upon future performance, which is subject to financial, economic, competitive and other factors affecting the Holding Company and DP/7UP, many of which are beyond their control.
ITEM 8. | 836400 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS EXCEPT PER SHARE DATA)
The table below summarizes selected consolidated financial data of the Company for each of the last five fiscal years:
OPERATING RESULTS FOR FISCAL YEAR ENDED:
BALANCE SHEET DATA AT PERIOD ENDED:
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No cash dividend was paid on the Company's common stock during the five years ended November 30, 1993.
Operating results for all prior periods have been reclassified to conform to the fiscal 1993 presentation for discontinued operations.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (IN THOUSANDS EXCEPT FOR SHARE AND PER SHARE AMOUNTS)
In June 1993, the Company completed the sales of its two owned-and-operated radio stations, WYNY-FM and KQLZ-FM (collectively, the "Stations"), and in November 1993 Westinghouse Electric Corporation ("WEC") acquired Radio & Records and the remaining net assets of Westwood One Stations Group, Inc. ("The Group") (a subsidiary initially set up by the Company as the owner of the Stations and Radio & Records in order to collateralize loans from WEC) in complete satisfaction of The Group's remaining obligations for the principal amount of loans and accrued interest thereon owed to WEC. Accordingly, the results of the Stations and Radio & Records are classified as discontinued operations for all periods presented.
The following table sets forth the consolidated statements of operations in dollars and as a percent of revenue for the three years ended November 30, 1993, 1992, and 1991, accompanied by dollar and percent comparisons covering 1993 vs 1992 and 1992 vs 1991:
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NM -- not meaningful
Westwood One derives substantially all of its revenue from the sale of advertising time to advertisers. Revenue decreased 2% to $99,579 in fiscal 1993 from $101,290 in fiscal 1992 and decreased 7% in fiscal 1992 from $108,586 in fiscal 1991. The decrease in revenue in fiscal 1993 was attributed to the non-recurrence of the Company's exclusive radio coverage of the 1992 Summer Olympics, partially offset by revenue growth associated with an overall increase in the market. The decrease in revenue in fiscal 1992 was primarily attributable to a 13% erosion of the national network radio revenue marketplace (according to the Radio Network Association). The decline in revenue in 1992 would have been slightly greater had the Company not had the exclusive radio coverage for the 1992 Summer Olympics. The Company's market share, based on advertising revenue reported to the Radio Network Association, was 24% in fiscal 1993 as compared to approximately 25% in fiscal 1992 and 24% in 1991.
Operating costs and expenses (excluding depreciation and amortization) primarily include affiliate compensation (to radio stations in exchange for commercial spots, which the Company sells to advertisers), current period production costs of syndicated radio programs (excluding the amortization of production costs) and network administration, which typically do not vary directly with revenue, and selling expenses (including agency commissions related to advertising revenue) which often vary closely with revenue. Operating costs and expenses excluding depreciation and amortization decreased 12% to $80,918 in fiscal 1993 from $92,249 in fiscal 1992 and increased 7% in fiscal 1992 from $86,287 in fiscal 1991. The 1993 decrease is primarily due to cost reduction programs associated with affiliate compensation, programming, news and related staff expenses, the non-recurrence of the 1992 Summer Olympics, and lower agency commissions. The fiscal 1992 increase is primarily attributable to costs associated with broadcasting the 1992 Summer Olympics, a provision for contract losses and higher affiliate compensation expense, partially offset by lower syndicated music programming expense, reduced agency commissions, lower write-offs of doubtful accounts and lower transmission expense.
Depreciation and amortization dropped 17% to $16,384 in 1993 from $19,661 in 1992 and dropped 11% in 1992 from $22,055 in 1991. The reductions are primarily due to lower amortization of production costs and lower write-offs resulting from fewer terminated station affiliation agreements.
Corporate general and administrative expenses decreased 26% to $4,468 in fiscal 1993 from $6,017 in fiscal 1992 and decreased 3% in fiscal 1992 from $6,175 in fiscal 1991. The decrease in 1993 was attributable to across-the-board expense cuts and the non-recurrence of one-time charges from 1992. In 1992, reduced legal and consulting fees were almost offset by a one-time charge for a vested benefit related to a new executive officer's employment contract, an executive search fee and expenses associated with restructuring loan agreements.
Severance and termination expenses of $2,063 in 1992 were principally due to management changes implemented to achieve future efficiencies.
Operating loss decreased 88% to $2,191 in 1993 from $18,700 in 1992 after a 215% increase in 1992 from a loss of $5,931 in 1991. The 1993 significant improvement was primarily due to extensive cost reduction programs and the non-recurrence of prior year severance and termination expenses, partially offset by the non-recurrence of profit from the 1992 Summer Olympics. The increase in the 1992 operating loss occurred principally due to the profit impact of lower revenue resulting from the overall decline in the marketplace (somewhat offset by profit from the 1992 Olympics), increased operating costs and expenses excluding depreciation and amortization and
significant severance and termination expenses, partially offset by lower depreciation and amortization.
Interest expense was $6,551, $5,562 and $5,610 in fiscal 1993, 1992 and 1991, respectively. The 18% increase in fiscal 1993 was primarily due to restructuring expenses accompanied by an increased interest rate associated with amending the terms of the Company's bank revolving credit facility and term loan.
In fiscal 1993, other income of $60 was principally comprised of investment income. In fiscal 1992 and 1991, other expense of $301 and $1,081, respectively, was due principally to provisions in 1992 and 1991 of $250 and $1,428, respectively, to write-down a parcel of real estate that was held for sale to its net realizable value, partially offset by investment income.
Equity in net loss of an unconsolidated subsidiary represents the Company's share of the operating performance of WNEW-AM, which was sold in August 1992.
Loss on the sale of an unconsolidated subsidiary of $6,536 in 1992 represents the provision for the sale of WNEW-AM, which closed on December 15, 1992.
Loss before taxes, discontinued operations, and extraordinary gain decreased 73% to $8,682 in 1993 from $31,888 in 1992 and increased 120% in 1992 from $14,523 in 1991. The 1993 dramatic improvement was attributable to the decreased operating loss and the elimination of both the equity in net loss and loss on sale of an unconsolidated subsidiary resulting from its sale in the third quarter of fiscal 1992. The increased loss in 1992 was principally due to the increased operating loss, the loss on the sale of an unconsolidated subsidiary, and the provision for the write-down to net realizable value of a parcel of real estate.
Starting in fiscal 1993 the Company no longer has deferred tax liabilities available to offset its loss from continuing operations resulting in a reduced benefit for income taxes of $10,491 in 1993. The benefit for income taxes increased 132% to $10,491 in 1992 from $4,519 in 1991, principally as a result of the change in pre-tax loss. The Company's effective tax rates in fiscal 1992 and 1991 were 33% and 31%, respectively.
Loss from continuing operations decreased $12,715 to $8,682 in 1993 from $21,397 in 1992 and increased $11,393 in 1992 from $10,004 in 1991 due to changes in the pre-tax loss, partially offset by the benefit for income taxes.
Loss on discontinued operations, net of income tax benefit, was $3,140 in 1993, $2,721 in 1992 and $6,778 in 1991. The 1993 loss represents the operating performance of discontinued operations through March 1, 1993. The decrease in the loss in 1992 was due to improved operating performance of WYNY-FM and Radio & Records, lower interest expense and the non-occurrence of costs associated with a 1991 format change at KQLZ-FM.
The $12,087 provision for loss on disposal of discontinued operations includes estimated future costs and operating results of the discontinued assets from March 1, 1993 until the date of disposition.
The Company had an extraordinary gain on the debt exchange offer in fiscal 1991, net of taxes, amounting to $25,618.
In 1992, the Financial Accounting Standards Board issued FAS No. 109 "Accounting for Income Taxes". The Company will adopt the standard on December 1, 1993, and currently estimates that its deferred tax liability will be increased by approximately $2,000. The resulting expense will be recorded in the statement of operations and reported as a cumulative effect of a change in an accounting principle.
LIQUIDITY AND CAPITAL RESOURCES
At November 30, 1993, the Company's cash and cash equivalents were $3,868, a decrease of $2,587 from November 30, 1992. The decrease in cash of $2,587 combined with the cash provided before financing activities of $92,544 and the proceeds from the issuance of common stock of $1,507 were used to reduce outstanding borrowings by $96,638. Additionally, WEC acquired the outstanding stock of Radio & Records and the net assets of Westwood One Stations Group in complete satisfaction of the Group's remaining debt and a conversion to common stock of $2,068 face value of Senior Debentures occurred. Consequently, total debt was reduced to $60,149 at November 30, 1993, a decrease of $118,430 from $178,579 at November 30, 1992.
For fiscal 1993, net cash from operating activities was $2,045, a decrease of $7,207 from fiscal 1992. The decrease was primarily attributable to higher prior year network collections associated with fourth quarter 1991 revenue and a large reduction in accounts payable and accrued liabilities primarily related to reduced interest, partially offset by improved broadcast cash flow (based on the consolidated statement of operations, calculated by subtracting from revenue, operating costs and expenses excluding depreciation and amortization) and receipt of a multi-year license fee (deferred revenue). Net cash provided by investing activities was $90,499, an increase of $101,841 over the prior year, principally due to net proceeds from the sales of two radio stations, an unconsolidated subsidiary and a parcel of real estate. Consequently, cash provided before financing activities increased by $94,634 from 1992.
The Company used the assets of The Group as collateral for a revolving credit facility and for the 16% Senior Subordinated Debentures with WEC, both non-recourse to the Company, which amounted to $104,960 at November 30, 1992. In June 1993 the Company completed the sale of both radio stations and used the net proceeds to retire the 16% Debentures ($43,733) and reduce the outstanding balance of the revolving credit facility. Effective November 1, 1993, WEC acquired Radio & Records and the remaining net assets of The Group in complete satisfaction of The Group's remaining obligations for the principal amount of loans and accrued interest thereon owed to WEC.
On November 22, 1993 the Company repaid its Revolving Facility and term loan by entering into a new senior debt agreement involving a revolving facility and two term loans with a maximum borrowing capacity of $20,000. At November 30, 1993, the Company had outstanding borrowings under the revolving facility of $6,648 and available borrowings of $6,352.
From December 1, 1993 through January 15, 1994, holders of the Company's Senior Debentures converted $12,542 face amount of the Senior Debentures into 3,584,000 shares of the Company's common stock, reducing the outstanding amount of the Senior Debentures to $18,516.
In order to finance the acquisition of Unistar (which will be accounted for as a purchase) the Company anticipates obtaining a new senior loan with a syndicate of banks in the amount of $125,000. Additionally, the Company will sell 5 million shares of Common Stock and a warrant to purchase up to an additional 3 million shares of Common Stock at an exercise price of $3.00 per share (subject to certain vesting conditions) to INI for $15,000. The proceeds will be used to acquire
Unistar and repay its indebtedness ($101,300), repay the Company's current senior debt agreement, and improve working capital. Immediately following the acquisition, and as a condition to obtaining a new senior loan, the Company will also redeem its Senior Debentures.
Management believes that the Company's cash, anticipated cash flow from operations and available borrowings will be sufficient to finance current and forecasted operations and debt obligations over the next 12 months. Furthermore, management believes the acquisition of Unistar will strengthen the Company's liquidity.
ITEM 8. | 771950 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Financial Condition
Chrysler Financial Corporation's financial condition and liquidity improved during 1993 as it regained full access to the investment grade debt markets. During 1993, funding provided by capital market activities and the downsizing of nonautomotive operations through sales and liquidations, enabled the Company to repay all amounts outstanding under its revolving credit facilities and to provide financing support for automotive dealers and retail purchasers of Chrysler's products.
The Company's portfolio of receivables managed, which includes receivables owned and receivables serviced for others, totaled $28.3 billion at December 31, 1993, down from $30.1 billion and $33.7 billion at December 31, 1992 and 1991, respectively. The decline in receivables managed primarily reflects the downsizing of the Company's nonautomotive operations.
Receivables serviced for others primarily represent sold receivables which the Company services for a fee. Receivables serviced for others totaled $19.4 billion at December 31, 1993, compared to $18.3 billion and $18.4 billion at December 31, 1992 and 1991, respectively. The increase in receivables serviced for others reflects higher levels of automotive sold receivables, partially offset by the downsizing of nonautomotive operations.
The Company's total allowance for credit losses, including receivables sold subject to limited recourse provisions, totaled $494 million, $573 million and $557 million at December 31, 1993, 1992 and 1991, respectively. The total allowance for credit losses as a percentage of related finance receivables outstanding was 1.78%, 1.94% and 1.74% at December 31, 1993, 1992 and 1991, respectively. The decline in credit loss reserve levels is a result of nonautomotive asset sales and an improvement in automotive credit loss experience.
Total assets at December 31, 1993 declined to $14.4 billion from $17.5 billion at December 31, 1992. Total debt outstanding at December 31, 1993 was $8.4 billion compared to $11.8 billion at December 31, 1992. The Company's debt-to-equity ratio declined to 2.69 to 1 at December 31, 1993 compared to 3.92 to 1 at December 31, 1992. The decline in total assets, total debt and the debt-to-equity ratio reflects the downsizing of the Company and the use of nonautomotive asset sale proceeds to reduce the Company's outstanding indebtedness.
Results of Operations
Earnings before income taxes and cumulative effect of changes in accounting principles for 1993 totaled $267 million, compared to $295 million and $402 million in 1992 and 1991, respectively. The decline in 1993 earnings before income taxes and accounting changes from 1992 resulted largely from higher borrowing costs incurred under the Company's revolving credit agreements. The decline in 1992 earnings before accounting changes from the prior year was primarily due to lower levels of earning assets and increased borrowing costs incurred under the bank facilities, partially offset by lower provisions for credit losses.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations (continued)
The Company's net earnings after accounting changes were $129 million, $231 million and $276 million in 1993, 1992 and 1991, respectively. Accounting changes in 1993 and 1992 negatively impact the net earnings comparisons by $81 million. Net earnings for the year ended December 31, 1993 included charges totaling $30 million from the implementation of Statement of Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", and SFAS No. 112, "Employers' Accounting for Postemployment Benefits". Net earnings for the year ended December 31, 1992 included a $51 million favorable adjustment from the adoption of SFAS No. 109, "Accounting for Income Taxes".
Interest margin totaled $627 million in 1993, down 32 percent from 1992 primarily due to the sales of nonautomotive assets and higher average effective cost of borrowings incurred under the Company's bank facilities. Automotive financing income totaled $989 million in 1993, compared with $1.1 billion in 1992 and $1.4 billion in 1991. The decline in automotive financing income was primarily attributable to lower levels of earning assets and declining interest rates.
Automotive financing volume totaled $59.8 billion in 1993, compared to $46.6 billion and $41.5 billion in 1992 and 1991, respectively. The increase in automotive financing volume over the last two years was largely due to higher amounts of wholesale financing provided to automotive dealers. Financing support provided in the United States for new Chrysler vehicle retail deliveries (including fleet) and wholesale vehicle sales to dealers, and the number of vehicles financed over the last three years was as follows:
Interest income from the Company's nonautomotive financing operations totaled $429 million in 1993 compared with $841 million in 1992 and $1.2 billion in 1991. These nonautomotive operations had finance receivables outstanding of $2.8 billion at December 31, 1993 compared with $5.3 billion at December 31, 1992, and $7.2 billion at December 31, 1991. The decrease in nonautomotive finance receivables outstanding was due primarily to the downsizing of the Company's nonautomotive operations over the last two years.
Despite improved credit ratings and lower market interest rates, the Company's average effective cost of borrowings increased during 1993 compared to a year ago. This increase was primarily due to the amortization of up-front fees and costs associated with its U.S. and Canadian revolving credit agreements commencing in August 1992. The decline in the Company's average effective cost of borrowings from 1991 to 1992 was primarily due to lower market interest rates.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations (continued)
A comparison of borrowing costs is shown in the following table:
Operating expenses for 1993 totaled $463 million, compared to $595 million and $614 million in 1992 and 1991, respectively. The decline in operating expenses over the last two years was primarily attributable to the downsizing of the Company's nonautomotive operations and the containment of certain automotive-related operating expenses.
The Company's provision for credit losses for 1993 totaled $216 million compared to $309 million and $421 million in 1992 and 1991, respectively. The lower provision for credit losses reflects improved automotive credit loss experience and the downsizing of nonautomotive operations.
The Company's depreciation and other expenses totaled $194 million in 1993, compared to $242 million and $231 million in 1992 and 1991, respectively. The decline in depreciation and other expenses from 1992 to 1993 was primarily attributable to the downsizing of nonautomotive operations.
Net credit loss experience, including net losses on receivables sold subject to limited recourse provisions, for the years ended December 31, 1993, 1992 and 1991 was as follows:
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
Liquidity improved during 1993 due to an improved market perception of the Company's creditworthiness, proceeds from sales of nonautomotive operations and the achievement of investment grade credit ratings. The Company's improved access to the debt markets enabled it to issue $2.3 billion of term debt and increase the level of short-term notes outstanding (primarily commercial paper) to $2.8 billion.
Receivable sales continued to be a significant source of funding during 1993 as the Company realized $7.8 billion of net proceeds from the sale of automotive retail receivables, compared to $5.8 billion of net proceeds from the sale of automotive and nonautomotive retail receivables for the year ended December 31, 1992. In addition, revolving wholesale receivable sale arrangements provided funding which aggregated $4.6 billion and $4.3 billion at December 31, 1993 and 1992, respectively.
During 1993 the Company realized $2.4 billion in aggregate cash proceeds from the sale of substantially all of the net assets of the consumer and inventory financing businesses of Chrysler First and the sale of certain assets of Chrysler Capital.
At December 31, 1993, the Company had revolving credit facilities aggregating $5.2 billion, consisting of contractually committed U.S. credit lines of $4.7 billion expiring in August 1995, and $.5 billion of Canadian credit lines expiring in December 1995. The Company had automotive receivable sale agreements totaling $2.9 billion at December 31, 1993, consisting of a $2.5 billion U.S. automotive receivable sale agreement (of which $1.25 billion expires in September 1994 and $1.25 billion expires in September 1996), and a $.4 billion Canadian receivable sale agreement which expires in December 1995. In addition, up to $750 million of the total commitment under Chrysler's revolving credit agreement dated June 30, 1993 can be made available to the Company. As of December 31, 1993, none of the revolving credit facilities or receivables sale agreements were utilized.
As of December 31, 1993, the Company had contractual debt maturities of $4.1 billion in 1994 (including $2.8 billion of short-term notes), $.6 billion in 1995, $1.0 billion in 1996, $.2 billion in 1997, $.7 billion in 1998 and $1.8 billion in years thereafter.
The Company believes that cash provided by operations, receivable sales, issuance of term debt, and issuance of commercial paper backed by unused revolving credit facilities will provide sufficient liquidity in the future.
New Accounting Standards
In May 1993, the Financial Accounting Standards Board ("FASB") issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", which amends SFAS No. 5, "Accounting for Contingencies", by requiring creditors to evaluate the collectibility of both contractual interest and principal of receivables when evaluating the need for a loss accrual. The Company has not yet determined the effect of this new pronouncement on its results of operations and financial position. The Company plans to adopt SFAS No. 114 on or before January 1, 1995.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
New Accounting Standards (continued)
In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," effective for fiscal years beginning after December 15, 1993. This accounting standard specifies the accounting and reporting requirements for changes in the fair values of investments in certain debt and equity securities. Based upon its initial assessment, the Company believes that the implementation of this new accounting standard will have an immaterial impact on its consolidated operating results and financial position. The Company plans to adopt this standard effective January 1, 1994, as required.
ITEM 8. | 20164 | 1993 |
Item 6. Selected Financial Data -----------------------
PART II -------
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations --------------------- 1993 vs. 1992 - Consolidated
Consolidated revenues of $201 million were up 4 percent from the prior year's $193 million. Excluding the cumulative effects of accounting changes recorded in 1992, consolidated net income for 1993 increased 19.5 percent to $11.3 million. This increase in comparable earnings was primarily the result of higher non-operating income, as operating profit showed a slight decline.
Services (print and CD subscriptions and online products) accounted for all of the revenue increase as non-service revenues (software, outside printing, training media, books, and others) declined slightly. Service revenues amounted to 85.2 percent of consolidated revenues in 1993 and 84.6 percent in 1992, and increased 4.9 percent on higher prices and new print and CD product sales. Some of the CD sales replaced print products, but since CD products have more value- added features, they afford an opportunity for higher pricing than their print counterparts. Accordingly, while total service circulation increased only 1 percent, the annual subscription file dollar value, a more current measure of total subscription service business, increased 7.7 percent during 1993. The increase in service revenues was negatively affected by the absence of ETSI, the online network division which was sold in December, 1992. ETSI recorded revenues of $2,681,000 in 1992 and $2,472,000 in 1991. Non-service revenues amounted to $29.6 million, and declined .6 percent as higher software division sales were offset by lower sales for books, information-on-demand, training media, and printing sales to outside customers.
Operating expenses increased 4.5 percent in 1993. The expense increase was mainly due to eleven new services developed and launched in 1993, including four in CD format, and higher systems development costs. Product development expenses increased 16.9 percent to $5.3 million, reflecting increased CD and print service development efforts. Operating expenses in 1993 include an identifiable $3.9 million for developing improved business and publishing systems. The overall expense increase was lessened by the absence of ETSI, which recorded operating expenses of $4,435,000 in 1992 and $4,813,000 in 1991.
Operating profit declined 4 percent from 1992. The effect on operating profit from increased product and systems development expenses was mitigated by the absence of ETSI, which had a $1.8 million operating loss in 1992, and substantial improvements in the operating results for the international business unit and the tax planning software business.
Non-operating income nearly doubled as investment income increased 40.3 percent to $6.2 million due to substantially higher gains on sales of securities and larger portfolio balances. Nearly $2 million in gains were recorded in 1993, an amount not expected to be matched in 1994. A net gain on disposal of assets in 1993 compared to a net loss in 1992 increased other net non-operating income $1.1 million.
Earnings per share were $1.32 per share compared to $1.11 per share (before cumulative effects of accounting changes) in 1992. The consolidated federal, state, and local effective income tax rate was 28.5 percent in 1993 compared to 28.3 percent in 1992. A significant non-recurring item lowered the effective income tax rate in each year. In 1993, the effective rate was reduced 2 percent by the effect of the federal income tax rate change on net deferred tax assets.
(Continued)
In 1992, the effective rate was reduced 2.4 percent by a one-time realization of previously non-deductible expenses.
The 1993 operating results reflect a substantial investment in developing and launching new products and in developing improved publishing and business systems. The Company is undertaking these efforts in response to customers' demand for information in an electronic format and to make operations more efficient. The development effort is ongoing and will negatively affect operating results, but management believes these expenditures are necessary to protect and enhance the Company's long-term value.
Effective no later than 1994, the Company must account for the cost of providing continuing compensation and health care benefits for former employees in accordance with Statement of Financial Accounting Standards (SFAS) 112-- Employers' Accounting for Postemployment Benefits. The effect of adopting the new accounting standard has not been computed, but it is not expected to materially affect the financial position of the Company.
1992 vs. 1991 - Consolidated
Results for 1992 were negatively impacted by the new accounting standards adopted during the fourth quarter. Consolidated net income before the cumulative effects of the accounting changes was $9.4 million, compared to $8.6 million in 1991, an increase of 9.5 percent. As discussed in Notes 5 and 8 to the consolidated financial statements, the Company adopted SFAS 106,--Employers' Accounting for Postretirement Benefits Other Than Pensions and SFAS 109-- Accounting for Income Taxes retroactive to January 1, 1992. The cumulative effect of these accounting changes was a net expense of $19.5 million. Annual operating expenses for 1992 also included an additional $4.3 million as a result of adopting SFAS 106. Consolidated net loss for 1992 was $10.1 million.
Consolidated revenues of $193 million in 1992 increased 6.4 percent from $181.3 million in 1991. Service revenues amounted to 84.6 percent of total revenues in 1992 and 84.2 percent in 1991. Service revenues increased 6.9 percent in 1992 on higher prices and increased circulation. Seven new subscription services were launched in 1992 and subscription circulation increased 3 percent. Non- service revenues amounted to $29.8 million and increased 3.8 percent over 1991.
Operating expenses increased 6.6 percent due to higher employment expenses (including accrued postretirement benefits and severance expenses), more published pages, a $1.1 million increase in identifiable product development costs, and $2 million in identifiable expenses for improved business and publishing systems. The consolidated operating profit for 1992 was $10.1 million, an increase of 3.6 percent over 1991.
Overall favorable comparisons for non-operating items added to the year-to-year increase in income before cumulative effects of accounting changes. Investment income increased due to higher average portfolio balances during the year. Interest expense decreased due to lower interest rates and lower average outstanding debt. Other income (expense) was a higher net expense in 1992 compared to 1991 due to pre-tax losses recorded on the disposals of property, equipment, and a business unit.
The consolidated federal, state, and local effective income tax rate was 28.3% in 1992 compared to 32.2% in 1991. The lower rate reflects the benefits realized for previously non-deductible expenses, and a higher level of tax- exempt investment income.
(Continued)
Segments
The Company operates primarily in the business information publishing industry. Operations consist primarily of the production and marketing of information products in print and electronic form, and outside printing services. Activities in other industry segments provide less than ten percent of total revenues.
Deferred Tax Assets
In accordance with SFAS 109, the Company has recorded $12 million of net deferred tax assets as of year-end 1993. This amount includes $17.9 million related to the accrued postretirement benefits liability. No valuation allowance has been provided for the realization of the deferred tax assets.
In assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The Company has a consistent history of profitability and taxable income, and management believes this trend will continue. Factors supporting this conclusion are consistent profitable operations, a quality reputation in the markets served by the Company, a high renewal rate for subscription products, a growing deferred revenue liability (representing payments and orders for future fulfillment), and the recent successful introduction of products using new CD and electronic delivery methods.
In the opinion of management, it is more likely than not that the existing deferred tax assets will be realized in future years, and no valuation allowance is necessary.
Financial Resources and Cash Flows
The Company maintains its financial reserves in cash and investment securities which, along with its operating cash flows, are sufficient to fund ongoing cash expenditures for operations and to support employee ownership. Cash provided from operating activities amounted to $23.5 million in 1993, $34 million in 1992, and $22.4 million in 1991. Cash flow from operations declined in 1993 due to a 5.3 percent increase in expenditures and slightly lower collections. Cash flows from operations had increased substantially in 1992 due to a one-time change in the subscription billing cycle.
Cash outlays for capital expenditures were $9.1 million in 1993, compared with $5.2 million in 1992, and $17.4 million in 1991. This included equipment purchases, office furnishings, and building improvements. Capital expenditures in 1991 also reflect major renovations of older office space and equipment purchases for the new printing facility, and $1.6 million for purchased publications. Capital expenditures, are expected to be $7 million in 1994.
Sales of capital stock to employees provided $2.8 million of equity capital in 1993. Dividends paid to shareholders amounted to $7.7 million in 1993, $7.1 million in 1992, and $6.9 million in 1991. Other 1993 financing expenditures included $3.2 million for debt principal repayments and $2.2 million for repurchases of Class B and Class C capital stock.
(Continued)
For 1994, financing requirements include $4.2 million for scheduled debt repayment and $1.1 million for known repurchases of Class B and Class C stock.
With $85 million in cash and investment portfolios, the financial position and liquidity of the Company remains very strong. Should additional funding become necessary in the future, the Company has substantial debt capacity based on its operating cash flows and real estate equity which could be mortgaged. Since subscription monies are collected in advance, cash flows from operations, along with existing financial reserves and proceeds from the sales of capital stock, have been sufficient in past years to meet all operational needs, new product introductions, capital expenditures, debt repayments, and, in addition, provide funds for dividend payments and the repurchase of Class B and Class C stock tendered by shareholders.
PART II -------
Item 8. | 15393 | 1993 |
Item 6. Selected Financial Data. ------------------------ See cross-reference sheet for disclosures incorporated elsewhere in this Annual Report on Form 10-K.
Item 7. | Item 7. Management's Discussion and Analysis of Financial ------------------------------------------------- Condition and Results of Operations. -----------------------------------
CORPORATE PROFILE AND SIGNIFICANT DEVELOPMENTS - ----------------------------------------------
First Empire State Corporation ("First Empire") is a regional bank holding company headquartered in Buffalo, New York with consolidated assets of $10.4 billion at December 31, 1993. First Empire and its consolidated subsidiaries are hereinafter referred to as "the Company". The Company operates principally through two wholly owned banking subsidiaries, Manufacturers and Traders Trust Company ("M&T Bank") and The East New York Savings Bank ("East New York"). M&T Bank, with total assets of $8.6 billion at December 31, 1993, is a New York-chartered commercial bank with 106 offices throughout Western New York State and New York's Southern Tier, 13 offices in New York's Hudson Valley region and offices in New York City, Albany, Syracuse and Nassau, The Bahamas. East New York, with total assets of $1.8 billion at December 31, 1993, is a New York-chartered savings bank with 19 offices in metropolitan New York City.
M&T Bank's subsidiaries include M&T Mortgage Corporation, a mortgage banking company with offices in Ohio and Pennsylvania, M&T Securities, Inc., a broker/dealer, M&T Financial Corporation, an equipment leasing company, and M&T Capital Corporation, a venture capital company.
In recent years, the Company has grown through a series of acquisitions of part or all of other New York State-based financial institutions. In July 1992, the Company acquired Central Trust Company of Rochester, New York ("Central Trust"), and Endicott Trust Company of Endicott, New York ("Endicott Trust"), and simultaneously merged them with and into M&T Bank. The acquisitions added approximately $1.4 billion in assets and $1.3 billion in deposits to the Company's consolidated balance sheet on the acquisition date, and brought 38 banking offices in Western New York and New York's Southern Tier into M&T Bank's branch network.
In 1991 and 1990, M&T Bank and East New York also acquired selected assets and assumed selected liabilities of three failed thrift institutions in financially-assisted transactions with Federal regulators. In 1991, M&T Bank and East New York purchased approximately $1.7 billion of assets and assumed approximately $2.2 billion of deposits. In two similar transactions in 1990, M&T Bank acquired nearly $889 million in assets of the failed institutions and assumed approximately $1.7 billion of deposits. No material amounts of intangible assets were recorded in connection with these financially-assisted
transactions. The 1991 and 1990 acquisitions gave M&T Bank the rights to operate 20 former branch offices of the failed thrift institutions in the Buffalo metropolitan area and 15 branch offices in the Rochester, New York area. Additionally, as part of the 1991 acquisition, East New York added 3 branches in the New York City metropolitan area.
The acquisitions significantly expanded M&T Bank's market presence in both Buffalo and Rochester, despite the merger of many of the acquired branches with existing branches of M&T Bank. Each of the acquisitions has contributed to increases in net interest and fee income, as well as increased the level of operating expenses. The overall effect of the acquisitions was a significant positive contribution to the Company's net income in 1993.
During the fourth quarter of 1993, M&T Bank and East New York became stockholders of the Federal Home Loan Bank of New York. The Federal Home Loan Bank of New York is part of the Federal Home Loan Bank System, a national wholesale banking network of 12 regional, stockholder-owned banks. Such memberships provide M&T Bank and East New York with access to a readily-available, relatively low-cost wholesale funding source.
In response to increased consumer interest in alternative investments, three new mutual funds were added in 1993 to the Vision Group of Funds for which M&T Bank serves as investment adviser. These new funds expand the alternative investment options available to the Company's customers.
OVERVIEW - --------
The Company's net income was $102.0 million or $13.87 per common share in 1993, compared to $97.9 million or $13.41 per common share in 1992 and $67.2 million or $9.32 per common share in 1991. Fully diluted earnings per common share, which assumes the full conversion of outstanding preferred stock into common, was $13.42 in 1993, $12.98 in 1992 and $9.15 in 1991. The 1992 results include $28.1 million of gains from the sales of investment securities. Excluding the after-tax impact of these gains, net income in 1992 was $81.9 million or $11.13 per common share and fully diluted earnings per share was $10.86.
The securities gains realized in 1992 were the result of management's decision to adjust the Company's holdings of investment securities in response to the declining interest rate environment and the expected erosion in economic value of certain securities resulting from prepayment risk. Sales were additionally prompted by the restructuring of the Company's balance sheet in anticipation of the Central Trust and Endicott Trust acquisitions. These sales served to reduce the size of the Company's balance sheet and mitigated the impact of the acquisitions on regulatory capital ratios.
The Company achieved a return on average assets in 1993 of .98%, compared to 1.03% in 1992 and .81% in 1991. The return on average common stockholders' equity was 15.61% in 1993, 17.39% in 1992 and 13.82% in 1991. Excluding the effects of the 1992 securities gains, the return on average assets in 1992 was .86%, while the return on average common stockholders' equity was 14.43%.
Taxable-equivalent net interest income increased 8% in 1993 to $474.8 million, from $438.6 million in 1992. Taxable-equivalent net interest income was $337.7 million in 1991. An $823 million increase in 1993 in average earning assets resulting from loans obtained in the 1992 acquisitions and increased holdings of investment securities was the primary reason for the improved performance. Net interest income expressed as an annualized percentage of average earning assets was 4.76% in 1993, compared to 4.79% in 1992 and 4.22% in 1991.
Despite a 28% decline in 1993 from the prior year-end in the level of nonperforming loans, management considered it prudent to record a provision for possible credit losses of $80.0 million in 1993, 6% lower than the $85.0 million provided in 1992. The provision for possible credit losses was $63.4 million in 1991. Caution about the timing and sustainability of economic recovery in market areas served by the Company and the unsettled commercial real estate market in the New York City metropolitan area were the primary factors affecting management's decisions in determining the provision for possible credit losses.
Excluding securities gains, noninterest income for 1993 totaled $109.7 million, 12% above the $98.2 million in 1992, and 42% above the $77.2 million in 1991. Noninterest expense was $327.8 million in 1993, up 5% from $311.3 million in 1992 and 43% from $228.7 million in 1991.
On December 31, 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 expands the use of fair value accounting for certain securities that the reporting enterprise does not have the positive intent or ability to hold to maturity. For securities classified as "held to maturity", SFAS No. 115 retains the use of the "amortized cost" method of accounting. The adoption of the accounting statement had no impact on reported net income, but increased the carrying value of investment securities "available for sale" by $15.8 million. This resulted in an after-tax increase in stockholders' equity of $9.1 million, or $1.33 per common share.
NET INTEREST INCOME/LENDING AND FUNDING ACTIVITIES - --------------------------------------------------
As a result of growth in average earning assets, which rose $823 million or 9% to $10.0 billion, 1993 taxable-equivalent net interest income rose $36.2 million or 8% from 1992 to $474.8 million. Net interest income was $438.6 million in 1992 and $337.7 million in 1991, while average earning assets were $9.2 billion and $8.0 billion, respectively. The Company's net interest margin, expressed as an annualized percentage of average earning assets, was 4.76% in 1993, down slightly from 4.79% achieved in 1992, but up from 4.22% in 1991.
The Company continued to benefit from a relatively wide net interest spread, or the difference between the yield on earning assets and the rate paid on interest-bearing liabilities, of 4.33%, up from 4.29% in 1992. The net interest spread in 1991 was 3.57%. The increased net interest spread in 1993 reflects a 56 basis point (hundredths of one percent) widening in the difference between the yield on loans and leases and the rate paid on interest-bearing deposits. Largely offsetting such increase was the impact of increases in average balances of investment securities and money-market investments, which generally yield less than loans, and short-term borrowings.
Growth in average earning assets during 1993 was largely comprised of a $411 million or 6% increase in average loans. The growth in loans was driven by the full-year effect in 1993 of the July 1, 1992 acquisitions of Central Trust and Endicott Trust. Nevertheless, sluggish economic conditions in market areas served by the Company tended to hamper loan demand throughout much of 1993, particularly in the commercial sector. In addition to the increase in average loans, average investment securities grew $180 million and money-market assets rose $232 million from 1992.
The current interest rate environment as reflected in the historically high spread between prime and money-market rates has been favorable to many banks. However, management believes that reductions in such spread would adversely impact the Company's net interest margin. Although not necessarily indicative of a trend, 1993's fourth quarter net interest spread of 4.14% was below that achieved in any other quarter of 1993.
To help lessen the exposure to changing interest rates, the Company has entered into interest rate swaps as hedging transactions. The effects of these swaps, which had an aggregate notional amount of approximately $1.2 billion at December 31, 1993, are reflected in the yields on loans and the rates paid on interest-bearing deposits. The net effect of such swaps was to increase the Company's net interest spread by 36 basis points in 1993, 22 basis points in 1992 and 9 basis points in 1991. In general, in each interest rate swap transaction the Company is entitled to receive a fixed rate of interest and must pay a variable rate of interest based on London Inter-Bank Offer Rates ("LIBOR"). During 1993 the Company paid a weighted average variable rate of 3.32% on interest rate swaps and received a weighted average fixed rate of 6.10%. In 1992 and 1991 the weighted average variable rates paid were 4.08% and 6.10%, respectively, and the weighted average fixed rates received were 8.10% and 8.22%, respectively. Additionally, as of December 31, 1993, the Company had also entered into forward interest rate swaps with an aggregate notional amount of $475 million. These forward swaps had no effect on net income in 1993. Under the terms of the forward swaps outstanding at December 31, 1993, the Company will pay a weighted average variable rate based on LIBOR and receive a weighted average fixed rate of 5.89%.
Despite average net interest-free funds rising 22% to nearly $1.4 billion in 1993, the contribution of interest-free funds to the net interest margin fell in 1993 to .43% from .50% in 1992 and .65% in 1991. A 90 basis point drop in the average cost of interest-bearing liabilities, which is used to value the contribution of interest-free funds, offset the benefit derived from the increase in funding from interest-free sources in 1993.
While the acquisitions of loans in the July 1992 Central Trust and Endicott Trust transactions added significantly to the average balance of loans outstanding in 1993, the acquisitions did not materially alter the Company's mix of loans. Table 4 depicts by type, average loans outstanding for the Company in 1993, together with the percentage change in average loans by category over the past two years. Excluding home equity lines of credit, which are classified as consumer loans, approximately 63% of the Company's loans during 1993 were real estate loans, down slightly from 64% in 1992 and 67% in 1991. At the recent year-end, the Company held approximately $3.0 billion of commercial real estate loans and $1.5 billion of consumer real estate loans.
Commercial real estate loans are originated by the Company predominately in the metropolitan New York City area, including properties in neighboring states generally considered to be within commuting distance of New York City, and Western New York, which includes Buffalo, Rochester and the surrounding area. Commercial real estate loans are also originated in the Hudson Valley and Southern Tier regions of New York State. The typical commercial mortgage loan originated by the Company is a fixed-rate instrument with monthly payments and a five-year balloon payment of the remaining principal at maturity. For borrowers in good standing, the terms of the loan agreement may be extended for an additional five years at the then-current market rate of interest. Table 5 depicts by geographical area the type of collateral supporting commercial real estate loans as of December 31, 1993, as well as the size of the loans outstanding. Approximately 60% of the $1.7 billion of commercial real estate loans in the metropolitan New York City area were secured by multi-family residential properties. In addition, the Company had approximately $361 million of loans secured by office space and $158 million of loans secured by retail properties in the New York City metropolitan area. The Company's experience has been that office space and, to a lesser degree, retail properties tend to experience more volatile swings in value through economic cycles. Approximately 59% of the aggregate dollar amount of New York City area loans were for $3 million or less.
Commercial mortgage loans secured by properties located elsewhere in New York State were chiefly comprised of loans originated in Western New York. Given the nature of customers served in this market, collateral types tend to show greater diversity and include a significant amount of lending to customers who use the property in their trade or business, as well as real estate investors. The typical loan in this segment of the portfolio was $3 million or less.
The Company normally refrains from construction lending, except when the borrower has obtained a commitment for permanent financing upon project completion. As a result, the commercial construction loan portfolio totaled only $45.4 million, or .6% of total loans as of the recent year- end.
Of the $1.5 billion of real estate loans secured by one-to-four family residential properties at the 1993 year-end, approximately 80% were for properties located in New York State. At December 31, 1993, residential mortgage loans held for sale totaled $205 million. In 1992, the Company began originating residential mortgage loans in Ohio and Pennsylvania through M&T Mortgage Corporation. Most of these loans were originated for sale in the secondary market with servicing rights retained.
The Company's investment securities portfolio averaged $2,173 million in 1993, up from $1,993 million in 1992 and $1,725 million in 1991. These increases occurred despite ongoing prepayments of mortgage-backed securities held in the investment portfolio, induced by the current interest rate environment, and were largely achieved through purchases of collateralized mortgage obligations ("CMOs"), other adjustable rate mortgage-backed securities and shorter-term U.S. Treasury notes. The Company considered its overall interest-rate risk profile, including the effects of interest rate swaps, when purchasing securities during 1993. The Company attempts to purchase securities which management believes provide reasonable rates of return for the prepayment risk assumed.
As noted earlier, the Company adopted SFAS No. 115 on December 31, 1993 and designated approximately $2.2 billion of investment securities as "available for sale", as defined in the accounting pronouncement. The excess of estimated fair value over amortized cost, or net unrealized investment gain, for such securities was $9.1 million, net of applicable income taxes. Such amount has been included in stockholders' equity in the consolidated balance sheet as "Unrealized investment gains, net". The adoption of SFAS No. 115 had no impact on the Company's reported earnings for 1993.
The average balance of money-market assets, which are comprised of interest-bearing deposits at banks, trading account assets, Federal funds sold and agreements to resell securities, was $826 million in 1993, up from $594 million a year earlier. Total money-market assets averaged $396 million in 1991. The increase in 1993 in these lower-yielding discretionary investments generally reflects investment opportunities in various short-term money-market instruments, the relative lack of alternative securities deemed attractive for longer-term investment and sluggish loan demand.
Core deposits, which are comprised of noninterest-bearing demand deposits, interest-bearing transaction accounts, savings deposits and domestic time deposits under $100,000, provide the Company with a stable source of funds at generally lower interest rates than wholesale funds of similar expected maturities. Average core deposits in 1993 declined 1% to $7,178 million from $7,240 million in 1992, but, primarily due to acquisitions, grew 14% in 1992 from $6,366 million in 1991. Funding provided by core deposits totaled 72% of average earning assets in 1993, compared with 79% a year earlier and 80% in 1991. The declines in core deposits have been primarily in time deposit accounts as depositors seeking potentially higher returns continued to redeploy investment funds out of the banking system into alternative investment vehicles, such as mutual funds. An analysis of changes in the components of core deposits is presented in table 6.
In addition to core deposits, the Company uses short-term borrowings from banks, securities dealers, the Federal Home Loan Bank of New York and others as sources of funding. Short-term borrowings averaged $1,922 million in 1993, $801 million above 1992's average of $1,121 million. Short-term borrowings averaged $650 million in 1991. In general, short- term borrowings have been used to fund the Company's investments in discretionary money-market assets and investment securities, and to replace deposit outflows. With regard to deposits not considered to be core deposits, domestic time deposits of $100,000 or more averaged $294 million in 1993, down 10% from $326 million in 1992 and 44% from $522 million in 1991. Average offshore deposits, which are primarily comprised of accounts with balances of $100,000 or more, amounted to $120 million in 1993, down from $130 million a year earlier and $159 million in 1991.
PROVISION FOR POSSIBLE CREDIT LOSSES - ------------------------------------
The purpose of the provision is to replenish and build the Company's allowance for possible credit losses to a level necessary to maintain an adequate reserve position. In establishing the provision for possible credit losses, management considers historical loan losses incurred, the quality and size of the loan portfolios, the level of the allowance for possible credit losses and the economic climate.
The provision for possible credit losses was $80.0 million in 1993, compared with $85.0 million in 1992 and $63.4 million in 1991. Net charge- offs in 1993 decreased $10.5 million to $35.8 million, while nonperforming loans also decreased to $82.3 million at December 31, 1993 from $113.6 million a year earlier. Net charge-offs totaled $44.1 million in 1991 and nonperforming loans were $89.7 million at 1991's year-end. Net charge-offs as a percentage of average loans in 1993 were .51%, compared with .70% in 1992 and .75% in 1991. Despite declines in the level of net charge-offs and nonperforming loans of 23% and 28%, respectively, management considered it prudent to record a provision for possible credit losses in 1993 which was only 6% lower than 1992 due to concerns about the unsettled commercial real estate market, in particular in the New York City metropolitan area, and the timing and sustainability of economic recovery in market areas served by the Company in general. As a result, the allowance for possible credit losses was $195.9 million or 2.70% of net loans and leases outstanding at December 31, 1993, up from $151.7 million or 2.17% at December 31, 1992 and $100.3 million or 1.66% at December 31, 1991. The decrease in net charge-offs and lower nonperforming loan levels enabled the Company to establish an allowance-to-nonperforming loan ratio of 238%. The allowance's coverage of nonperforming loans was 134% a year earlier and 112% at December 31, 1991.
M&T Bank retains the contractual right to require the Federal Deposit Insurance Corporation ("FDIC") to repurchase prior to May 31, 1994 at a discount of 4% certain loans sold to M&T Bank by the FDIC from the portfolio of a failed thrift institution in the event such loans become adversely classified for regulatory purposes. As of December 31, 1993, such loans included approximately $100 million of commercial real estate loans and $249 million of consumer and residential mortgage loans.
A comparative allocation of the allowance for possible credit losses for each of the past five year-ends is presented in table 10. Amounts were allocated to specific loan categories based upon management's classification of loans under the Company's internal loan grading system and estimates of potential charge-offs inherent in each category. However, as the total reserve is available to absorb losses from any loan category, amounts assigned do not necessarily indicate future losses within these categories. The increase in the allocated portion of the reserve in 1993 compared to prior years is not necessarily indicative of a deterioration of credit quality within the loan portfolio, but rather reflects certain revisions to the assumptions used to
calculate the allocated portion of the reserve in 1993. Nevertheless, the unallocated portion of the reserve represents management's assessment of the overall level of credit risk in the loan portfolio over a longer time frame.
Due to the size of the Company's commercial real estate loan portfolio, the Company's credit loss experience has been and will continue to be influenced by real estate prices, in particular, and overall economic conditions, in general. During 1993 the Company incurred $19.2 million of net charge-offs on commercial real estate loans, including $14.2 million on loans domiciled in the New York City metropolitan area, where declines in real estate values have been more pronounced. Nonperforming commercial real estate loans totaled $48.3 million at December 31, 1993, compared to $93.3 million a year earlier. Included in these totals were loans secured by properties in the New York City metropolitan area of $29.7 million and $49.3 million at December 31, 1993 and 1992, respectively.
The Company has limited exposure to possible losses originating from concentrations of credit extended to any specific industry. No such concentration exceeded 10% of total loans outstanding at December 31, 1993. Furthermore, the Company had no exposure to lesser-developed countries, and only $1.4 million of foreign loans in total. Highly leveraged transactions, including outstanding commitments, comprised only $87.0 million or approximately 1% of loans outstanding at December 31, 1993.
At December 31, 1993, repossessed assets taken in foreclosure of defaulted loans totaled $12.2 million, compared to $16.7 million and $10.4 million at year-end 1992 and 1991, respectively.
OTHER INCOME - ------------
Excluding the effects of investment securities transactions, other income totaled $109.7 million in 1993, 12% above the $98.2 million earned in 1992 and 42% improved from $77.2 million in 1991.
Benefiting from a full year of revenue derived from customers of the former Central Trust and Endicott Trust, along with higher revenues from securities clearing, income from trust and investment services increased 41% to $23.9 million in 1993 from $16.9 million in 1992. The 1993 result was more than double 1991's $11.8 million, also largely due to twelve months of income from former Central Trust and Endicott Trust customers and higher securities clearing revenues. Including fee income from acquired deposits, service charges on deposit accounts increased 14% to $32.3 million in 1993, while in 1992 there was a 37% increase to $28.4 million from $20.7 million in 1991. The full-year effect of the Central Trust and Endicott Trust acquisitions helped increase merchant discount and other credit card fees to $7.9 million in 1993, from $6.7 million and $5.8 million in 1992 and 1991, respectively. Trading account profits were $2.7 million in 1993, up from $1.7 million earned in 1992, but down from $5.0 million earned in 1991.
Other revenues from operations were $42.9 million in 1993, down slightly from $44.5 million in 1992, but up 26% from $33.9 million in 1991. Included in other revenues from operations were gains from the sales of out-of-state loans obtained in acquisitions of $2.8 million in 1993, $6.0 million in 1992 and $5.6 million in 1991. Excluding such gains, other revenues from operations increased 4% from 1992 and 41% from 1991. Although revenues attributable to the acquisitions contributed to the improvement in 1993, the increase in other revenue from 1992 was, in large part, also due to additional income from the origination, sale and servicing of residential mortgage loans, asset management services and other loan fees. Other revenues in 1992 included $2.5 million of non- recurring earnings on options written to sell certain mortgage-backed securities. At December 31, 1993, residential mortgage loans serviced for others were approximately $2.9 billion. In 1993, the Company purchased servicing rights for approximately $395 million of residential mortgage loans.
OTHER EXPENSE - -------------
Other expense totaled $327.8 million in 1993, up from $311.3 million in 1992 and $228.7 million in 1991. During 1993, the Company completed both the integration of Central Trust and Endicott Trust operations into M&T Bank and the major project to upgrade the Company's computer systems. The completion of these significant initiatives served to reduce operating expenses. However, offsetting the impact of these reduced expenses were the inclusion of a full year of ongoing operating expenses associated with the Central Trust and Endicott Trust franchises, increased processing costs associated with the additional revenues from residential mortgage banking activities and increased advertising and promotional expenses.
Salaries and employee benefits expense was $154.3 million in 1993, 18% higher than the $130.8 million in 1992. Salaries and benefits expense was $103.2 million in 1991. The additional six months of expense associated with the acquired franchises of Central Trust and Endicott Trust, merit salary increases and growth in the Company's residential mortgage lending and servicing business were the primary factors contributing to the increase in 1993. Staffing requirements necessitated in large part by acquisition activity has resulted in an increase in the number of employees in recent years. The number of full-time equivalent employees was 4,028 at December 31, 1993, compared to 3,959 and 3,053 at December 31, 1992 and 1991, respectively.
Nonpersonnel expenses for 1993 totaled $173.5 million, down 4% from $180.6 million in 1992. Such expenses were $125.5 million in 1991. Several significant factors in 1993 more than offset the increases in expenses associated with the 1992 acquisitions and other business growth previously noted. Most notable was a $12.1 million reduction to $4.7 million in write-downs of the carrying value of excess servicing fees and purchased mortgaged servicing rights associated with residential mortgage loans serviced for others. The amount of excess fees and purchased servicing rights recorded as assets was $17 million at December 31, 1993. As previously noted, the project to significantly upgrade the Company's major computer systems was successfully completed in 1993. Expenses associated with this project were approximately $1.0 million in 1993, compared with $9.2 million in 1992 and $4.7 million in 1991.
INCOME TAXES - ------------ The provision for income taxes in 1993 was $71.5 million, up from $64.8 million in 1992 and $47.6 million in 1991. The effective tax rates were 41% in 1993 and 1991 and 40% in 1992.
On August 10, 1993, President Clinton signed the Omnibus Budget Reconciliation Act of 1993 into law. As part of the legislation, effective January 1, 1993, the tax rate applied to corporate taxable income in excess of $10 million was increased 1% to 35%. Under SFAS No. 109, the effects of the higher tax rate (and other changes made by the legislation) are recognized in determining financial statement income and deferred tax assets and liabilities in the period that includes the date of enactment. Accordingly, the aggregate effect of the legislation was to increase income tax expense and the effective tax rate in 1993 by approximately $792 thousand and .46%, respectively, including a $698 thousand benefit related to years prior to 1993.
In the first quarter of 1992, the Company prospectively adopted SFAS No. 109 which mandates a liability method of accounting for income taxes. Such adoption did not result in any net adjustment to the Company's balance sheet and, accordingly, there was no charge in the consolidated statement of income for 1992 resulting from the change in accounting principle.
INTERNATIONAL ACTIVITIES - ------------------------
The Company's investment in international assets was $62 million and $36 million at December 31, 1993 and 1992, respectively. Total offshore deposits were $189 million and $118 million at December 31, 1993 and 1992, respectively.
LIQUIDITY AND INTEREST RATE SENSITIVITY - ---------------------------------------
A critical element in managing a banking institution is ensuring that sufficient cash flow and liquid assets exist to satisfy demands for loans, deposit withdrawals and other corporate purposes. The Company's core deposit base has historically provided a large source of funds. Such deposits financed 68% of the Company's earning assets at December 31, 1993, compared to 83% at December 31, 1992. Consistent with the experience of other financial institutions, the Company's core deposits, both in amount and as a percentage of earning assets, have declined. Such decline has been primarily in time deposit accounts as many depositors have transferred funds out of the banking system into alternative investment vehicles, such as mutual funds. The Company supplements funding from core deposits with various wholesale funds such as Federal funds purchased and securities sold under agreements to repurchase. Additionally, during 1993 M&T Bank and East New York became stockholders of the Federal Home Loan Bank of New York. Among other things, such memberships provide a combined credit facility of approximately $500 million, secured by residential mortgage loans and investment securities. Borrowings outstanding under such credit facility were $310 million at December 31, 1993. Further, funding is available through various arrangements for unsecured short-term borrowings from a wide group of banks and other financial institutions which, while informal and sometimes reciprocal, aggregate to several times anticipated funding needs. Other sources of liquidity include maturities of money- market assets, repayments of loans and investment securities, and cash flow generated from operations.
First Empire's ability to pay dividends and fund operating expenses is primarily dependent on the receipt of dividend payments from its banking subsidiaries, which are subject to various regulatory limitations. Additionally, First Empire maintains a line of credit with a commercial bank.
First Empire and the Company do not currently anticipate engaging in any activity, in either the short- or long-term, which would cause a significant strain on liquidity. Management believes that available sources of funds are currently more than sufficient to meet anticipated funding needs.
Table 14 reflects the effect of repricing assets and liabilities on a contractual basis, and is presented in accordance with industry practice. The cumulative repricing figures in the table represent the net position of assets and liabilities contractually subject to repricing in specific time periods, adjusted for the impact of interest rate swaps entered into as hedge transactions. Management believes this measure does not appropriately depict interest rate risk since changes in interest rates do not necessarily affect all categories of earning assets and interest- bearing liabilities equally nor, as presented in the table, on the contractual maturity or repricing date. Additionally, assessing interest rate risk from a static position fails to consider ongoing lending and deposit gathering activities as well as projected changes in balance sheet composition.
In management's opinion, the foregoing interest rate sensitivity analysis does not appropriately reflect the Company's actual sensitivity to changes in the interest rate environment. Management monitors interest rate sensitivity with the aid of a computer model which takes into account typical interrelationships in the magnitude and timing of the repricing of all banking
and investment products, including the effects of expected prepayments. Through analysis of such information, management believes that the Company's exposure to changing interest rates, as modified by interest rate swaps, is substantially different than the data presented in the accompanying table may imply. Management believes that the Company's net interest income would benefit from rising interest rates over a two to three year period; however, it is expected that higher interest rates would have a short-term detrimental effect on net interest income. Management closely monitors interest rate risk and stands ready to take action to mitigate the Company's exposure when circumstances deem it prudent to do so.
As part of overall interest rate sensitivity management, the Company has entered into currently effective interest rate swap contracts to help balance the Company's interest rate sensitivity position. The notional amount of such contracts was approximately $1.2 billion at December 31, 1993. In general, under the terms of these swaps, the Company receives a fixed rate of interest and pays a variable rate. The swaps increased net interest income by $34.2 million and net interest margin by 34 basis points in 1993. The increase in net interest income and margin in 1992 was $20.1 million and 22 basis points, respectively. Of the interest rate swaps currently in effect, $400 million mature in the first quarter of 1996. In general, beginning in 1995, the notional amount of the remaining swaps currently in effect will decline depending on the level of interest rates or the prepayment behavior of mortgage-backed securities to which the swaps are indexed. As of December 31, 1993, the Company had also entered into several forward swaps having a notional amount of $475 million. Such forward swaps had no effect on net interest income in 1993.
CAPITAL - ------- Common stockholders' equity totaled $684.0 million at December 31, 1993, compared with $586.8 million and $495.8 million at the end of 1992 and 1991, respectively. On a per share basis, common stockholders' equity was $99.43 at December 31, 1993, up from $85.79 per share a year earlier and $73.91 at December 31, 1991. Total stockholders' equity was $724.0 million or 6.99% of total assets at December 31, 1993, compared with $626.8 million or 6.54% at December 31, 1992 and $535.8 million or 5.84% at December 31, 1991. The ratio of average total stockholders' equity to average total assets was 6.45%, 6.10% and 5.96% in 1993, 1992 and 1991, respectively.
Included in stockholders' equity were $9.1 million of net unrealized investment gains resulting from the Company's adoption of SFAS No. 115 on December 31, 1993. Such unrealized gains represent the amount by which fair value exceeded amortized cost for investment securities classified pursuant to SFAS No. 115 as "available for sale", net of applicable income taxes.
To assess the capital adequacy of banking institutions, Federal regulators have implemented risk-based capital measures. Generally, a banking institution is required to maintain risk-based "core capital" and "total capital" ratios of at least 4% and 8%, respectively. In addition to the risk-based measures, Federal bank regulators have also implemented a minimum "leverage" ratio guideline of 3% of the quarterly average of total assets. The capital ratios of the Company and its banking subsidiaries, M&T Bank and East New York, as of December 31, 1993 are presented in table 15.
Excluding the effects of realized and unrealized gains from investment securities, First Empire's rate of internal capital generation rose to 12.66% in 1993 from 11.59% in 1992 and 11.00% in 1991. As a supplement to capital additions generated from earnings, First Empire issued $40 million of cumulative convertible 9% preferred stock in March 1991. Additionally, M&T Bank issued $75 million of ten year subordinated notes in December 1992, which further strengthened the "total capital" ratios of M&T Bank and the Company.
Cash dividends on common stock of $13.1 million were paid in 1993 compared with $10.8 million in 1992 and $9.3 million in 1991. In the second quarter of 1993, First Empire's quarterly common dividend rate was increased to $.50 per share from $.40. In total, dividends per common share increased to $1.90 in 1993 from $1.60 in 1992. Total dividends paid per common share were $1.40 in 1991. Dividends of $3.6 million were paid to the preferred stockholder in 1993 and 1992. Preferred stock dividends totaled $2.9 million in 1991.
In December 1993 First Empire announced a plan to purchase and hold as treasury stock up to 506,930 shares of its common stock as a reserve for the possible future conversion of its 9% convertible preferred stock. Such preferred stock is convertible at any time into shares of First Empire's common stock at a conversion price of $78.90625 per share, subject to certain adjustments. First Empire has the right to redeem the preferred stock without premium on or after March 31, 1996. However, upon receipt of notification of such a planned redemption, the holder may convert the preferred stock into common shares. As of December 31, 1993, no common shares had been purchased pursuant to the plan.
RECENTLY ISSUED ACCOUNTING STANDARDS NOT YET ADOPTED - ---------------------------------------------------- In May 1993 the Financial Accounting Standards Board issued SFAS No. 114 "Accounting by Creditors for Impairment of a Loan". SFAS No. 114 requires that creditors measure certain impaired loans based on the present value of expected future cash flows, discounted at the loan's effective interest rate or at the loan's observable value or the fair value of underlying collateral, if the loan is collateral-dependent. SFAS No. 114 applies to financial statements for fiscal years beginning after December 15, 1994. When adopted, SFAS No. 114 is not expected to have an adverse impact on the Company's results of operations.
33.1
FIRST EMPIRE STATE CORPORATION AND SUBSIDIARIES Table 11
MATURITY OF DOMESTIC CERTIFICATES OF DEPOSIT AND TIME DEPOSITS WITH BALANCES OF $100,000 OR MORE
Dollars in thousands December 31, 1993 - ---------------------------- ----------------- Under 3 months $ 188,666 3 to 6 months 30,336 6 to 12 months 19,243 over 12 months 51,072 - ---------------------------- ----------------- Total $ 289,317 ============================ =================
Item 8. | 36270 | 1993 |
Item 6. Selected Financial Data
Reference is made to the Registrant's Annual Report to Shareholders, page 28, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Reference is made to the Registrant's Annual Report to Shareholders, pages 24 to 27, for the year ended December 31, 1993, incorporated herein and filed as Exhibit 13.
Item 8. | 40874 | 1993 |
Item 6. Selected Financial Data: - -------------------------------------------------------------------------------- Eight-Year Summary Selected Financial And Statistical Data (Dollars in thousands except per share data)
(a) After extraordinary charges in 1990 and 1987 resulting from prepayment of debt obligations of $1.24 million or $.03 per share net of tax, and $.68 million or $.02 per share, net of tax, respectively. (b) Income per common share for 1987 and 1986 is based upon pro forma net income of $17.71 million and $10.69 million, respectively. (c) After a charge in 1992 of $10.65 million or $.26 per share resulting from the cumulative effect of a change in accounting principle for income taxes. (d) Year of initial public offering. (e) First full year of operations.
Item 7. | Item 7. Management's Discussion and Analysis:
Management's Discussion and Analysis Calgon Carbon Corporation
Overview
Industry
Worldwide recessionary conditions continued to adversely affect the activated carbon industry during 1993. Pricing of activated carbon products was impacted by the lack of demand in relation to increased activated carbon production and reactivation capacity worldwide.
The overall United States market showed a slight increase but this was offset by declines in Europe and Japan where recessionary conditions increased. Potential markets in Eastern Europe did not materialize due to lack of funds.
Certain trends continue to affect the activated carbon industrial process and environmental markets. First, companies are increasing their efforts to reengineer processes to reduce waste and cost of production, thereby decreasing the demand for activated carbon and service. Second, there has been a delay of major carbon fills particularly in the municipal potable water area.
The markets for equipment utilized in the application of activated carbon for water and air purification and industrial processes remain weak. Lack of bid awards and extremely competitive conditions in metal fabrication reduced pricing and lowered margins.
The Company
The Company experienced recessionary effects in all market and product areas. Reduced volume resulted in significant pricing pressure in most areas of the business. Potential major carbon fills in the United States potable water market did not occur in 1993. Increased activity in the European potable water market, principally by water companies in the United Kingdom offset shortfalls in the United States and other countries.
As a result of decreased volume during the year, the Company effectively idled two lines at its Catlettsburg, Kentucky plant in order to control inventory levels. Hourly workers were laid off as a result of this action.
In order to match the work force to present activity levels, the worldwide salaried staff was reduced 8% by the end of 1993.
Based upon present conditions, the Company has taken steps and will continue to focus its efforts on improving customer satisfaction through a total quality effort. Two new product lines, Filtraform/TM/ (activated carbon in cylindrical and panel shapes) and Centaur/TM/ (activated carbon with greatly enhanced catalytic properties) have been introduced.
The activated carbon activities in Germany will be operated at a level in line with their markets and will be required to self-finance investment requirements.
The Company continues to believe that the potable water market has significant potential; however, development efforts will be concentrated in industrial process markets as it is anticipated that recovery from recessionary conditions will occur first in these markets.
Results of Operations
Consolidated net sales in 1993 declined by $28.9 million or 9.7% versus 1992. This decrease was throughout the carbon, service and equipment areas. The overall decrease was the net result of volume and price decreases due to the worldwide recession and excess capacity in the carbon industry and to the effect of unfavorable currency rate changes of $9.4 million. On a market basis, net sales to the industrial process area decreased by 12.4% while net sales in the environmental area declined by 6.2% in 1993 versus 1992. The industrial process decline occurred primarily in the original equipment manufacture and food areas due to significant non-repeat 1992 sales and product selection shifts. The decrease in the environmental market also reflected the non-repeating nature of significant 1992 municipal category sales. Net sales in 1992 decreased by $10.0 million or 3.2% from 1991. Minor increases were experienced in the carbon, service and charcoal/liquid areas offset by a nearly 30% decline in the equipment area. Currency exchange had an overall positive effect of approximately $5.2 million on 1992 sales as compared to 1991. From a market standpoint, sales into the industrial process area declined 2.7% from 1991 to 1992 and sales to the environmental area declined 4.8% for the similar period.
Gross profit before depreciation as a percentage of net sales was 39.0%, 40.8% and 40.5% for 1993, 1992 and 1991, respectively. The 1993 decline from 1992 was primarily the combination of lower selling prices and customer shifts to lower margin products. The slight improvement from 1991 to 1992 can generally be attributed to a reduced level of low-margin major equipment sales and improvement in variable gross margins somewhat offset by the impact of higher fixed manufacturing costs in relation to the volume of sales.
Depreciation increased by $2.0 million in 1993 versus 1992 and by $3.7 million in 1992 over 1991. The 1993 increase was principally the result of the full year's depreciation rate used for the Pearl River, Mississippi plant in 1993 versus a half year rate for 1992, its first year of operation. The 1992 increase can particularly be associated with the aforementioned start-up of this plant but also resulted from other significant capital spending.
Selling, general and administrative expenses decreased by $1.9 million in 1993 versus 1992 while 1992 reflected an increase of $2.1 million over 1991. The 1993 decrease was primarily related to reduced personnel costs resulting from the year-end 1992 voluntary retirement incentive program in the United States, other worldwide staff terminations, 1993 initiated cost control programs including the absence of executive bonuses due to the Company's performance and reductions due to currency rate changes. These decreases were partially offset by inflation. The 1992 increase over 1991 was primarily due to increased sales personnel associated costs in the United States as the Company attempted to maintain momentum and market share.
Research and development expenses, as a percentage of sales, were 2.4%, 2.1% and 1.9% in 1993, 1992 and 1991, respectively.
Interest income increased by $0.4 million in 1993 over 1992 but decreased by $0.6 million in 1992 from 1991. The 1993 increase was due to increased investable cash resulting from moving from the previous year's borrowing position. Conversely, the decrease in 1992 versus 1991 was the result of borrowings in 1992.
Interest expense decreased in 1993 by $0.4 million from 1992 and increased by $0.3 million over 1991. Both changes were the result of borrowing activity in the indicated years.
The effective tax rate for 1993 was 37.8% compared to 34.9% in 1992 and 37.2% in 1991. The 1993 increase was primarily the result of the United States passage of the "Omnibus Budget Reconciliation Act of 1993" which was retroactive to January 1, 1993, which not only affected the current year's tax provision, but also required the remeasurement of the Company's deferred tax liability to revised tax rates. The 1992 change versus 1991 was the result of the Company's January 1, 1992, adoption of the Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes". This also resulted in an unfavorable cumulative adjustment to first quarter 1992 net income of $10.7 million. (See Note 11 to the Consolidated Financial Statements.)
The Company does not believe that inflation has had a significant effect on its business during the periods discussed.
Working Capital and Liquidity
Net cash flows from operating activities totalled $41.1 million in 1993, $45.4 million in 1992 and $47.2 million in 1991. The Company expects to be a net generator of cash, providing sufficient funding on an annual basis for debt service, working capital, payment of dividends and a maintenance level of capital expenditures, short of any major capital expansions.
During 1992 and 1991, significant capital was expended in building the Pearl River plant which had a total cost of approximately $68 million. This project is now completed.
During the second quarter of 1993 the Company negotiated two new credit facilities, one with a bank in the United States and one in Germany in the amounts of $10 million and approximately $11.5 million (deutsche mark 20 million) respectively. These credit facilities have a duration of one year and "until further notice", respectively. As a result, the Company has two United States credit facilities in the amounts of $10 million each, expiring as of April 30, 1994 and May 30, 1994 and the aforementioned German credit facility. Based upon its present financial position and history of operations, it is contemplated that these credit facilities, coupled with cash flow from operations, will provide sufficient liquidity to cover its debt service and any reasonable foreseeable working capital, capital expenditure, stock repurchase and dividend requirements.
In July of 1993, the board of directors authorized the purchase of up to two million shares, or approximately 5% of the Company's common stock. Purchases will be made from time to time at prices that management considers appropriate and the repurchased shares will be held as treasury stock. During the year, the Company began to purchase these shares. During this period, 153,600 shares were purchased at a cost of $1.6 million.
It is the current intention of the Company to declare and pay quarterly cash dividends on its common stock. The Company has paid cash dividends since the third quarter of 1987, the quarter succeeding the one in which the Company went public. The declaration and payment of dividends is at the discretion of the Board of Directors of the Company. The declaration and payment of future dividends and the amounts thereof will be dependent upon the Company's results of operations, financial condition, cash requirements for its business, future prospects and other factors deemed relevant by the Board of Directors.
Capital Expenditures and Investments
Capital expenditures were $15.1 million in 1993, $24.0 million in 1992 and $70.6 million in 1991. Major expenditures in 1993 were made for production improvements at the Blue Lake, California plant ($3.2 million), a specific new product production capability at the Neville Island, Pennsylvania plant ($1.8 million) and costs associated with domestic service customer capital ($2.7 million). The 1992 and 1991 expenditure amounts included costs associated with the construction of the Pearl River prime carbon production facility. Capital expenditures for the year of 1994 are projected to be approximately $21.0 million.
Item 8. | 812701 | 1993 |
Item 6. Five Year Summary of Selected Financial Data
NOTE: Dollars are in thousands except per share amounts. All years include 52 weeks.
* Restated to give retroactive effect for 5-for-1 stock split in July 1992. Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Business Environment
As of December 25, 1993, the Company operated 425 retail grocery stores representing approximately 18.1 million square feet of retail space. Historically, the Company's primary competition has been from national and regional chains and smaller independents located throughout its market areas. The Company has continued to experience increased competition from mass merchandisers. The products offered by these retailers include many of the same items sold by the Company.
All of the Company's stores are located in Florida with the exception of 15 stores located in Georgia and one store located in South Carolina. The Company opened its first store in Georgia during the fourth quarter of 1991, four stores during 1992 and 10 additional stores during 1993. The Company opened its first store in South Carolina during the fourth quarter of 1993. The Company intends to continue to pursue vigorously new locations in Florida and other states.
Liquidity and Capital Resources
Operating activities continue to be the Company's primary source of liquidity. Net cash provided by operating activities was approximately $370.4 million in 1993 compared with $296.8 million in 1992 and $313.7 million in 1991. Working capital was approximately $137.2 million as of December 25, 1993 as compared with $241.2 million and $271.4 million as of December 26, 1992 and December 28, 1991, respectively. Cash and cash equivalents aggregated $199.0 million as of December 25, 1993, as compared with $293.5 million and $332.8 million as of December 26, 1992 and December 28, 1991, respectively.
Capital expenditures totaled $320.2 million in 1993. These expenditures were primarily incurred in connection with the opening of 29 new stores and remodeling or expanding 13 stores which added 1.63 million square feet. Significant expenditures were incurred in the continued expansion of the Deerfield Beach, Florida facility, acquisition of a grocery warehouse in Orlando, Florida and construction of a new general merchandise warehouse in Lakeland, Florida and a new distribution center in Lawrenceville, Georgia. In addition, the Company closed four stores. Capital expenditures totaled $202.6 million in 1992. These expenditures were primarily incurred in connection with the opening of 20 new stores and remodeling or expanding 12 stores which added 1.14 million square feet. Significant expenditures were incurred in expanding the Deerfield Beach facility. In addition, the Company closed 12 stores. Capital expenditures totaled $159.0 million in 1991. These expenditures were primarily incurred in connection with the opening of 20 new stores and remodeling or expanding 11 stores which added 1.10 million square feet. In addition, the Company closed six stores.
The Company hopes to open as many as 60 stores in 1994. Although real estate development is unpredictable, the Company's 1994 new store growth represents a reasonable estimate of anticipated future growth. Capital expenditures for 1994, primarily made up of new store construction, the remodeling or expanding of several existing stores and the expansion and construction of distribution facilities, are expected to be approximately $400 million. This capital program is subject to continuing change and review. The 1994 capital expenditures are expected to be financed by internally generated funds and current liquid assets. In the normal course of operations, the Company replaces stores and closes unprofitable stores. The impact of future store closings is not expected to be material. The Company is self-insured, up to certain limits, for health care, fleet liability, general liability and workers' compensation claims. Reserves are established to cover estimated liabilities for existing and anticipated claims based on actual experience including, where necessary, actuarial studies. The Company has insurance coverage for losses in excess of varying amounts. The provision for self-insured reserves was $90.1 million, $78.7 million and $56.2 million in fiscal 1993, 1992 and 1991, respectively. The Company does not believe its self-insurance program will have a material adverse impact on its future liquidity, financial condition or results of operations.
The Company has committed lines of credit for $75.0 million. These lines are reviewed annually by the banks. The interest rate for these lines is at or below the prime rate. No amounts were outstanding on the lines of credit as of December 25, 1993 or December 26, 1992.
Cash generated in excess of the amount needed for current operations and capital expenditures is invested in short-term and long-term investments. Short-term investments were approximately $59.8 million in 1993 compared with $50.4 million in 1992. Long- term investments, primarily comprised of tax exempt bonds and preferred stocks, were approximately $199.4 million in 1993 compared with $126.8 million in 1992. Management believes the Company's liquidity will continue to be strong.
The Company currently repurchases common stock at the stockholders' request in accordance with the terms of the Company's Employee Stock Purchase Plan. The Company expects to continue to repurchase its common stock, as offered by its stockholders from time to time, at its then currently appraised value. However, such purchases are not required and the Company retains the right to discontinue them at any time.
Results of Operations
The Company's fiscal year ends on the last Saturday in December. Fiscal years 1993, 1992 and 1991 included 52 weeks.
Sales for fiscal 1993 were $7,472.7 million as compared with $6,664.3 million in fiscal 1992, a 12.1% increase. This reflects an increase of $426.5 million or 6.4% in sales from stores that were open for all of both years (comparable stores) and sales of $381.9 million or 5.7% from the net impact of 29 new stores and four closed stores. This activity contributed a net increase of 9.0% or approximately 1.50 million square feet in retail space.
Sales for fiscal 1992 were $6,664.3 million as compared with $6,139.7 million in fiscal 1991, an 8.5% increase. This reflects an increase of $283.9 million or 4.6% in sales from stores that were open for all of both years (comparable stores) and sales of $240.7 million or 3.9% from the net impact of 23 new stores and 12 closed stores. This activity contributed a net increase of 5.9% or approximately .88 million square feet in retail space. This includes the acquisition of three stores from affiliated companies and the three stores closed as a result of extensive damage caused by Hurricane Andrew. In 1992, the Company identified potential environmental problems relating to properties that are owned or leased. Other income, net includes $8.0 million which was accrued for estimated clean-up costs. On August 24, 1992, Hurricane Andrew destroyed three of the Company's stores in south Florida. Several other stores sustained varying degrees of damage but were operational within four weeks. In management's opinion, the resulting property damage and business interruption losses are substantially covered by insurance and are immaterial to the Company's financial position and operations.
Cost of merchandise sold including store occupancy, warehousing and delivery expenses was approximately 78.1% of sales in 1993 as compared with 77.8% and 77.3% in 1992 and 1991, respectively. In 1993 and 1992, cost of merchandise sold increased as a percent of sales due to competitive pressures.
Operating and administrative expenses, as a percent of sales, were 19.1%, 19.3% and 19.9% in 1993, 1992 and 1991, respectively. In 1993, the Company's workers' compensation expense increased approximately $17.5 million or 89% as compared to 1992 due to increases in claim payments and estimated reserves for claim payments. The significant components of operating and administrative expenses are payroll costs, employee benefits and depreciation.
In August 1993, the "Omnibus Budget Reconciliation Act of 1993" became effective. The major provision of the new tax law affecting the Company is the increase in the maximum corporate income tax rate from 34% to 35%. This 1% increase in the tax rate was retroactive to January 1, 1993. Therefore, in accordance with Financial Accounting Standard No. 109, "Accounting for Income Taxes," the Company recognized an additional $3.5 million income tax expense during fiscal year 1993.
In recent years, the impact of inflation on the Company's food prices continues to be lower than the overall increase in the Consumer Price Index.
New Accounting Standards
The Company adopted Statement 109, without restating prior years' financial statements, in the first quarter of 1993. This Standard requires a change from the deferred method to the asset and liability method of accounting for income taxes. The cumulative effect of the change in method resulted in a reduction of deferred Federal and state income taxes and an increase in net earnings of approximately $11.8 million.
The Company adopted Financial Accounting Standard No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," in the first quarter of 1993. This Standard requires that an employer's obligation for postretirement benefits be fully accrued by the date the employees attain full eligibility to receive these benefits. The Company provides certain life insurance benefits for retired employees. Employees become eligible for these benefits when they reach normal retirement age while working for the Company. The cumulative effect of the change in method resulted in a decrease in net earnings of approximately $15.3 million. At the beginning of 1993, the accumulated postretirement obligation accrued was $24.6 million. During 1993, the Company's accrual increased approximately $1.9 million in additional annual costs under the new Standard.
In May 1993, the Financial Accounting Standards Board issued Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities," effective for fiscal years beginning after December 15, 1993. This Standard expands the use of fair value accounting for certain debt securities that are classified as available-for-sale or trading but retains the use of the amortized cost method for investments in debt securities that the Company has the positive intent and ability to hold to maturity. The Company will prospectively adopt Statement 115 in the first quarter of 1994. This Standard is not expected to materially affect the Company's financial statements. In November 1992, the Financial Accounting Standards Board issued Financial Accounting Standard No. 112, "Employers' Accounting for Postemployment Benefits," effective for fiscal years beginning after December 15, 1993. This Standard requires the accrual of a liability for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. The Company has historically accrued postemployment benefits; therefore, the adoption of Statement 112 will not materially affect the Company's financial statements.
Item 8. | 81061 | 1993 |
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
Earnings per share of $2.45 in 1993 were the highest in Company history, following 1992 earnings of $2.26. The record 1993 earnings exceeded the previous all-time high of $2.37 in 1991 by 3%.
The 1993 earnings were favorably impacted by higher operating revenues due to weather-related increases in retail gas and electric sales. Greater maintenance and nonfuel-related operating expenses and fewer sales to wholesale electric customers partially offset the impact of the higher retail sales. Increased allowance for funds used during construction resulting from the Company's expanded construction program also contributed to the higher earnings.
For the thirty-fifth consecutive year, the Board of Directors declared a dividend increase to common shareholders at its January 1994 meeting. Payable in March 1994, the Company's new quarterly dividend is 41-1/4cents per share, increasing the indicated annual rate to $1.65 per share.
ELECTRIC OPERATIONS.
The table below compares changes in operating revenues, operating expenses, and electric sales between 1993 and 1992, and between 1992 and 1991, in summary form.
Higher weather-related sales to the Company's retail customers was the primary reason for the 6.3% ($15.3 million) rise in electric operating revenues. Effective October 1, 1993, the Company implemented the first step (about 1% overall) of a three-step increase in its base electric rates to recover the cost of complying with the Clean Air Act Amendments of 1990 (see "Rate and Regulatory Matters"), however, the rate increase had little impact on electric revenues during 1993. In 1992, operating revenues declined 7.9% ($20.8 million) due to fewer sales to retail and wholesale customers.
Cooler winter weather and much warmer summer temperatures, when cooling degree days were 30% greater than the prior year and about 17% above normal, were responsible for the 12.1% and 6.3% increases in residential and commercial sales, respectively. Following flat sales in 1992, industrial sales rose 5.7% during the current year due to increased manufacturing activity. Total system sales were up 7.6% over 1992. The Company experienced a 3.1% overall decline in system sales in 1992 when cooling degree days were down 30%.
During 1993, the Company's electric customer base grew by 1,276, or 1%, totaling 118,163 at year end.
In addition to greater system sales, 1993 system revenues increased approximately $2.7 million due to the recovery of higher unit fuel costs (see subsequent discussion of changes in the cost of fuel for electric generation), following a $4.7 million reduction in electric revenues in 1992 due to lower unit costs. Changes in the cost of fuel for electric generation and purchased power are reflected in customer rates through commission approved fuel cost adjustments.
Because of the current worldwide oversupply of primary aluminum and softening demand for rolled can sheet aluminum in the United States, the Aluminum Company of America (Alcoa) shut down several older potlines at various manufacturing facilities. Alcoa Generating Corporation (AGC), a wholly-owned subsidiary of Alcoa, provides the energy requirements for five potlines at Alcoa's Warrick County, Indiana facility from its Warrick Generating Station. Since 1987, the Company has provided electric energy to AGC (a wholesale customer) for a sixth potline. On July 20,1993, Alcoa shut down the oldest of the six potlines at the Warrick County manufacturing operation. The Company estimates that the decline in electric sales related to the potline for 1993 represented approximately $4.8 million in nonsystem revenues and approximately $.8 million in operating income compared to the prior year. Greater sales to other nonsystem customers, due in part to the region's warmer summer temperatures, partially offset the decline in sales to AGC. Total nonsystem sales by the Company declined 8.3% during the year. On an annual basis, the decline in revenue related to the reduced sales to AGC is estimated at $14.4 million with a corresponding $2.4 million decline in operating income. The Company anticipates that a portion of the decline in operating income will be offset in the future by increases in sales to other nonsystem customers made possible by the reduced commitment to AGC. Most sales to nonsystem customers, including AGC, are on an "as available" basis under interchange agreements which provide for significantly lower margins than sales to system customers.
Due to the much warmer summer temperatures, and to the increased demand by industrial customers, a new all-time peak load obligation of 1,100 megawatts was reached on July 28, 1993. The previous record peak, 1,054 megawatts, was set in 1988. The 1992 peak of 992 megawatts was held down by the unseasonably cool summer weather. The Company's total generating capacity at the time of the 1993 peak was 1,238 megawatts, representing an 11% capacity margin.
Fuel for electric generation, the most significant electric operating cost, was comparable to 1992. Slightly (2.8%) higher costs of coal per MMBtu consumed due to less favorable volume-related pricing, higher average per unit mine production costs, and the amortized cost of the buyout of one of the Company's long-term coal contracts (see "Rate and Regulatory Matters"), were offset by a decline in generation. The Company continues to pursue further reductions in coal prices as a key component of its strategy to remain a low-cost provider of electricity. The decline in 1992 fuel cost reflected a 6.2% decrease in generation and a lower average cost of coal consumed.
The greater energy requirements of the Company's customers and favorably priced power were the primary reasons for the increased purchases of electricity from other utilities, up substantially (220%) during 1993. Purchased electric energy costs decreased 48% in 1992 due to fewer purchases and lower average rates paid for such power.
After a 4.1% decrease in 1992, other operation expenditures rose 8.2% ($2.3 million) during the current year chiefly due to increased provisions for injuries and damages, consulting and legal expenditures related to a coal contract buyout (see "Rate and Regulatory Matters") and ongoing coal contract negotiations and litigation, and increases in various administrative and general costs.
Greater production plant maintenance activity was the primary reason for the 20% ($4 million) increase in electric maintenance expense. The Company performed a scheduled major turbine generator overhaul on A.B. Brown Unit 2 during the year and completed a major overhaul on the Culley Unit 1 turbine generator begun in late 1992. The Culley Unit 1 turbine generator overhaul was the only major maintenance project during 1992, when electric maintenance expenditures were down $4.5 million.
Depreciation and amortization expense increased slightly in 1993 reflecting normal additions to utility plant and the completion of the warehouse and operations building at the Company's new Norman P. Wagner Operations Center. A decline in depreciation and amortization occurred in 1992 when amortization provisions related to the deferred return on the phasein of A. B. Brown Unit 2 expired.
While inflation has a significant impact on the replacement cost of the Company's facilities, under the rate-making principles followed by the Indiana Utility Regulatory Commission (IURC), under whose regulatory jurisdiction the Company is subject, only the historical cost of electric and gas plant investment is recoverable in revenues as depreciation. With the exception of adjustments for changes in fuel and gas costs and margin on sales lost under the Company's demand side management programs (see "Demand Side Management"), the Company's electric and gas rates remain unchanged until a rate application is filed and a general rate order is issued by the IURC.
In addition to the impact of higher 1993 pretax income on income tax expense, the Company provided approximately $.5 million of additional federal income tax expense to reflect the higher tax rates enacted under the Omnibus Budget Reconciliation Act of 1993. (See Note1 of the Notes to Consolidated Financial Statements for further discussion.) Decreased income tax expense in 1992 was chiefly attributable to lower pretax income. The decrease in taxes other than income taxes during the current year resulted from a 1992 increase in property tax expense reflecting the general reassessment of the Company's property.
GAS OPERATIONS.
The following table compares changes in operating revenues, operating expenses, and gas sold and transported between 1993 and 1992, and between 1992 and 1991, in summary form.
Greater sales of natural gas and higher gas costs recovered through retail rates led to an 11.5% ($7.2 million) increase in gas operating revenues. Effective August 1, the Company implemented the first step (about 4% overall) of a two-step increase in its base gas rates (see "Rate and Regulatory Matters"), however, the impact on gas revenues during 1993 was not significant.
A 5.6% rise in the Company's gas sales in 1993 reflected increased sales to residential and commercial customers, up 12.8% and 10.2%, respectively. Although heating degree days during the period were about normal, they were 10% greater than those recorded in 1992. Deliveries to industrial customers under the Company's sales and transportation tariffs were up 7.6%, reflecting the increased manufacturing activity of several of the Company's largest industrial customers. In 1992, residential sales were flat and commercial sales were up only 3.1% due to milder winter weather; industrial sales and transportation volumes increased 6.7% during the same period.
During 1993, 1,402 new gas customers were added to the Company's system, raising the year end total 1.4% to 100,398.
On December 23, 1993, the Company entered into a definitive agreement to acquire Lincoln Natural Gas, a small gas distribution company of approximately 1,300 customers contiguous to the eastern boundary of the Company's gas
service territory. The acquisition is expected to be completed by mid-1994, subject to necessary regulatory and shareholder approvals.
The recovery of higher unit gas costs, up 6.1%, through retail rates in 1993 raised revenues $2.7 million following a $1.3 million increase in revenues related to the recovery of higher unit costs in the prior year. During the past two years, the market for purchase of natural gas supply has been very volatile with the average price ranging from a low of $1.34 per Dth in February 1992 to the peak of $2.58 per Dth in May 1993. Prices have declined somewhat since May but remain above the February low reflecting a general tightening of the balance between available supply and demand after several years of excess supply. Changes in the cost of gas sold are passed on to customers through IURC approved gas cost adjustments.
Cost of gas sold, the major component of gas operating expenses, was up 9.7% ($4.5 million) in 1993, following a 13.2% ($5.4 million) increase in 1992. The higher costs in both 1993 and 1992 reflected the increased deliveries to customers and higher unit costs.
Although the Company's primary pipeline supplier, Texas Gas Transmission Corporation (TGTC), implemented revised tariffs November 1, 1993 to reflect certain changes required by Federal Energy Regulatory Commission (FERC) Order 636, the Company's 1993 purchased gas costs were relatively unaffected by the new tariffs. As of November 1,1993, TGTC ceased to be a supplier of natural gas to the Company, and the Company assumed full responsibility for the purchase of all its natural gas supplies. (See "Rate and Regulatory Matters" for further discussion of FERC Order No. 636 and of the impact on future purchased gas costs and procurement practices of the Company.)
Other operation and maintenance expenses were 31% ($3.1 million) greater than the prior year due to increased provisions for injuries and damages (see "Environmental Matters" for discussion of the Company's investigation of the possible existence of facilities utilized for the manufacture of gas), abnormally low distribution maintenance expenses in 1992, and increases in various administrative and general costs.
Depreciation expense for 1993 and 1992 reflected increased gas plant additions during the past several years due to new business requirements and various improvements made to the distribution system. Partially offsetting the impact of increased gas plant additions were lower depreciation rates implemented during 1993 as a result of the Company's recent gas rate case.
Income tax expense for the current year was comparable to 1992, following a substantial decrease in income tax expense in 1992 resulting from lower pretax operating income.
OTHER INCOME AND INTEREST CHARGES.
Other income was $2.5million greater during 1993 due to increased allowance for equity funds used during construction, resulting primarily from the construction of the Company's new sulfur dioxide scrubber. (See "Clean Air Act" for further discussion.) Following a significant increase in nonutility income in 1991, nonutility income declined in 1992. The decline was largely due to lower fees from AGC for operation of its Warrick Generating Station.
Interest expense during the current year was relatively unchanged. The impact of an additional $45 million of long- term debt issued during the second quarter was offset by savings from refinancing $105 million of long-term debt in the second quarter, which reduced annual interest expense by $1 million, and by additional interest capitalized due to the increased construction program.
RATE AND REGULATORY MATTERS.
In November 1992, the Company petitioned the IURC requesting a general increase in gas rates, the first such adjustment since 1982. On July 21,1993, the IURC approved an overall increase of approximately 8%, or $5.5 million in revenues, in the Company's base gas rates. The increase is to be implemented in two equal steps. The first step of the rate adjustment, approximately 4%, took place August 1, 1993; the second step will become effective August 1, 1994.
In addition to seeking relief for rising operating and maintenance costs and substantial investment in utility plant over the past decade, the Company sought to restructure its tariffs, make available additional services, and "unbundle" existing services to better serve its gas customers and strategically position itself to address the changes brought about by the continued deregulation of the natural gas industry. (See subsequent discussion of FERC Order No. 636 in this section.)
On May 24, 1993, the Company petitioned the IURC for an adjustment in its base electric rates representing the first step in the recovery of the financing costs on its investment through March 31, 1993 in the Clean Air Act Compliance project presently being constructed at the Culley Generating Station. The majority of the costs are for the installation of a sulfur dioxide scrubber on Culley Units 2 and 3. (See "Clean Air Act" for further discussion of the project and previous approval of ratemaking treatment of the incurred costs.) On September 15,1993, the IURC granted the Company's request for a 1% revenue increase, approximately $1.8 million on an annual basis, which took effect October 1, 1993. The Company anticipates petitioning the IURC in February 1994 for a 2-3% increase for financing costs related to the project construction expenditures incurred since April 1,1993, with implementation of the new rates effective mid-1994.
On December 22, 1993, the Company filed a request with the IURC for the third of the three planned general electric rate increases. This final adjustment, expected to occur in early 1995, is estimated to be 6-9% and is necessary to recover financing costs related to the balance of the project construction expenditures, costs related to the operation of the scrubber, and certain nonscrubber-related costs such as additional costs incurred for postretirement benefits other than pensions beginning in 1993 and the recovery of demand side management program expenditures (see "Demand Side Management").
Over the past several years, the Company has been actively involved in intensive contract negotiations and legal actions to reduce its coal costs and thereby lower its electric rates. During 1992, the Company was successful in negotiating a new coal supply contract with one of its major coal suppliers. The new agreement, effective through 1995, was retroactive to 1991. Included in the agreement was a provision whereby the contract could be reopened by the Company for modification of certain coal specifications. In early 1993, the Company reopened the contract for such modifications. In response, the coal supplier elected to terminate the contract enabling the Company to buy out the remainder of its contractual obligations and acquire lower priced spot market coal. The cost of the contract buyout in 1993, which was based on estimated tons of coal to be consumed during the agreement period, and related legal and consulting services, totaled approximately $18 million. The Company anticipates that $2 million in additional buyout costs for actual tons of coal consumed above the previously estimated amount may be incurred during the 1994-1995 period. On September 22, 1993, the IURC approved the Company's request to amortize all buyout costs to coal inventory during the period July 1,1993 through December 31, 1995 and to recover such costs through the fuel adjustment clause beginning February 1994.
The Company estimates the savings in coal costs during the 1991-1995 period, net of the total buyout costs, will approximate $56 million. The net savings are being passed back to the Company's electric customers through the fuel adjustment clause.
The Company is currently in litigation with another coal supplier in an attempt to restructure an existing contract. Under the terms of the original contract, the Company was allegedly obligated to take 600,000 tons of coal annually. In early 1993, the Company informed the supplier that it would not require shipments under the contract until later in 1993. On March 26, 1993, the Company and the supplier agreed to resume coal shipments under the terms of their original contract except the invoiced price per ton would be substantially lower than the contract price. As approved by the IURC, the Company has charged the full contract price to coal inventory for subsequent recovery through the fuel adjustment clause. The difference between the contract price and the invoice price has been deposited in an escrow account with an offsetting accrued liability which will be paid either to the Company's ratepayers or its coal supplier upon settlement of the litigation. The escrowed amount was $8,749,000 at December 31, 1993. This litigation is scheduled for trial in June of 1994. Since the litigation arose due to the Company's efforts to reduce fuel costs, management believes that any related costs should be recoverable through the regulatory ratemaking process.
In late 1993, in a further effort to reduce coal costs, the Company and the supplier entered into a letter agreement, effective January 1, 1994, and until the litigation is settled, whereby the Company will purchase an additional 50,000 tons monthly above the alleged base requirements at a price lower than the original contract price for tons over 50,000 per month.
In April 1992, the Federal Energy Regulatory Commission (FERC) issued Order No. 636 (the Order) which required interstate pipelines to restructure their services. In August 1992, the FERC issued Order No. 636-A which substantially reaffirmed the content of the original Order. Under the Order, the stated purpose of which is to improve the competitive structure of the natural gas pipeline industry, existing pipeline sales service was "unbundled" so that gas supplies are sold separately from interstate transportation services. This restructuring has occurred through tariff filings by pipelines after negotiations with their customers. Customers, such as the Company and ultimately its gas customers, could benefit from enhanced access to competitively priced gas supplies as well as from more flexible transportation services. Conversely, customer costs will rise because the Order requires pipelines to implement new rate design methods which shift additional demand-related costs to firm customers; additionally, the FERC has authorized the pipelines to seek recovery of certain "transition" costs associated with restructuring from their customers.
On November 2, 1992, the Company's major pipeline supplier, Texas Gas Transmission Corporation (TGTC), filed a recovery implementation plan with the FERC as part of its revised compliance filing regarding the Order. On October 1, 1993, the FERC accepted, subject to certain conditions, the TGTC recovery implementation plan (the Plan). The Plan, which addresses numerous issues related to the implementation of the requirements of the Order, became effective November 1, 1993. Under new TGTC transportation tariffs, which reflect the Plan's provisions, the Company will incur additional annual demand-related charges of approximately $1.9 million. Savings from lower volume-related transportation costs will partially offset the additional charges. TGTC has not yet determined the Company's allocation of transition costs, however, an estimate of such costs and implementation of revised TGTC tariffs to recover such costs are expected during the first quarter of 1994. Due to the anticipated regulatory treatment at the state level, the Company does not expect the Order to have a detrimental effect on its financial condition or results of operations.
ENVIRONMENTAL MATTERS.
The Company is currently investigating the possible existence of facilities once owned and operated by the Company, its predecessors, previous landowners, or former affiliates of the Company utilized for the manufacture of gas.
These facilities, if they existed, would have been operated from the 1850's through the early 1950's under industry standards then in effect. Operations at these facilities would have ceased many years ago. However, due to current environmental regulations, the Company and other responsible parties may be required to take remedial action if certain materials are found at the sites of these former facilities.
The Company has just recently initiated its investigation, and preliminary assessments have not yet been performed on any sites. However, based on its research, the Company has identified the existence and general location of four sites at which contamination may be present. The Company intends to perform preliminary assessments of all four sites during 1994 and, more than likely, will perform comprehensive investigations of some, or all, of these sites to determine if remedial action is required and to estimate the extent of such action and the associated costs.
The Company has notified all known insurance carriers providing coverage during the probable period of operation of these facilities of potential claims for coverage of environmental costs. The Company has not, however, recorded any receivables representing future recovery from insurance carriers. Additionally, the Company is attempting to identify all potentially responsible parties for each site. The Company has not been named a potentially responsible party by the Environmental Protection Agency for any of these sites.
While the Company intends to seek recovery from other responsible parties or insurance carriers, the Company does not presently anticipate seeking recovery of these investigation costs from its ratepayers. Therefore, the Company has expensed the $.5 million of anticipated cost of performing preliminary site assessments and the more comprehensive specific site investigations of all four sites. If, however, the specific site investigations indicate that significant remedial action is required, the Company will seek recovery of all related costs in excess of amounts recovered from other potentially responsible parties or insurance carriers through rates.
Although the IURC has not yet ruled on a pending request for rate recovery by another Indiana utility of such environmental costs, the IURC did grant that utility authority to utilize deferred accounting for such costs until the IURC rules on the request.
NATIONAL ENERGY POLICY ACT OF 1992.
In late 1992, the National Energy Policy Act of 1992 (the Act) was signed into law, enacting the first comprehensive energy legislation since the National Energy Act of 1978.
Key provisions contained in the Act, specifically Title VII (Electricity), are expected to cause some of the most significant changes in the history of the electric industry. The primary purpose of Title VII is to increase competition in electric generation by enabling virtually nonregulated entities, such as exempt wholesale generators, to develop power plants, and by providing the FERC authority to require a utility to provide transmission services, including the expansion of the utility's transmission facilities necessary to provide such services, to any entity generating electricity. Although the FERC may not order retail wheeling, the transmission of electricity directly to an ultimate consumer, it may order wheeling of electricity generated by an exempt wholesale generator or another utility to a wholesale customer of a regulated utility.
The changes brought about by the Act may require, or provide opportunities for, the Company to compete with other utilities and wholesale generators for sales to existing wholesale customers of the Company and other potential wholesale customers. The Company has long-term contracts with its five wholesale customers which mitigate the opportunity for other generators to provide service to them. Many observers of the electric utility industry, including major credit rating agencies, certain financial analysts, and some industry executives, have expressed an opinion that retail wheeling to large retail customers and other elements of a more competitive business environment will occur in the electric utility industry, similar to developments in the telecommunications and natural gas industries. The timing of these projected developments is uncertain. In addition, the FERC has adopted a position, generically and on a case- by-case basis, that it will pursue a more competitive, less regulated, electric utility industry. Although the Company is uncertain of the final outcome of these developments, it is committed to pursuing, and is moving rapidly to implement, its corporate strategy of positioning itself as a low-cost energy producer and the provider of high quality service to its retail as well as wholesale customers.
The Company already has some of the lowest per unit administrative, operation, and maintenance costs in the nation, and is continuing its efforts to further reduce its coal costs (see previous discussion of coal contract renegotiation in "Rates and Regulatory Matters").
CLEAN AIR ACT.
Revisions to federal clean air laws were enacted in 1990 which have a significant impact on all of American industry. Electric utilities, especially in the Midwest, were severely impacted by Title IV (acid rain provisions) of the Clean Air Act Amendments of 1990.
Title IV mandates utilities to significantly reduce emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx) from coal-burning electric generating facilities in two steps. The Company is required to reduce annual emissions of SO2 on a Company-wide basis by approximately 50% by 1995 (Phase I). By the year 2000 (PhaseII), the Company must reduce emissions of SO2 by approximately 50% from the allowed 1995 level. Since the Company's two newest coal- fired generating units, A.B. Brown Units 1 and2 (500 MW total), are equipped with SO2 removal equipment (scrubbers), the impact of the law, although significant, is not as great for the Company as for some other midwestern utilities.
To meet the Phase I requirements and nearly all of the Phase II requirements, the Company's Clean Air Act Compliance Plan (the Compliance Plan), which was developed as a least-cost approach to compliance, proposed the installation of a single scrubber at the Culley Generating Station to serve both Culley Unit 2 (92MW) and Culley Unit 3 (250 MW) and the installation of state of the art low NOx burners on these two units.
In January 1992, the Company filed a petition with the IURC, requesting preapproval of the Compliance Plan and proposing recovery of financing costs to be incurred during the construction period. In October 1992, the IURC approved a stipulation and settlement agreement between the Company and intervenors pertaining to the petition, which essentially granted the request.
Construction of the facilities, originally projected to cost approximately $115 million including the related allowance for funds used during construction, began during 1992 with completion and testing expected to occur in late 1994. Construction costs are currently running under budget. Commercial operation will begin about January 1, 1995 to
comply with requirements of the Clean Air Act Amendments of 1990. Under the settlement agreement, the maximum capital cost of the compliance plan to be recovered from ratepayers is capped at approximately $107 million, plus any related allowance for funds used during construction. The estimated cost to operate and maintain the facilities, including the cost of chemicals to be used in the process, is $4-6 million per year, beginning in 1995.
By installing a scrubber, the Company was entitled to apply for extra allowances, called "extension allowances", to the federal EPA. However, because utilities applied for more extension allowances than the Act made available, the federal EPA established a lottery procedure to determine which utilities would actually receive the extension allowances. In order to ensure receipt of a majority of the extension allowances, the Company, and nearly all of the other applying utilities, formed an allowance pooling group. As a result, the Company will receive about 88,000 extension allowances, which it has sold to another party under a confidential agreement. The Company will credit the proceeds to customers over 1995-1999, reducing the rate impact of the Compliance Plan.
With the addition of the scrubber, the Company expects to exceed the minimum compliance requirements of Phase I of the Clean Air Act and have available unused allowances, called "overcompliance allowances", for sale to others. Proceeds from sales of overcompliance allowances will also be passed through to customers.
The scrubbing process utilized by the Culley scrubber produces a salable by-product, gypsum, a substance commonly used in wallboard and other products. In December 1993, the Company finalized negotiations for the sale of an estimated 150,000 to 200,000 tons annually of gypsum to a major manufacturer of wallboard. The agreement will enable the Company to reduce certain operating costs and to credit ratepayers with the proceeds from the sale of the gypsum, further mitigating the rate impact of the Compliance Plan.
The rate impact related to the Compliance Plan, estimated to be 7-10%, is being phased in over a three year period beginning in October 1993. (See "Rate and Regulatory Matters" for further discussion.)
DEMAND SIDE MANAGEMENT.
In October 1991, the IURC issued an order approving expenditures by the Company for development and implementation of demand side management (DSM) programs. The primary purpose of the DSM programs is to reduce the demand on the Company's generating capacity at the time of system peak requirements, thereby postponing or avoiding the addition of generating capacity. Thus, the order of the IURC provided that the accounting and ratemaking treatment of DSM program expenditures should generally parallel the treatment of construction of new generating facilities.
Most of the DSM program expenditures are being capitalized per the IURC order and will be amortized over a 15 year period beginning at the time the Company reflects such costs in its rates. The Company is requesting recovery of these costs in its general electric rate increase request filed December 22, 1993 (see "Rates and Regulatory Matters" for further discussion). In addition to the recovery of DSM program costs through base rate adjustments, the Company is collecting, through a quarterly rate adjustment mechanism, most of the margin on sales lost due to the implementation of DSM programs.
The Company expects to incur costs of approximately $51 million on DSM programs during the 1994-1998 period. By 1998, approximately 108 megawatts of capacity are expected to be postponed or eliminated due to these programs. Based on the latest projections, the expenditures for DSM programs, as approved by the IURC, will total an estimated $195 million through the year 2012 and result in overall savings of $160 million to ratepayers due to deferring the construction of about 156 megawatts of new generating capacity.
INTEGRATED RESOURCE PLAN.
In November 1993, the Company filed with the IURC a biannual update to its Integrated Resource Plan (IRP), including the DSM program expenditures referred to above. The IRP process is a least-cost approach to determining the combination of new generating facilities and conservation and load management options that will best meet customers' future energy needs.
The 1993 IRP update was the result of a nine month evaluation of detailed technology costs, customer energy use patterns, and market information, and includes natural gas conservation options not in the initial 1991 IRP. If the new IRP is approved by the IURC, the Company will implement several new DSM programs recommended by the IRP, including a residential weatherization pilot project. Supply side options recommended by the IRP include strategies to diversify the Company's natural gas suppliers, maximize the use of economical purchased power during peak usage periods, and expand the strategic use of the Company's gas storage fields.
While the Company intends to aggressively utilize various DSM programs to help delay the need for additional power sources, the 1993 IRP forecasts the need of a 125 megawatt base-load generating plant in the early 21st century to meet the future electricity needs of the Company's customers.
POSTEMPLOYMENT BENEFITS.
In November 1992, the FASB issued SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective for years beginning after December 15, 1993, which will require the Company to accrue the estimated cost of benefits provided to former or inactive employees after employment but before retirement age. Postemployment benefits include, but are not limited to, salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits (including workers' compensation), and continuation of benefits such as health care and life insurance coverage. The Company will adopt SFAS No. 112 on January 1, 1994. The impact of the new statement will not have a material impact on financial position or results of operations.
LIQUIDITY AND CAPITAL RESOURCES.
The Company experienced record earnings per share during 1993, and financial performance continued to be solid. Internally generated cash, bolstered by the increased retail sales, provided over 74% of the Company's construction and DSM program expenditures, despite the requirements of the Culley scrubber project. Earnings continued to be of high quality, of which 11.4% represented allowance for funds used during construction. The ratio of earnings to fixed charges (SEC method) was 3.8:1, the embedded cost of long-term debt is approximately 6.6%, and the Company's long-term debt continues to be rated AA by major credit rating agencies.
The Company has access to outside capital markets and to internal sources of funds that together should provide sufficient resources to meet capital requirements. The Company does not anticipate any changes that would materially alter its current liquidity.
On April 30, 1993, the Company called $84.5 million of its first mortgage bonds at a premium, plus accrued interest. The bonds called were the 8% due 2001, the 8% due 2002, the 8.35% due 2007, the 9-1/4% due 2016, and the 8-5/8% due 2017. The bonds called, having a weighted average interest rate of 8.5%, were refunded with two $45 million issues carrying interest rates of 6% and 7.6%, due 1999 and 2023, respectively.
On May 11, 1993, the Company issued two series of adjustable rate first mortgage bonds in connection with the sale of Warrick County, Indiana environmental improvement revenue bonds. The proceeds of the bonds have been placed in trust and are being used to finance a portion of the Culley scrubber project. The first series of bonds was for $22.2 million due 2028, the interest rate of which is fixed at 4.65% through April 30, 1998. The second series of bonds was for $22.8 million due 2023; the interest rate of this series is fixed at 6% through maturity.
On June 15, 1993, the Company retired $20 million of 8.50% first mortgage bonds maturing in June of 1993 with $20 million of 7-5/8% first mortgage bonds due 2025.
The only financing activity during 1992 was in December when the Company called 75,000 shares of 8.75% series cumulative preferred stock at $102 per share, plus accrued dividends, with the issuance of 75,000 shares of 6.50% series redeemable cumulative preferred stock, at $100 per share.
During the five year period 1994-1998, the Company anticipates that a total of $47.7 million of debt securities will be redeemed.
Construction expenditures, including $4.5 million for DSM programs, totaled $80.1 million during 1993, compared to the $52.1 million expended in 1992. As discussed in "Clean Air Act", construction of the new scrubber continued in 1993, requiring $49.2 million. The remainder of the 1993 construction expenditures consisted of the normal replacements and improvements to gas and electric facilities.
The Company expects that construction requirements for the years 1994-1998 will total approximately $270 million. Included in this amount is approximately $44 million to comply with the Clean Air Act amendments by 1995 and approximately $51 million of capitalized expenditures to develop and implement DSM programs. While the Company expects the majority of the construction program and debt redemption requirements to be provided by internally generated funds, external financing requirements of $50-70 million are anticipated.
At year end, the Company had $11 million in short-term borrowings, leaving unused lines of credit and trust demand note arrangements totaling $16 million.
The Company is confident that its long-term financial objectives, which include maintaining a capital structure near 45-50% long-term debt, 3-7% preferred stock, and 43-48% common equity, will continue to be met, while providing for future construction and other capital requirements.
Item 8. | 92195 | 1993 |
|
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
Admiral was formed in 1987 for the purpose of effecting the Contributed Property Exchange Offer and Merger with Haven and had no prior operating history. Admiral's acquisition of Haven occurred on June 16, 1988, and has been accounted for as if it occurred on June 30, 1988. The following table sets forth selected consolidated financial data for the operations of Haven and for Admiral for the five years ended June 30, 1993. In addition, selected financial data on the financial position of Admiral is shown as of June 30, 1993, 1992, 1991, 1990, and 1989. Such information is qualified in its entirety by the more detailed information set forth in the financial statements and the notes thereto included elsewhere herein.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
Admiral was formed in 1987 and had no operations until its acquisition of Haven on June 16, 1988. The acquisition was accounted for as though it had occurred on June 30, 1988, so that the five years ended June 30, 1993 are the first years during which Admiral reported operations. Admiral's only significant asset is its investment in Haven and, therefore, the operations being reported on are primarily those of its subsidiary, the predecessor registrant Haven.
COMPARISON OF YEARS ENDED JUNE 30, 1993 AND 1992
GENERAL. Net loss for 1993 was $20,193 or $0.002 per share. This compares to a net loss for 1992 of $20,194 or $0.002 per share. Admiral was inactive at June 30, 1993 and 1992.
TOTAL INCOME. Admiral's gross revenues were $0 and $0 in 1993 and 1992, respectively.
COMPENSATION EXPENSE. Compensation expenditures were eliminated during fiscal 1990, when all employees were terminated. Consequently, compensation expense were $0 and $0 in 1993 and 1992.
TOTAL OTHER EXPENSE. Other expense includes amortization of organizational expenses of $20,194 and $20,193 in 1992 and 1993.
COMPARISON OF YEARS ENDED JUNE 30, 1992 AND 1991
GENERAL. Net loss for 1992 was $20,194 or $0.002 per share. This compares to a net loss for 1991 of $21,043 or $0.002 per share. Admiral was inactive at June 30, 1992 and 1991.
TOTAL INCOME. Admiral's gross revenues were $0 and $0 in 1992 and 1991, respectively.
COMPENSATION EXPENSE. Compensation expenditures were eliminated during fiscal 1990, when all employees were terminated. Consequently, compensation expense were $0 and $0 in 1992 and 1991.
TOTAL OTHER EXPENSE. Other expense items, including amortization of organizational expenses of $20,194 and $20,193 in 1992 and 1991, were reduced as a result of Admiral ceasing active operations during fiscal 1990, when all employees were terminated, Admiral's offices were vacated, and Admiral became inactive. Consequently, other expense decreased from $21,044 in 1991 to $20,194 in 1992.
LIQUIDITY AND CAPITAL RESOURCES
Admiral has been reduced to a corporate "shell," with no operations or current activity. There is no corporate liquidity, no available capital resources, and no immediately foreseeable prospects for the future improvement of Admiral's financial picture.
Admiral management intends to seek a new line of business. as yet unidentified. In connection therewith, Admiral's management believes that a restructuring of Admiral may be necessary in order to raise capital for new operations, and any such restructuring may have a substantial dilutive effect upon Admiral's existing shareholders. Admiral has no ongoing commitments or obligations other than with respect to its obligations related to the acquisition of Haven.
ITEM 8. | 828530 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Page No.
APS D-1 Monongahela D-3 Potomac D-5 West Penn D-7 AGC D-9
D-1
D-2
(a) Reflects a two-for-one common stock split effective November 4, 1993. (b) Capability available through contractual arrangements with nonutility generators. (c) Preliminary.
D-3
D-3
(a) Capability available through contractual arrangements with nonutility generators.
D-5
D-6
D-7
D-8
(a) Capability available through contractual arrangements with nonutility generators.
D-9
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ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Page No.
APS M-1 Monongahela M-9 Potomac M-18 West Penn M-27 AGC M-36
M-1 APS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONSOLIDATED NET INCOME Earnings per share were $1.88 in 1993 and were $1.83 and $1.80 in 1992 and 1991. Consolidated net income was $215.8 million, $203.5 million, and $194.0 million. The increase in consolidated net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses. All per share amounts have been adjusted to reflect the November 4, 1993, two-for-one stock split (See Note F to the consolidated financial statements).
SALES AND REVENUES KWh sales to and revenues from residential, commercial, and industrial customers are shown on page D-2. Such kWh sales increased 3.3% and 1.5% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Increase from Prior Year 1993 1992 (Millions of Dollars) Increased kWh sales $ 46.6 $ 9.1 Fuel and energy cost adjustment clauses (a) 57.0 37.9 Rate increases (b): Pennsylvania 25.2 5.8 Maryland 12.7 11.7 West Virginia 5.3 12.4 Virginia 2.5 1.8 Ohio 2.1 1.7 47.8 33.4 Other 6.2 .1 $157.6 $80.5 (a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income. (b) See ITEM 1. RATE MATTERS for further information on rate changes.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were approximately normal, cooling degree days increased 69% over 1992 and were 25% over normal, contributing to the 1993 kWh sales increases. The subsidiaries experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
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KWh sales to industrial customers increased .3% in 1993 and 2.9% in 1992. The relatively flat industrial sales growth in 1993 followed record industrial sales in 1992 which occurred in almost all industrial groups. One particular group, coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items: 1993 1992 1991 KWh sales (in billions): From subsidiaries' generation 1.2 3.2 5.8 From purchased power 11.2 14.6 12.4 12.4 17.8 18.2 Revenues (in millions): From subsidiaries' generation $ 28.5 $ 91.7 $158.5 From sales of purchased power 318.2 373.8 366.5 $346.7 $465.5 $525.0
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by subsidiaries' generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the subsidiaries' ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989--a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income.
The decrease in other revenues in 1993 resulted from an agreement with the Federal Energy Regulatory Commission to record in 1993 about $14 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years.
M -3 OPERATING EXPENSES Fuel expenses decreased 4% in 1993 and 6% in 1992. Both decreases were primarily due to decreases in kWh generated. The 1992 decrease also included a 1% decrease in average coal prices. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with other utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA) and is comprised of the following items: 1993 1992 1991 (Millions of Dollars) Purchased power: For resale to other utilities $280.9 $344.0 $332.7 From PURPA generation 105.2 94.0 68.9 Other 33.8 12.7 29.0 Total power purchased 419.9 450.7 430.6 Power exchanges, net (2.5) .7 (1.4) $417.4 $451.4 $429.2
The amount of power purchased from other utilities for use by subsidiaries and for resale to other utilities depends upon the availability of the subsidiaries' generating equipment, transmission capacity, and fuel, and their cost of generation and the cost of operations of other utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to other utilities is described under SALES AND REVENUES above. The cost of power purchased for use by the subsidiaries, including power from PURPA generation, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the subsidiaries' regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net income. The increases in purchases from PURPA generation reflect additional generation from new PURPA projects. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in employee benefit costs and salaries and wages. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $5 million. The subsidiaries are currently recovering approximately 85% of SFAS No. 106 expenses in rates and will be requesting recovery of substantially all of the remainder in 1994 rate cases. During 1992, the subsidiaries implemented significant changes to their benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 20% greater than 1993 amounts.
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Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The subsidiaries currently accrue for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993. The subsidiaries are also experiencing, and expect to continue to experience, increased expenditures due to the aging of their power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the Clean Air Act Amendments of 1990 (CAAA).
Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note I to the consolidated financial statements) and the replacement of aging equipment at the subsidiaries' power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $4 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($5 million) and increased property taxes ($2 million). These increases were offset by decreased West Virginia Business and Occupation taxes (B&O taxes) due to decreased generation in that state. The 1992 increase resulted from increased property taxes ($4 million), increases in gross receipts taxes ($3 million), and increased capital stock taxes ($2 million), offset by decreased B&O taxes ($2 million).
The net increase of $13 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($9 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($3 million). The net decrease in 1992 of $4 million resulted primarily from plant removal and certain bond refinancing cost tax deductions for which deferred taxes were not provided. Note B to the consolidated financial statements provides a further analysis of income tax expenses.
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The combined increase of $4 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. Fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the levels of short-term debt maintained by the companies.
The decrease in dividends on preferred stock of subsidiaries reflects the 1992 redemption of three series totaling $25 million with dividend rates of 9.4% to 9.64% and the 1993 redemption of an additional $2 million of 4.7% to $7.16 series, offset by the 1992 sale of $40 million of market auction preferred stock with an average dividend rate of 2.6%.
LIQUIDITY AND CAPITAL RESOURCES
SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". System companies need cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for their construction programs. To meet these needs, the companies have used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the companies' cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
CAPITAL REQUIREMENTS
Construction expenditures for 1993 were $574 million and for 1994 and 1995 are estimated at $500 million and $400 million, respectively. These estimates include $161 million and $53 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA discussed under ITEM 1. ENVIRONMENTAL MATTERS. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for
M-6
compliance with both Phase I and Phase II of the CAAA. The subsidiaries are estimating amounts of approximately $1.4 billion, which includes $482 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the subsidiaries have additional capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note G to the consolidated financial statements).
INTERNAL CASH FLOWS
Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $270 million in 1993. Regulatory commission orders received in Maryland, Pennsylvania, Virginia, and West Virginia provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with various amounts of lag. Based upon the authorizations received and requested and new rate cases planned in 1994, internal generation of cash can be expected to increase.
The increase in other investments reflects the 1993 cash surrender values for secured benefit plans and a related prepayment. Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($54 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the subsidiaries' regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
FINANCINGS
In October 1993, the Company issued 2,400,000 shares of its common stock for $64.1 million. Also during 1993, the Company issued 1,364,846 shares of common stock under its Dividend Reinvestment and Stock Purchase Plan (DRISP), and Employee Stock Ownership and Savings Plan (ESOP) for $36.1 million. During 1993 the subsidiaries issued $43 million of 6.25% to 6.3% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $634 million of debt securities having interest rates of 7% to 9.75% through the issuance of $652 million of securities having interest rates of 4.95% to 7.75%. The costs
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associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $44 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt increased from $11.2 million in 1992 to $130.6 million in 1993. The subsidiaries canceled or postponed approximately $152 million of debt and equity financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its subsidiaries established an internal money pool whereby surplus funds of the Company and certain subsidiaries may be borrowed on a short-term basis by the Company's subsidiaries. This has contributed to the decrease in the 1993 temporary cash investment amounts. Allegheny Generating Company in 1992 replaced its $65.7 million of commercial paper with $50.9 million of money pool borrowings and $2.4 million of four-year, 6.05%-6.10% medium-term notes. Allegheny Generating Company has available an established program to replace money pool borrowings with medium-term notes or commercial paper.
At December 31, 1993, unused lines of credit with banks were $149 million. In addition, a multi-year credit program was established in January 1994, which provides that the subsidiaries may borrow on a standby revolving credit basis up to $300 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the subsidiaries plan to issue about $230 million of new securities, consisting of both debt and equity issues and, if economic and market conditions make it desirable, may refinance up to $728 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The subsidiaries may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available. The Company plans to fund the subsidiaries' sale of common stock through the issuance of short-term debt and DRISP/ESOP common stock sales.
The subsidiaries anticipate that they will be able to meet their future cash needs through internal cash generation and external financings as they have in the past and possibly through alternative financing procedures.
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ENVIRONMENTAL MATTERS AND OTHER CONTINGENCIES
In the normal course of business, the subsidiaries are subject to various contingencies and uncertainties relating to their operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note I to the consolidated financial statements.
All of the state jurisdictions in which the subsidiaries operate have enacted hazardous and solid waste management legislation. While the subsidiaries do not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The subsidiaries are incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the subsidiaries.
As of January 1994, Monongahela has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and Monongahela, Potomac Edison, and West Penn have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the subsidiaries. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against any or all of the subsidiaries. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at subsidiary-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of Monongahela. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the subsidiaries believe potential liability of the subsidiaries is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by Monongahela for an amount substantially less than the anticipated cost of defense. While the subsidiaries believe that all of these cases are without merit, they cannot predict the outcome of these cases or whether other cases will be filed.
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Monongahela
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Income Net income was $61.7 million, $58.3 million, and $54.1 million in 1993, 1992, and 1991, respectively. The increase in net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses.
Sales and Revenues KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-3 and D-4 Such kWh sales increased .3% in 1993 and decreased 1.0% in 1992. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase (Decrease) from Prior Year
1993 1992 (Millions of Dollars)
Increased (decreased) kWh sales $ 6.6 $(5.3) Fuel and energy cost adjustment clauses (a) 11.8 12.3 Rate increases (b): West Virginia 4.1 12.1 Ohio 2.1 1.6 6.2 13.7
Other .2 (1.3) $24.8 $19.4
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.
(b) Reflects a surcharge in West Virginia for recovery of carrying charges on expenditures to comply with the Clean Air Act Amendments of 1990 (CAAA), designed to produce $3.1 million on an annual basis effective on July 1, 1992, which was increased to $8.7 million on an annual basis effective on July 1, 1993, and a rate increase in Ohio, designed to produce $3.3 million on an annual basis, which became effective on July 21, 1992.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were only 6% above normal, cooling degree days increased 54% over 1992, contributing to the 1993 kWh sales increases. The Company experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
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KWh sales to industrial customers decreased 4.4% in 1993 and .7% in 1992. The 1993 decrease was primarily due to continuing declines in sales to coal and primary metals customers. Coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993. Lower sales to primary metals customers was due in part to one iron and steel customer's increased use of its own generation.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .3 1.0 1.8 From purchased power 2.8 3.6 3.1 3.1 4.6 4.9
Revenues (in millions): From Company generation $ 8.4 $ 26.7 $ 48.5 From sales of purchased power 77.6 92.9 91.5 $86.0 $119.6 $140.0
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWH) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off.
The increase in other revenues in 1993 and 1992 resulted from continued increases in sales of capacity, energy, and spinning reserve to other affiliated companies because of additional capacity and energy available from new PURPA projects in both years. This increase was offset in part in 1993 by an agreement with the Federal Energy Regulatory Commission to record in 1993 about $3 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. About 90% of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on net income.
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Operating Expenses
Fuel expenses decreased 3% in 1993 and 9% in 1992. Both decreases were primarily due to decreases in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $ 68.6 $ 85.5 $ 83.0 From PURPA generation 55.7 37.4 13.2 Other 8.1 3.1 7.2 Power exchanges, net (.6) .3 (.5) Affiliated transactions: AGC capacity charges 23.3 24.2 25.1 Energy and spinning reserve charges .5 2.8 5.3 $155.6 $153.3 $133.3
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The increases in purchases from PURPA generation reflects additional generation from new PURPA projects. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute. Energy and spinning reserve charges decreased in 1993 and 1992 primarily because of additional generation available from new PURPA projects.
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The increase in other operation expense for 1993 and 1992 resulted primarily from increases in salaries and wages and employee benefit costs. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, will increase future employee benefit costs for postretirement benefit expenses. The Company is currently recovering approximately 50% of SFAS No. 106 expenses in rates and will be requesting recovery of the remainder in 1994 and early 1995 rate cases. This reflects for West Virginia and Ohio only the recovery of the previously authorized pay-as-you-go component. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 25% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
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Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $1 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($1 million) and increased property taxes ($1 million), offset by decreased West Virginia Business and Occupation taxes (B&O taxes) ($1 million) due to decreased generation in that state. The 1992 decrease resulted from decreased B&O taxes ($2 million) and prior period B&O tax adjustments ($2 million), offset somewhat by increases in gross receipts and property taxes ($2 million).
The net increase of $6 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($4 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). The net decrease in 1992 of $3 million resulted primarily from plant removal and certain bond refinancing cost tax deductions for which deferred taxes were not provided. Note B to the financial statements provides a further analysis of income tax expenses.
The combined increase of $2 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures primarily associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease as the Company completes its Phase I compliance program. The decrease in other income, net, in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used
M-14
internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
Capital Requirements Construction expenditures for 1993 were $141 million and for 1994 and 1995 are estimated at $103 million and $83 million, respectively. These estimates include $39 million and $10 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $400 million, which includes $122 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has additional capital requirements of debt maturities (see Note H to the financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, was about $69 million for 1993. A regulatory commission order has been received in West Virginia authorizing procedures to provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with a certain amount of lag. Based upon the authorization received and new rate cases planned in 1994 and early 1995, internal generation of cash can be expected to increase.
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Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($13 million). The five- year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $10.68 million of 6.25% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $67 million of debt securities having interest rates of 7.5% to 9.5% through the issuance of $72 million of securities having interest rates of 5.625% to 5.95%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $12 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. Short-term debt, including notes payable to affiliates under the money pool, increased from $8.0 million in 1992 to $63.1 million in 1993. The Company canceled or postponed approximately $69 million of debt and equity financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available.
At December 31, 1993, the Company had SEC authorization to issue up to $100 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $81 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $50 million of new equity securities and, if economic and market conditions make it desirable, may refinance up to $285 million of first
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mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the financial statements.
All of the state jurisdictions in which the Company operates have enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
As of January 1994, the Company has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the
M-17
Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of the Company. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by the Company for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
M-18 Potomac
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Income
Net income was $73.5 million, $67.5 million, and $58.2 million in 1993, 1992, and 1991, respectively. The increase in net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses.
Sales and Revenues
KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-5 and D-6. Such kWh sales increased 6.3% and 2.0% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase from Prior Year 1993 1992 (Millions of Dollars) Increased kWh sales $24.4 $ 7.7 Fuel and energy cost adjustment clauses (a) 19.1 10.4 Rate increases (b): Maryland 12.7 11.7 Virginia 2.5 1.8 West Virginia 1.1 .3 16.3 13.8 Other 2.9 .2 $62.7 $32.1
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.
(b) Reflects a rate increase in Maryland, designed to produce $11.3 million on an annual basis, which became effective on February 25, 1993, and a rate increase in Virginia, designed to produce $10.0 million on an annual basis, which became effective on September 28, 1993, subject to refund. The Maryland surcharge for recovery of carrying charges on Clean Air Act Amendments of 1990 (CAAA) compliance investment of $1.7 million effective on June 4, 1992, which was increased to $3.9 million effective on December 3, 1992, was rolled into base rates effective with the February 1993 increase. Rate increases also include a CAAA surcharge in West Virginia designed to produce $.8 million on an annual basis effective July 1, 1992, which was increased to $2.2 million on an annual basis effective July 1, 1993.
The increased kWh sales to residential and commercial customers in 1993 reflect both higher use and growth in number of customers. While 1993 heating degree days showed only a slight increase over 1992, and were only 7%
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above normal, cooling degree days increased 82% over 1992 and were 12% over normal, contributing to the 1993 kWh sales increases. The Company experienced a normal winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
KWh sales to industrial customers increased 4.3% in 1993 and 2.0% in 1992. The increase in both years occurred in almost all industrial groups, the most significant of which in 1993 was from sales to cement customers.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .4 1.0 1.8 From purchased power 3.5 4.4 3.8 3.9 5.4 5.6 Revenues (in millions): From Company generation $8.6 $27.5 $47.4 From sales of purchased power 99.5 113.6 114.3 $108.1 $141.1 $161.7
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on net income.
The decrease in other revenues in 1993 resulted from an agreement with the Federal Energy Regulatory Commission to record in 1993 about $4 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years.
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Operating Expenses Fuel expenses decreased 4% in 1993 and 6% in 1992. Both decreases were primarily due to decreases in kWh generated. The 1992 decrease also included a 1% decrease in average coal prices. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities, capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $87.9 $104.6 $103.7 Other 10.5 3.7 8.9 Power exchanges, net (.8) .2 (.4) Affiliated transactions: AGC capacity charges 28.0 29.6 31.3 Other affiliated capacity charges 28.4 21.9 23.4 Energy and spinning reserve charges 51.1 41.2 37.6 $205.1 $201.2 $204.5
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power purchased from nonaffiliates for use by the Company and affiliated energy and spinning reserve charges are mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The 1993 increase in other purchased power reflects efforts to conserve coal because of selective work stoppages by the United Mine Workers of America for most of the year.
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While the Company does not currently purchase generation from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), several projects have been proposed, and an agreement has been reached with one facility to commence purchasing generation in 1999. This project and others may significantly increase the cost of power purchases passed on to customers. The increase in affiliated capacity and energy and spinning reserve charges in 1993 was due to growth of kWh sales to retail customers and an increase in affiliated energy available because of energy purchased by an affiliate from new PURPA projects in 1992 and 1993.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in employee benefit costs and salaries and wages. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $1.5 million. The Company is currently recovering approximately 90% of SFAS No. 106 expenses in rates and will be requesting recovery of the remainder in 1994 rate cases. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 25% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system.
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The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $1 million in 1993 due to increases in gross receipts taxes resulting from higher revenues from retail customers ($1 million) and increased property taxes ($1 million), offset by decreased West Virginia Business and Occupation taxes due to decreased generation in that state ($1 million). The 1992 increase was due to increased property ($1 million) and gross receipts ($1 million) taxes.
The net increase of $2 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($3 million) and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million), offset by plant removal tax deductions for which deferred taxes were not provided ($1 million). The net increase in 1992 was primarily due to an increase in income before taxes. Note B to the financial statements provides a further analysis of income tax expenses.
The combined increase of $2 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. The decrease in other income, net in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stock,
M-23
and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
During 1993, the Company continued its participation in the Collaborative Process for Demand-Side Management in Maryland with the Maryland PSC Staff, Office of People's Counsel, the Department of Natural Resources, Maryland Energy Administration, and the Company's largest industrial customer. The Company received the Maryland PSC's approval to implement a Commercial and Industrial Lighting Rebate Program as of July 1, 1993. Through December 31, 1993, the Company had received applications for $7.5 million in rebates related to the commercial lighting program. Program costs, including rebates and lost revenues, are deferred and are to be recovered through an energy conservation surcharge over a five-year period.
Capital Requirements Construction expenditures for 1993 were $179 million and for 1994 and 1995 are estimated at $136 million and $106 million, respectively. These estimates include $40 million and $10 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $350 million, which includes $153 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has
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additional annual capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note H to the financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $75 million in 1993. Regulatory commission orders received in all of the state jurisdictions and the FERC provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with various amounts of lag. Based upon the authorizations received and new rate cases planned in 1994, internal generation of cash can be expected to increase.
Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($14 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $13.99 million of 6.25% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $121 million of debt securities having interest rates of 7% to 9.5% through the issuance of $129 million of securities having interest rates of 5.875% to 7.75%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $9 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. The Company canceled or postponed approximately $36 million of debt financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short- term borrowing needs, to the extent that certain of the companies have funds available.
M-25
At December 31, 1993, the Company had SEC authorization to issue up to $115 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $84 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $75 million of new debt securities and, if economic and market conditions make it desirable, may refinance up to $231 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the financial statements.
All of the state jurisdictions in which the Company operates have enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
M-26
As of January 1994, Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of MP. The Company is joint owner with MP in five generating plants, including four operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
M-27
West Penn
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Net Income
Consolidated net income was $102.1 million, $98.2 million, and $101.2 million in 1993, 1992, and 1991, respectively. The increase in consolidated net income in 1993 resulted primarily from kWh sales and retail rate increases, offset in part by higher expenses. Higher retail revenues in 1992 from a surcharge to recover increases in various state taxes and greater kWh sales were more than offset by higher expenses.
Sales and Revenues
KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-7 and D-8. Such kWh sales increased 3.1% and 2.7% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase from Prior Year
1993 1992 (Millions of Dollars)
Increased kWh sales $15.5 $ 6.7 Fuel and energy cost adjustment clauses (a) 26.2 15.2 Rate increases (b) 25.2 5.8 Other 3.1 1.3
$70.0 $29.0
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.
(b) Reflects a base rate increase on an annual basis of about $61.6 million in Pennsylvania effective May 18, 1993, including $26.1 million for recovery of carrying charges on Clean Air Act Amendments of 1990 (CAAA) compliance costs, and in 1992 also reflects a surcharge effective August 24, 1991, to recover Pennsylvania tax increases.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days remained about the same as 1992, and were only 6% below normal, cooling degree days increased 70% over 1992 and were 46% over normal, contributing to the 1993 kWh sales increases. The Company experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
M-28
KWh sales to industrial customers increased .8% in 1993 and 6.3% in 1992. The relatively flat industrial sales growth in 1993 followed increases in industrial sales in 1992 which occurred in almost all industrial groups. One particular group, coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .4 1.3 2.3 From purchased power 5.0 6.5 5.4
5.4 7.8 7.7
Revenues (in millions): From Company generation $11.5 $37.5 $62.5 From sales of purchased power 141.0 167.2 160.7
$152.5 $204.7 $223.2
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off.
The decrease in other revenues in 1993 and 1992 resulted from continued decreases in sales of energy and spinning reserve to an affiliated company because of additional energy available to it from new PURPA projects commencing in both years. The 1993 decrease was also due in part to an agreement with the Federal Energy Regulatory Commission to record in 1993 about $6 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. Most of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income.
M-29 Operating Expenses
Fuel expenses decreased 4% in each of the years of 1993 and 1992 primarily due to decreases in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $124.5 $153.9 $146.0 From PURPA generation 49.6 56.5 55.6 Other 15.2 5.9 12.9 Power exchanges, net (1.2) .3 (.5) Affiliated transactions: AGC capacity charges 42.3 43.5 44.1 Energy and spinning reserve charges 4.7 3.5 3.8 Other affiliated capacity charges .7 .6 .6
$235.8 $264.2 $262.5
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net
M-30
income. The decrease in purchases from PURPA generation in 1993 was due to a planned generating outage at one PURPA project. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in salaries and wages and in 1993 also from employee benefit costs. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $3.1 million. The Company is currently recovering all of SFAS No. 106 expenses in rates. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 5% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
M-31
Depreciation expense increases resulted primarily from additions to electric plant and in 1993 also from a change in depreciation rates and net salvage amortization as a result of the May 1993 rate order. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the consolidated financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $2 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($3 million) offset in part by decreased West Virginia Business and Occupation taxes (B&O taxes) ($2 million) due to decreased generation in that state. The 1992 increase resulted from increased property and capital stock taxes ($4 million), increased B&O taxes ($1 million), and increases in gross receipts taxes ($1 million).
The net increase of $7 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($6 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). The net decrease in 1992 of $4 million resulted primarily from a decrease in income before taxes. Note B to the consolidated financial statements provides a further analysis of income tax expenses.
The combined increase of $.3 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. The decrease in other income, net, in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the consolidated financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such
M-32
as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
Capital Requirements Construction expenditures for 1993 were $251 million and for 1994 and 1995 are estimated at $258 million and $208 million, respectively. These estimates include $82 million and $33 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable ruling of the Pennsylvania PUC allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $700 million, which includes $207 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has additional capital requirements of debt maturities (see Note H to the consolidated financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $119 million in 1993. A regulatory commission order has been received from the PUC which provides for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with a certain amount of lag. Based upon the authorization received and a new rate case planned in 1994, internal generation of cash can be expected to increase.
M-33
Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($27 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $18.04 million of 6.30% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $246 million of debt securities having interest rates of 7% to 9.75% through the issuance of $251 million of securities having interest rates of 4.95% to 6.375%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $12 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. The Company canceled or postponed approximately $47 million of debt financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available.
At December 31, 1993, the Company had SEC authorization to issue up to $170 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $135 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $105 million of new securities, consisting of both debt and equity issues and, if economic and market conditions make it desirable, may refinance up to $212 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction program, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the consolidated financial statements.
Pennsylvania has enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
M-35
As of January 1994, Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System- operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of MP. The Company is joint owner with MP in four generating plants, including three operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
M-36
AGC
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
As described under Liquidity and Capital Resources, revenues are determined under a cost of service formula rate schedule. Therefore, if all other factors remain equal, revenues are expected to decrease each year due to a normal continuing reduction in the Company's net investment in the Bath County station and its connecting transmission facilities upon which the return on investment is determined. Revenues for 1993 and 1992 decreased due to a reduction in interest charges and net investment, and reduced operating expenses which are described below. Additionally, revenues for 1993 and 1992 were reduced by the recording of estimated liabilities for possible refunds pending final Federal Energy Regulatory Commission (FERC) decisions in rate case proceedings (see Liquidity and Capital Resources).
The net investment (primarily net plant less deferred income taxes) decreases to the extent that provisions for depreciation and deferred income taxes exceed net plant additions. The decrease in operating expenses in 1993 resulted from a decrease in federal income taxes due to a decrease in income before taxes ($1.9 million) offset by an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($.5 million), partially offset by an increase in operation and maintenance expense. The decrease in operating expenses in 1992 resulted primarily from reduced federal income taxes because of a decrease in income before taxes, partially offset by increases in taxes other than income.
The increase in taxes other than income in 1992 was due to increased property taxes.
The decreases in interest on long-term debt in 1993 and 1992 were the combined result of decreases in the average amount of and interest rates on long-term debt outstanding.
Liquidity and Capital Resources
SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company's only operating assets are an undivided 40% interest in the Bath County (Virginia) pumped-storage hydroelectric station and its connecting transmission facilities. The Company has no present plans for construction of any other major facilities.
M-37
Pursuant to an agreement, the Parents buy all of the Company's capacity in the station priced under a "cost of service formula" wholesale rate schedule approved by the FERC. Under this arrangement, the Company recovers in revenues all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment.
Through February 29, 1992, the Company's return on equity (ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC. On March 1, 1990, the ROE decreased from 12% to 11.25%, and on March 1, 1991, it was increased to 11.53%. In December 1991, the Company filed for a continuation of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the Public Service Commission of West Virginia, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE, with any resultant rate decreases subject to refund from March 1, 1992 through May 31, 1993. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation have been filed by all parties for consideration by the full Commission. On January 28, 1994, the JCA filed a joint complaint claiming that both the existing ROE of 11.53% and the ALJ's recommended ROE of 10.83% are unjust and unreasonable. This new complaint requests an ROE of 8.53%, with rates subject to refund beginning April 1, 1994.
In 1993, the Company issued $50 million of 5.75% medium-term notes due 1998, $50 million of 5.625% debentures due 2003, and $100 million of 6.875% debentures due 2023 to refund $50 million 8% debentures due 1997, $50 million 8.75% debentures due 2017, and $100 million 9.125% debentures due 2016. The Company and its affiliates in 1992 established an internal money pool as a facility to accommodate intercompany short- term borrowing needs, to the extent that certain of the companies have funds available.
- 42 -
ITEM 8. | 67646 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA -------------------------------------
See Page 1 ("Selected Financial Data") and Pages 44 - 45 ("Supplemental Financial Data") of the Company's Annual Report to Shareholders for the year ended December 31, 1993, which is incorporated by reference herein pursuant to Rule 12b-23 of the Act and Instruction G(2) to Form 10-K.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ---------------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------
See Page 1 ("Selected Financial Data") and Pages 17 - 23 of the Company's Annual Report to Shareholders for the year ended December 31, 1993, which is incorporated by reference herein pursuant to Rule 12b-23 of the Act and Instruction G(2) to Form 10-K.
ITEM 8. | 49423 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data for the last five (5) fiscal years ended December 31:
FISCAL YEAR ENDED DECEMBER 31 INCOME (LOSS) STATEMENT 1993 1992 1991 1990 1989 - -------------------------- ---- ---- ---- ---- ---- Revenues $0 0 0 0 0 Cost and Expense 2,689 10,060 17,351 2,917 7,916 Income (Loss) from Continuing Operations ($2,689) (10,060) (17,351) (2,917) (7,916) Income (Loss from Continuing Operations per Common Share * * * * *
BALANCE SHEET ---------------- Current Assets 0 0 0 0 0 Working Capital 0 0 0 0 0 Total Assets 10,551 10,551 10,551 10,551 10,551 Total Liabilities 120,580 117,891 107,831 90,480 87,563 Shareholders' Equity * * * * * Dividends Declared/Paid per Common Share 0 0 0 0 0
* LESS THAN $.01 PER SHARE
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(a) FINANCIAL CONDITION
The Company utilized substantially all of its funds in 1987 and 1988 investigating several merger/acquisition candidates. It currently has no funds available, without debt or equity financing, to proceed with ongoing internal operations. It has been inactive since December 31, 1988.
(b) RESULTS OF OPERATIONS
The Company is inactive. It has had no operation(s) since December, 1988. As of that date, the Company had no Current Assets, and Total Assets (consisting entirely of office equipment and organization expenses) were $15,754.
For the fiscal year ending December, 1993, the Company had a net loss of $2,689 which was the result of general and administra-
tive expense and accruing interest on outstanding obligations of the Company and not a result of any operation(s).
(c) EFFECT OF INFLATION
Inflation and changing prices do not have a significant effect on the Company since presently it has no sales revenues or business activity.
ITEM 8. | 814153 | 1993 |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following table expresses certain items in PG&W's Statements of Income contained in Item 8 | 77242 | 1993 |
|
Item 6. Selected Financial Data
CENTERIOR ENERGY
The information required by this Item is contained on Pages and attached hereto.
CLEVELAND ELECTRIC
The information required by this Item is contained on Pages and attached hereto.
TOLEDO EDISON
The information required by this Item is contained on Pages and attached hereto.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
CENTERIOR ENERGY
The information required by this Item is contained on Pages through attached hereto.
CLEVELAND ELECTRIC
The information required by this Item is contained on Pages through attached hereto.
TOLEDO EDISON
The information required by this Item is contained on Pages through attached hereto.
Item 8. | 20947 | 1993 |
Item 6. Selected Financial Data
Year Ended December 31 1993 1992 1991 1990 1989 Management Fees $63,107,331 $57,388,268 $55,357,599 $51,581,824 $46,575,914 Net income 146,399 9,083 24,680 46,473 3,586 Net income per Class A Share 31.66 1.96 5.38 9.91 .75 Weighted average number of Class A Common Shares outstanding 4,624 4,633 4,591 4,691 4,760
As of December 31 1993 1992 1991 1990 1989 Total assets $11,432,203 $ 8,841,177 $ 8,579,945 $ 7,783,120 $ 7,185,424 Shareholders' equity 1,606,724 1,472,881 1,444,973 1,448,127 1,424,891
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources
The Corporation had cash and cash equivalents and short-term investments of approximately $1.3 million at December 31, 1993 and 1992. The largest component of the Corporation's working capital was a receivable from the Partnership. This receivable represents the costs incurred by the Corporation in providing management and labor services to the Partnership but not yet paid by the Corporation and therefore not yet collected from the Partnership. The Corporation has no short-term or long-term debt. During 1993, the Corporation offered Class A and Class B Common Shares and received $11,141 under that offering. Class A and Class B Common Shares redeemed during 1993 totalled $23,697. Management believes, given the relationship between the Corporation and the Partnership whereby the Corporation is reimbursed by the Partnership for its cost in providing management and labor services to the Partnership, and given the Corporation's cash and cash equivalents and short-term investment of $1.3 million, that the Corporation's liquidity is adequate to meet both short-term and long-term needs.
Results of Operations
Years ended December 31, 1993 and 1992:
Net income in 1993 was $146,399, or $31.66 per Class A Common Share, compared to $9,083, or $1.96 per share in 1992. Income earned by the Corporation on its investment in the Partnership was up $51,398 in 1993 and the management fee earned by the Corporation based on the Partnership's return on equity and rent and other reimbursable expenses was up $175,185. These increases are a result of the improved 1993 operating results of the Partnership and an increase in reimbursable expenses. Federal income tax expense was up due to the increase in income.
During 1993 the Corporation adopted Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The Corporation elected to recognize the accrued benefits earned by employees as of January 1, 1993 (transition obligation) prospectively, which means this cost will be recognized as a component of the net periodic postretirement benefit cost over a period of approximately 20 years. The effect of adopting the new rules increased the 1993 net periodic postretiement benefit cost by approximately $850,000 and is expected to increase future postretirement benefit costs by a like amount. This cost was included in the management fee charged to the Partnership in 1993 and, therefore, had no impact on the operating results of the Corporation. Also during 1993, as a result of lower prevailing interest rates, the Corporation decreased the discount rate used to determine its projected benefit obligation for its pension plan and for its postretirment health care benefits. The change in the discount rate, from 8% to 7.5%, is expected to increase these benefit costs in future years by approximately $365,000. Because the Corporation charges all employee benefit costs to the Partnership as part of the management fee, the change in the discount rate will not impact the future operating results of the Corporation.
Years ended December 31, 1992 and 1991:
Net income in 1992 was $9,083, or $1.96 per Class A Common Share, compared to $24,680, or $5.38 per share in 1991. Income earned by the Corporation on its investment in the Partnership was up $59,498 in 1992 and the management fee earned by the Corporation based on the Partnership's return on equity and rent and other reimbursable expenses was also up, both due to the improved 1992 operating results of the Partnership. Interest earned and other income decreased by $132,549, due to a 50% decrease in rental income and due to lower interest rates. The rental income decrease was a result of lower occupancy of outside tenants in the office building leased by the Corporation to the Partnership and to outside tenants.
Item 8. | 821026 | 1993 |
Item 6. Selected Financial Data.
The information set forth under the caption "Financial Summary" on pages 18 and 19 of the registrant's Annual Report to Shareholders for the year ended December 31, 1993, is incorporated by reference under Item 14 herein. Additionally, long-term debt at December 31 for each of the last five years was as follows (in thousands): 1993 - $214,176, 1992 - $123,027, 1991 - $145,584, 1990 - $163,703, 1989 - $186,680.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
"Management's Discussion and Analysis of Financial Condition and Results of Operations," appearing on pages 14 through 17 of the registrant's Annual Report to Shareholders for the year ended December 31, 1993, is incorporated by reference under Item 14 herein.
Item 8. | 716006 | 1993 |
Item 6. Selected Financial Data Annual Report to Stockholders, pages 46-47, information regarding the sale of Sundstrand Data Control Division to AlliedSignal, Inc. on pages 25, 27, 28, 36, 38 and 39, information regarding the changes in accounting standards on pages 25, 26, 27, 28, 38 and 39, information regarding the restructuring of the aerospace segment on pages 26 and 36, information regarding the acquisition of the Electrical Systems Division of Westinghouse Electric Corporation on pages 26, 27, 28 and 36, and information regarding provisions for interest for asserted tax deficiencies on page 40.
Item 7. | Item 7. Management's Discussion and Annual Report to Stockholders, Analysis of Financial Condition pages 25-29. and Results of Operations
Item 8. | 95395 | 1993 |
Item 6. Selected Financial Data. -----------------------
The information set forth under the caption "Selected Financial and Operating Data" on page 13 of FRP's 1993 Annual Report to unitholders is incorporated herein by reference.
FRP's ratio of earnings to fixed charges for each of the years 1989 through 1993, inclusive, was 4.8x, 16.5x, 4.4x, 1.0x and a shortfall of $233.5 million, respectively. For purposes of this calculation, earnings are income from continuing operations before fixed charges. Fixed charges are interest and that portion of rent deemed representative of interest.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -----------------------------------------------------------
IMC-AGRICO COMPANY Freeport-McMoRan Resource Partners, Limited Partnership (FRP) and IMC Fertilizer, Inc. (IMC) formed a joint venture (IMC-Agrico Company), effective July 1, 1993, for their respective phosphate fertilizer businesses, including phosphate rock and uranium. IMC-Agrico Company is governed by a policy committee having equal representation from each company and is managed by IMC. Combined annual savings of at least $95 million in production, marketing, and general and administrative costs are expected to result from this transaction, the full effect beginning by the end of the second year of operations. The operating efficiencies achievable by the joint venture should enable it to generate positive cash flow in a low-price environment, such as that experienced in 1993, and to be in a position to earn significant profits if product prices rise to historical levels. As discussed below and in Note 4 to the financial statements, significant restructuring charges were recorded in connection with this transaction.
As a result of the joint venture, FRP is engaged in the phosphate rock mining, fertilizer production, and uranium oxide extraction businesses only through IMC-Agrico Company. FRP will continue to operate its sulphur and oil businesses. FRP has varying sharing ratios in IMC-Agrico Company, as discussed in Note 2 to the financial statements, which were based on the projected contributions of FRP and IMC to the cash flow of the joint venture and on an equal sharing of the anticipated savings.
FRP transferred the assets it contributed to IMC-Agrico Company at their book carrying cost and proportionately consolidates its interest in IMC-Agrico Company. As a result, FRP's operating results subsequent to the formation of IMC-Agrico Company vary significantly in certain respects from those previously reported. Phosphate fertilizer realizations and unit production costs were fundamentally changed as the majority of the FRP contributed fertilizer production facilities are located on the Mississippi River, whereas the IMC contributed fertilizer production facilities are located in Florida. Fertilizer produced on the Mississippi River commands a higher sales price in the domestic market because of its proximity to markets; however, raw material transportation costs at the Florida facilities are lower for phosphate rock, partially offset by increased sulphur transportation costs.
1993 RESULTS OF OPERATIONS COMPARED WITH 1992 After discussions with the staff of the Securities and Exchange Commission (SEC), FRP is reclassifying certain expenses and accruals previously recorded in 1993 as restructuring and valuation of assets. In response to inquiries, FRP advised the SEC staff that $3.2 million originally reported as restructuring and valuation of assets represented the cumulative effect of changes in accounting principle resulting from the adoption of the new accounting policies that FRP considered preferable, as described in Note 1 to the financial statements. FRP also informed the SEC staff of the components of other charges included in the amount originally reported as restructuring and valuation of assets. FRP concluded that the reclassification and the related supplemental disclosures more accurately reflect the nature of these charges to 1993 net income in accordance with generally accepted accounting principles. These reclassifications had no impact on net income or net income per share.
FRP incurred a net loss of $246.1 million ($2.37 per unit) for 1993 compared with net income of $20.2 million ($.20 per unit) for 1992. Results for 1993 were adversely impacted by charges totaling $197.3 million ($1.90 per unit) related to (a) restructuring the administrative organization at Freeport-McMoRan Inc. (FTX), the general partner of FRP (Note 4), (b) asset sales/recoverability charges (Note 4), (c) adjustments to general and administrative expenses and production and delivery costs discussed below, and (d) changes in accounting principle, discussed further in Note 1 to the financial statements. Excluding these items, 1993 earnings were lower reflecting significant decreases in phosphate fertilizer, phosphate rock, sulphur, and oil revenues, primarily due to reduced sales volumes and average market prices for these products (see Selected Financial and Operating Data). Depreciation and amortization expense declined primarily because of reduced sales volumes. The reduction in general and administrative expenses reflects the benefits from the 1993 restructuring activities, partially offset by charges resulting from the restructuring project discussed below. Interest expense increased, as no interest was capitalized subsequent to the Main Pass sulphur operations becoming operational for accounting purposes in July 1993.
Restructuring Activities. During the second quarter of 1993, FTX undertook a restructuring of its administrative organization. This restructuring represented a major step by FTX to lower its costs of operating and administering its businesses in response to weak market prices of the commodities produced by its operating units. As part of this restructuring, FTX significantly reduced the number of employees engaged in administrative functions, changed its management information system (MIS) environment to achieve efficiencies, reduced its needs for office space, outsourced a number of administrative functions, and implemented other actions to lower costs. As a result of this restructuring process, which included the formation of IMC-Agrico Company, the level of FRP's administrative cost has been reduced substantially over what it would have been otherwise, which benefit will continue in the future. However, the restructuring process entailed incurring certain one-time costs by FTX, a portion of which were allocated to FRP pursuant to its management services agreement with FTX.
FRP's restructuring costs totaling $33.9 million, including $22.1 million allocated from FTX based on historical allocations, consisting of the following: $15.5 million for personnel related costs; $7.0 million relating to excess office space and furniture and fixtures resulting from the staff reduction; $1.8 million relating to the cost to downsize its computing and MIS structure; $8.8 million related to costs directly associated with the formation of IMC-Agrico Company; and $.8 million of deferred charges relating to FRP's credit facility which was substantially revised in June 1993. As of December 31, 1993, the remaining accrual for these restructuring costs totaled $3.1 million.
In connection with the restructuring project, FRP changed its accounting systems and undertook a detailed review of its accounting records and valuation of various assets and liabilities. As a result of this process, FRP recorded charges totaling $24.9 million, comprised of the following: (a) $10.0 million of production and delivery costs consisting of $6.3 million for revised estimates of environmental liabilities and $3.7 million primarily for adjustments in converting accounting systems, (b) $7.6 million of depreciation and amortization costs consisting of $6.5 million for estimated future abandonment and reclamation costs and $1.1 million for the write-down of miscellaneous properties, and (c) $7.3 million of general and administrative expenses consisting of $4.0 million to downsize FRP's computing and MIS structure and $3.3 million for the write-off of miscellaneous assets.
Agricultural Minerals Operations FRP's agricultural minerals segment, which includes its fertilizer, phosphate rock, and sulphur businesses, reported a loss of $55.9 million on revenues of $619.3 million for 1993 compared with earnings of $18.0 million on revenues of $799.0 million for 1992. Significant items impacting the segment earnings are as follows (in millions):
Agricultural minerals earnings - 1992 $ 18.0 Major increases (decreases) Sales volumes (67.4) Realizations (103.2) Other (9.1) ------ Revenue variance (179.7) Cost of sales 81.4* General and administrative and other 24.4* (73.9) ------ Agricultural minerals earnings - 1993 $(55.9) ======
- - - ------- * Includes $17.5 million in cost of sales and $7.3 million in general and administrative expenses resulting from the restructuring project discussed above.
Weak industrywide demand and changes attributable to FRP's participation in IMC-Agrico Company resulted in FRP's 1993 reported sales volumes for diammonium phosphate (DAP), its principal fertilizer product, declining 17 percent from that of a year-ago. The weakness in the phosphate fertilizer market prompted IMC-Agrico Company to make strategic curtailments in its phosphate fertilizer production. However, late in the year increased export purchases contributed to a rise in market prices, helping to rekindle domestic buying interests which had been unwilling to make purchase commitments. The increased demand, coupled with low industrywide production levels, caused reduced inventory levels. Late in 1993, IMC-Agrico Company increased its production levels in response to the improving markets and projected domestic and international demand for its fertilizer products. Unit production cost, excluding $17.5 million of changes related to the restructuring project, declined from 1992 reflecting initial production efficiencies from the joint venture, reduced raw material costs for sulphur, and lower phosphate rock mining expenses, partially offset by increased natural gas costs and lower production volumes. FRP's realization for DAP was lower reflecting the near 20-year low prices realized during 1993 as well as an increase in the lower-priced Florida sales by IMC-Agrico Company.
FRP believes that the outlook for 1994 is for improved prices caused by more normal market demand. Spot market prices improved from a low of nearly $100 per short ton of DAP (central Florida) in July 1993 to just over $140 per ton by year end. Industry inventories at year end were below average levels, despite a fourth quarter rebound in industry production. Export demand is expected to remain at more normal levels during the first half of 1994, with China, India, and Pakistan expected to be active purchasers. Additionally, domestic phosphate fertilizer demand is expected to benefit from increased corn acreage planted due to lower government set- asides and to increased fertilizer application rates necessitated by the widespread flooding that caused a depletion of nutrients in a number of midwestern states.
FRP's proportionate share of the larger IMC-Agrico Company phosphate rock operation caused 1993 sales volumes to increase from 1992, with IMC- Agrico Company operating its most efficient facilities to minimize costs.
Combined sulphur production from the Caminada and Main Pass mines increased compared with 1992; however, sales volumes declined 16 percent, primarily because of reduced purchases by IMC-Agrico Company resulting from its curtailed fertilizer production. Due to the significant decline in the market price of sulphur, FRP recorded a second-quarter 1993 noncash charge to earnings (not included in segment earnings) for the excess of capitalized cost over expected realization of its non-Main Pass sulphur assets, primarily the Caminada sulphur mine (Note 4). Due to significant improvements in Main Pass sulphur production, FRP ceased the marginally profitable Caminada operations in January 1994. The shutdown of Caminada will have no material impact on FRP's reported earnings. Although reduced global demand has forced production cutbacks worldwide, sulphur prices remain depressed. A rebound in price is not expected until demand improves.
At Main Pass, sulphur production increased significantly during 1993 and achieved, on schedule, full design operating rates of 5,500 tons per day (approximately 2 million tons per year) in December 1993 and has since sustained production at or above that level. As a result of the production increases, Main Pass sulphur became operational for accounting purposes beginning July 1, 1993. Recognizing Main Pass sulphur operations in income and discontinuing associated capitalized interest did not affect cash flow, but adversely affected reported operating results.
Oil Operation
1993 1992 ---- ---- Sales (barrels) 3,443,000 4,884,000 Average realized price $14.43 $15.91 Earnings (in millions) $(1.5) $4.6
Since completion of development drilling in mid-April 1993, oil production for the Main Pass joint venture (in which FRP owns a 58.3 percent interest) increased significantly, averaging over 20,000 barrels per day for December 1993. Production for 1994 is expected to approximate that of 1993 if water encroachment follows current trends, with the anticipated drilling of additional wells (estimated to cost FRP approximately $4 million) offsetting a production decline in existing wells. Due to the dramatic decline in oil prices at year-end, FRP recorded a $60.0 million charge to earnings (not included in segment earnings) reflecting the excess net book value of its Main Pass oil investment over the estimated future net cash flow to be received. Future price declines, increases in costs, or negative reserve revisions could result in an additional charge to future earnings.
CAPITAL RESOURCES AND LIQUIDITY
Net cash used in operating activities during 1993 was $2.9 million compared with $120.1 million net cash provided during 1992, due primarily to lower income from operations. Net cash provided by investing activities was $2.5 million compared with $209.9 million used for 1992, reflecting the reduced level of capital expenditures (following completion of Main Pass development expenditures and the cost efficiency program during 1992) and the proceeds from asset sales. Net cash provided by financing activities during 1993 was $17.8 million reflecting net borrowings of $139.0 million partially offset by lower distributions resulting from unpaid distributions to FTX since early-1992 (discussed below), compared with $93.1 million for 1992 which had a net reduction of borrowings totaling $186.2 million funded by $430.5 million in proceeds from the public sale of FRP units in February 1992.
Cash flow from operations for 1992 was $120.1 million compared with $106.5 million for 1991. Net cash used in investing activities declined to $209.9 million from $346.9 million in 1991, due primarily to reduced capital expenditures. Net cash provided by financing activities declined to $93.1 million in 1992 from $243.5 million in 1991, with 1991 including net borrowings of $421.2 million.
Publicly owned FRP units have cumulative rights to receive quarterly distributions of 60 cents per unit through the distribution for the quarter ending December 31, 1996 (the Preference Period) before any distributions may be made to FTX. FRP has announced that beginning with the distribution for the fourth quarter of 1993 it no longer intends to supplement distributable cash with borrowings. Therefore, FRP's future distributions will be dependent on the distributions received from IMC-Agrico Company, which will primarily be determined by prices and sales volumes of its commodities and cost reductions achieved by its combined operations, and the future cash flow of FRP's oil and sulphur operations (including reclamation expenditures related to its non-Main Pass sulphur assets). On January 21, 1994, FRP declared a distribution of 60 cents per publicly held unit ($30.3 million) and 12 cents per FTX-owned unit ($6.2 million), payable February 15, 1994, bringing the total unpaid distribution due FTX to $239.2 million. Unpaid distributions due FTX will be recoverable from future FRP cash available for quarterly distributions as discussed in Note 3 to the financial statements. The January 1994 distribution included $30.9 million received from IMC-Agrico Company for its fourth-quarter 1993 distribution (including $9.3 million from working capital reductions) and $13.0 million in proceeds from the sale of certain previously mined phosphate rock acreage.
In September 1993, FTX agreed to manage for one year Fertiberia, S.L., the restructured phosphate and nitrogen fertilizer businesses of FESA Fertilizantos Espanoles, a wholly owned subsidiary of ERCROS, S.A., a Spanish conglomerate. FTX has assumed no financial obligations during this period. The goal of the management services agreement is to establish Fertiberia as a financially viable concern. If financial viability can be established, FRP has agreed to negotiate the acquisition of a controlling equity interest in Fertiberia.
In June 1993, FTX amended its credit agreement in which FRP participates, extending its maturity (Note 5). As of February 1, 1994, $425.0 million was available under the credit facility. To the extent FTX and its other subsidiaries incur additional debt, the amount available to FRP under the credit facility may be reduced. FRP believes that its short- term cash requirements will be met from internally generated funds and borrowings under its existing credit facility.
ENVIRONMENTAL
FTX and its affiliates, including FRP, have a history of commitment to environmental responsibility. Since the 1940s, long before public attention focused on the importance of maintaining environmental quality, FTX and its affiliates have conducted preoperational, bioassay, marine ecological, and other environmental surveys to ensure the environmental compatibility of its operations. FTX's Environmental Policy commits FTX and its affiliates' operations to full compliance with local, state, and federal laws and regulations, and prescribes the use of periodic environmental audits of all domestic facilities to evaluate compliance status and communicate that information to management. FTX has access to environmental specialists who have developed and implemented corporatewide environmental programs. FTX's operating units, including FRP, continue to study and implement methods to reduce discharges and emissions.
Federal legislation (sometimes referred to as "Superfund") requires payments for cleanup of certain abandoned waste disposal sites, even though such waste disposal activities were performed in compliance with regulations applicable at the time of disposal. Under the Superfund legislation, one party may, under certain circumstances, be required to bear more than its proportional share of cleanup costs at a site where it has responsibility pursuant to the legislation, if payments cannot be obtained from other responsible parties. Other legislation mandates cleanup of certain wastes at unabandoned sites. States also have regulatory programs that can mandate waste cleanup. Liability under these laws involves inherent uncertainties.
FRP has received notices from governmental agencies that it is one of many potentially responsible parties at certain sites under relevant federal and state environmental laws. Further, FRP is aware of additional sites for which it may receive such notices in the future. Some of these sites involve significant cleanup costs; however, at each of these sites other large and viable companies with equal or larger proportionate shares are among the potentially responsible parties. The ultimate settlement for such sites usually occurs several years subsequent to the receipt of notices identifying potentially responsible parties because of the many complex technical and financial issues associated with site cleanup. FRP believes that the aggregation of any costs associated with these potential liabilities will not exceed amounts accrued and expects that any costs would be incurred over a period of years.
FRP, through FTX, maintains insurance coverage in amounts deemed prudent for certain types of damages associated with environmental liabilities which arise from unexpected and unforeseen events and has an indemnification agreement covering certain acquired sites (Note 7).
FRP has made, and will continue to make, expenditures at its operations for protection of the environment. Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls, which will be charged against income from future operations. Present and future environmental laws and regulations applicable to FRP's operations may require substantial capital expenditures and may affect its operations in other ways that cannot now be accurately predicted.
1992 RESULTS OF OPERATIONS COMPARED WITH 1991
FRP reported 1992 net income of $20.2 million ($.20 per unit) compared with $15.0 million ($.18 per unit) for 1991, which included an insurance settlement gain (Note 7) of $17.7 million ($.21 per unit) and a charge of $96.8 million ($1.16 per unit) to reflect the cumulative effect of the change in accounting principle for postretirement benefits other than pensions (Note 6). Excluding the nonrecurring items, income for 1992 was lower primarily because of reduced agricultural minerals and uranium earnings, partially offset by profitable Main Pass oil operations.
Revenues were virtually unchanged from 1991 with increases in oil and phosphate rock revenues partially offsetting a decrease in phosphate fertilizer revenues. Production and delivery costs as a percent of revenues declined due to increased oil production, which has lower production and delivery costs than FRP's other products. Depreciation and amortization expense rose primarily because of higher oil production, and general and administrative expenses increased due to the additional effort and support required by Main Pass. Interest costs of $19.1 million for 1992 and $23.3 million for 1991, associated primarily with Main Pass development, were capitalized.
Agricultural Minerals Operations Revenues and earnings for 1992 totaled $799.0 million and $18.0 million compared with $880.5 million and $78.9 million for 1991, respectively, reflecting weak market prices for phosphate fertilizers and sulphur. However, FRP's 1992 average unit production cost for phosphate fertilizers was lower than during 1991. Significant items impacting the segment earnings are as follows (in millions):
Agricultural minerals earnings - 1991 $ 78.9 Major increases (decreases) Sales volumes 27.0 Realizations (107.8) Other (.7) ------ Revenue variance (81.5) Cost of sales 41.9 General and administrative and other (21.3) ------ (60.9) ------ Agricultural minerals earnings - 1992 $ 18.0 ======
Phosphate fertilizer sales volumes were slightly lower during 1992, whereas the average realization was 13 percent lower. Phosphate fertilizer realizations declined steadily throughout 1992 because of curtailed purchases by China, the largest single fertilizer importer, and supply and demand uncertainty in Europe, the former Soviet Union, and India. Also contributing to the decline in prices were lower raw material costs, most notably for sulphur, as producers in the weakening market passed along these cost savings to buyers in an attempt to preserve market share. FRP's phosphate rock and fertilizer facilities operated at or near capacity, with the 1992 phosphate fertilizer unit production cost averaging 7 percent less than during 1991 due to reduced raw material costs for sulphur and lower phosphate rock mining expenses, despite higher natural gas costs. Unit production cost also benefited during the latter part of 1992 as FRP completed a $60.0 million capital program to improve efficiency and lower costs.
Sulphur production and sales volumes for 1992 declined 8 percent and 7 percent, respectively, from 1991 as the Garden Island Bay and Grand Isle mines ceased production in 1991. However, production increased at the Caminada mine, which had a significantly lower unit production cost than either Garden Island Bay or Grand Isle had prior to depletion, resulting in an average sulphur unit production cost 7 percent lower than during 1991. FRP's 1992 sulphur realization reflects the price declines which occurred since mid-1991, as world sulphur markets were burdened by the collapse of the Soviet Union as well as by a further decline in demand in Western Europe. During 1992, several Canadian sulphur marketers built inventory rather than accept depressed prices; however, others intensified their efforts to sell into the important Tampa, Florida market.
Phosphate rock production and sales benefited from the capacity expansion completed in mid-1992 at one of FRP's two operated phosphate rock mines, and also reflect the output from FRP's Central Florida Pebbledale property, where sales began in July 1991 under a mining agreement with IMC.
Oil Operation 1992 1991 --------- ------- Sales (barrels) 4,884,000 350,800 Average realized price $15.91 $13.34 Earnings (in millions) $4.6 $(.6)
Earnings for Main Pass, which initiated oil production in late 1991, benefited from FRP's marketing efforts, which alleviated earlier problems related to its high-sulphur oil, and high average production rates.
______________________________________
The results of operations reported and summarized above are not necessarily indicative of future operating results.
Item 8. | 793421 | 1993 |
Item 6. Selected Financial Data
(A) The Company operates as a cooperative organization, and pays patronage dividends to member dealers on earnings derived from business done with such dealers. It is the practice of the Company to distribute all patronage sourced earnings in the form of patronage dividends. Earnings before patronage dividends and patronage dividends will normally be the same, except for differences caused by the timing of the recognition of certain items for income tax purposes.
(B) The form in which patronage dividends are to be distributed can only be determined at the end of each year when the amount distributable to each of the member dealers is known. For the five years ended December 31, 1993, patronage dividends were payable as follows:
(C) Numbered notes refer to Notes to Financial Statements, beginning on page.
Item 7. | Item 7. Management's Discussion And Analysis Of Financial Condition And Results Of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Company's ability to generate cash adequate to meet its needs ("liquidity") results from internally generated funds, short-term lines of credit and long-term financings (see Notes 3 and 4 to the financial statements). These sources have been sufficient to finance the Company's seasonal and other working capital requirements and its capital expenditure programs.
The Company had unused unsecured lines of credit of $69.0 million at December 31, 1993. Any borrowings under these lines of credit would bear interest at the prime rate or less. Long-term financings are arranged as determined necessary to meet the Company's capital or other requirements, with principal amount, timing and form dependent on prevailing debt markets and general economic conditions.
Capital expenditures for new and improved facilities were $16.3, $34.6 and $37.9 million in 1993, 1992 and 1991, respectively. During 1993, the Company financed the $16.3 million of capital expenditures out of current and accumulated internally generated funds, and short-term and long-term borrowings. 1994 capital expenditures are anticipated to be approximately $30.9 million primarily for improvements to existing facilities.
As a cooperative, the Company distributes substantially all of its patronage source earnings to its members in the form of patronage dividends, which are deductible for income tax purposes (see headings "Patronage Dividend Determinations And Allocations" and "Federal Tax Treatment of Patronage Dividends"). The 1991 capital gain from the sale and leaseback of the Los Angeles, California facility constitutes nonpatronage-sourced income and is not available for distribution as patronage dividends.
The Company expects that existing and new internally generated funds, along with established lines of credit and long-term financings, will continue to be sufficient to finance the Company's patronage dividend and capital expenditure programs.
Operations--1993 Compared to 1992
Net sales increased 7.9% in 1993 primarily due to increases in volume from existing dealers. Sales of basic hardware and paint merchandise (including warehouse, bulletin, and direct shipments) increased 6.8%. Lumber and building material sales experienced a higher percentage increase in 1993. Net dealer outlets decreased as set forth on page 1 as a result of increased sales and marketing efforts with existing dealers and increased competition.
Gross profit increased $2,829,000 or 1.9% vs. 1992 due primarily to higher net merchandise discounts and allowances. Gross profit decreased as a percent of sales, however, due to reduced handling charges on competitively priced items and shifts in the Company's sales mix.
Warehouse and distribution expenses decreased by $641,000 or 2.0% due to decreased building rental and facility costs and increased levels of warehousing costs absorbed into cost of sales, partially offset by increased personnel and equipment costs and traffic freight subsidies.
Selling, general, and administration expenses increased by $5,927,000 or 12.2% due to higher personnel costs and marketing expenses partially offset by higher advertising and retail support income.
Interest expense increased $1,418,000 in 1993 despite lower interest rates due to increased long-term debt resulting from the financing of planned capital expenditures and increased inventory levels. The use of both short-term borrowings and long-term financing is expected to continue to fund planned capital expenditures (see liquidity and capital resources and Notes 3 and 4 to the financial statements).
Operations--1992 Compared to 1991
Net sales increased 9.8% in 1992 primarily due to increases in volume from existing dealers. Sales of basic hardware and paint merchandise (including warehouse, bulletin, and direct shipments) increased 6.9%. Lumber and building material sales experienced a higher percentage increase in 1992. Total paint sales increased 12.3%. Net dealer outlets decreased as set forth on page 1 as a result of increased sales and marketing efforts with existing dealers and increased competition.
Gross profit increased $13,276,000 or 9.9% vs. 1991 but is comparable as a percentage of sales primarily due to higher net merchandise discounts and allowances and a lower LIFO provision partially offset by reduced handling charges as a percent of sales caused by a shift in the sales mix.
Warehouse and distribution expenses increased by $3,310,000 or 11.4% due to higher personnel costs related to volume increases, increased building rental costs and higher 1992 start-up and closing costs incurred in conjunction with the replacement of a facility.
Selling, general, and administration expenses increased by $4,013,000 or 9.0% due to higher personnel costs and marketing expenses partially offset by higher advertising income.
Interest expense increased $1,370,000 in 1992 despite lower interest rates due to increased long and short-term debt resulting from the financing of planned capital expenditures and increased inventory levels. The use of both short-term borrowings and long-term financing is expected to continue to fund planned capital expenditures (see liquidity and capital resources and Notes 3 and 4 to the financial statements).
Other income, net decreased $2,973,000 in 1992 due primarily to the 1991 gain on the sale of the Los Angeles facility (see Note 11 to the financial statements).
Inflation and Changes in Prices
The Company's business is not generally governed by contracts that establish prices substantially in advance of the receipt of goods or services. As vendors increase their prices for merchandise supplied to the Company, the Company increases the price to its dealers in an equal amount plus the normal handling charge on such amounts. In the past, these increases have provided adequate gross profit to offset the impact of inflation on operating expenses.
Item 8. | 2024 | 1993 |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS
FINANCIAL CONDITION
Grossman's Inc. financial condition at December 31, 1993 reflects management actions taken to improve future liquidity. Significant 1993 events affecting year end financial condition are as follows:
- - Operating results in Eastern Division stores were significantly below prior year levels and current year expectations, resulting in lower than anticipated cash flows and necessitating unplanned borrowings under the Company's revolving credit agreements.
- - The Company reviewed both individual store and market performance and determined that 22 Eastern Division stores should be closed and the assets redeployed. A $34.3 million store closing provision was recorded in the third quarter.
- - The Company announced an agreement for the sale of its 35 acre headquarters site in Braintree, Massachusetts to Kmart Corporation. Financial reporting of the sale is being deferred until certain contingencies are resolved and the sale is consummated.
- - A non-cash adjustment of $30.2 million was recorded, establishing a valuation allowance to offset deferred tax assets recorded in 1991.
- - The Company entered into a new three-year revolving credit agreement, secured by receivables, inventory and certain other assets.
- - A $20.5 million non-cash adjustment to stockholders' investment was recorded to reflect the difference between the accumulated pension benefit obligation and the estimated value of pension plan assets. This adjustment resulted from a reduction in the discount rate assumption used to compute actuarially the cost of the future obligation.
- - Three Contractors' Warehouse stores were opened, including the first in the Midwest, and 15 Eastern Division stores were repositioned.
- - The Eastern Division distribution center became fully operational, and long-term financing for the facility was finalized.
Eastern Division operating returns and cash flows during the first nine months of 1993 were significantly below expectations, principally due to increased competition, concurrent with a continued stagnant Northeast economy. As a result, management actions were taken to improve operating returns, liquidity and future cash flows.
During the first four months of 1993, operating performance was affected negatively by severe spring weather conditions, resulting in declines in comparable store sales during each of these months. As ground conditions dried out, operating performance normalized and the Company realized increases in comparable store sales during the balance of the second quarter. Operating performance in the second quarter exceeded the prior year level. During the third quarter, operating performance began to decline significantly in the
Eastern Division. Steps taken to react to diminishing store performance, including price reductions, inventory management and promotional activities, did not counterbalance the declining operational results, particularly in those stores affected most by competition. As the quarter progressed, management performed a review of each Eastern Division store and a determination was made to close 22 marginally performing stores. A charge of $34.3 million was recorded at the end of the quarter to cover closing costs, lease expenses in eleven of the closed stores, severance and outplacement costs, inventory writedowns, other anticipated expenses and the net unrecoverable amount of property, plant and equipment.
The process of closing the 22 stores was completed in the fourth quarter of 1993. One additional store was closed in early 1994. Three properties, the former Nashua, New Hampshire, Eastport, Maine and Erie, Pennsylvania stores, have been sold, the latter two in early 1994. Two additional properties are under agreement to be sold in 1994, and one lease agreement has been terminated in a favorable settlement. The remaining seven owned properties and ten leased properties continue to be marketed actively. It is anticipated that the sale of some or all of the properties will occur over a period of years, resulting in a liquidity improvement at the time of each respective sale.
In a separate transaction, the Company announced an agreement to sell its 35 acre headquarters site in Braintree, Massachusetts to Kmart Corporation. The sale is contingent upon certain approvals and conditions customary in commercial real estate transactions. The purchase price is dependent upon the number of square feet finally approved by local authorities having jurisdiction over the proposed site plan. Consummating the transaction is subject to the permitting process, the timing of which cannot be predicted at this time. If the transaction is consummated, the Company expects to realize significant cash flow and a gain from the sale. Upon the sale of the site, the Company plans to relocate its offices to available space in the vicinity of its current offices.
The Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109. This standard requires, among other things, recognition of future tax benefits, measured by enacted tax rates, attributable to deductible temporary differences between financial statement and income tax bases of assets and liabilities and net operating loss carryforwards to the extent that management assesses the utilization of such net operating loss carryforwards to be more likely than not. The statement also requires deferred tax assets to be reduced by a valuation allowance if, based on the weight of available evidence, management cannot make a determination that it is more likely than not that some portion or all of the related tax benefits will be realized. Furthermore, the statement requires that a valuation allowance be established or adjusted if a change in circumstances causes a change in judgment about the future realizability of the deferred tax assets. At December 31, 1992, the Company had recorded deferred tax assets totalling $30.2 million, with no related valuation allowance, based upon management's assessment at that time that taxable income of the Company would more likely than not be sufficient to utilize fully the net operating loss carryforwards prior to their ultimate expiration in the year 2001. At September 30, 1993, based upon unanticipated 1993 operating results and a
reassessment of future expectations, the Company established a valuation allowance to reduce the carrying value of deferred tax assets to zero. The Company has not recognized any future tax benefits that may be realized from taxable losses incurred in 1993. The Company anticipates that its judgment about the future realizability of the deferred tax assets will not be amended until a sustained period of income has been achieved and is likely to continue.
As a result of the charges discussed above and the Company's nine-month operating performance, at September 30, 1993, the Company was not in compliance with certain covenants contained in its revolving credit agreement and certain other loan agreements. The Company's lenders waived such defaults through December 15, 1993.
On December 15, 1993, the Company entered into a loan and security agreement with BankAmerica Business Credit, Inc., which provides for borrowings up to $60 million, including letters of credit up to $15 million. Borrowings pursuant to this agreement are secured by inventories, receivables and certain other assets. At December 31, 1993, cash borrowings under this agreement totalled $23.2 million and outstanding standby letters of credit, issued in the normal course of business principally to guarantee payment of insurance obligations, totalled $11.4 million. The agreement has a three-year term, with one-year renewal periods thereafter. Interest is payable at 1% over Prime Rate (7% at December 31, 1993), with a Eurodollar option available for borrowings in excess of $5 million. The agreement contains various covenants which, among other things, require minimum levels of net worth, establish minimum interest and fixed charge coverage ratios, and establish maximum levels of capital expenditures. Other loan agreements were amended to contain similar covenants. The borrowings under the revolving credit agreement have been classified as long-term at December 31, 1993, as borrowings during 1994 are expected to remain at or above the year end 1993 level.
The Company has changed its actuarial assumption for the discount rate used to value pension obligations from 9.5% to 7.0%. As a result, a non-cash adjustment of $21.9 million was recorded, reducing prepaid pension assets and establishing a $15.2 million minimum liability equal to the difference between the accumulated pension benefit obligation and the estimated value of pension plan assets. An intangible asset was established of $1.4 million, equal to unrecognized prior service cost, and a $20.5 million adjustment to stockholders' investment was recorded in accordance with Statement of Financial Accounting Standards No. 87. The minimum liability, intangible asset and adjustment to stockholders' investment will be measured annually and will change based on interest rate assumptions, changes in the benefit obligation and changes in the value of plan assets.
Inventory at December 31, 1993 totalled $121.8 million, a $1.4 million decrease from the prior year end. Inventory declines as a result of Eastern Division store closings were offset by inventory in three Contractors' Warehouse stores opened during 1993 and increased lumber prices.
Property, plant and equipment and capital lease obligations reflect the results of actions taken in support of three principal strategic initiatives: repositioning of Eastern Division stores to strengthen their appeal to target customers, expanding the Company's Contractors' Warehouse concept and development and installation of its Eastern Division automated, integrated replenishment system. Capital expenditures of $15.1 million and capital lease
additions of $7.2 million were made principally in support of these initiatives. Subject to funds availability, management plans to continue capital expenditures in support of the Contractors' Warehouse expansion and Eastern Division replenishment system, including new register systems; however, in light of 1993 store performance, repositioning of additional Eastern Division stores will be slowed.
Expansion of the Contractors' Warehouse concept continued in 1993, with a store opening in Colton, California in March and store openings in Carson, California and Cincinnati, Ohio in June. Expansion of this concept will continue in 1994 with two planned store openings in the Midwest. In addition, the Company's Mexican joint venture is scheduled to open its first store in Monterrey, Mexico in the 1994 second quarter. This store will be modeled after the Contractors' Warehouse concept. The Company also opened one Grossman's store and three Mr. 2nd's Bargain Outlet Stores during 1993.
The repositioning of 15 Eastern Division stores was completed prior to the 1993 spring selling season. The Company also completed the expansion to 300,000 square feet of its Distribution Center in Manchester, Connecticut. The Company purchased and expanded the distribution facility to support the Eastern Division's new automated, integrated replenishment system, which is currently operational.
In January 1993, the Company paid $10.8 million as the final installment on its Zero Coupon Notes. In February 1993, the Company entered into long-term financing of $6.1 million on the Eastern Division distribution center. Upon receipt of the loan proceeds, full payment was made on the existing two-year $4.9 million mortgage. The new mortgage has a 15 year amortization period, with the balance due at the end of ten years. The Company also received $750,000 in proceeds from two mortgage loans provided by the State of Connecticut for equipment within the distribution facility.
The Company believes that existing funds, funds generated from operations, proceeds to be received from the sale of properties and funds available under the $60 million loan and security agreement will be sufficient to satisfy debt service requirements, to pay other liabilities in the normal course of business and to finance planned capital expenditures.
RESULTS OF OPERATIONS
1993 COMPARED WITH 1992
The 1993 net loss of $68.3 million compares to net income of $6.2 million in 1992. Significant items affecting 1993 net income were as follows:
- - Higher seasonal operating losses during the first quarter of 1993 resulting from severe weather conditions in the Northeast and West adversely affected sales.
- - Staff reductions were effected in the Eastern Division, largely as a result of the continued implementation of the division's automated, integrated replenishment system. Expenses related to these reductions were recorded in the third quarter.
- - Eastern Division store operating results and cash flows declined significantly in the third quarter. These results were affected negatively by Northeast economic conditions and competition. Steps taken to offset these declines were only partially successful.
- - After a complete review of all stores in all markets, 22 marginally performing Eastern Division stores were closed and a store closing provision of $34.3 million was recorded in the third quarter. Store closings were completed in the fourth quarter.
- - Based upon unanticipated operating losses and a reassessment of future expectations, in the third quarter, the Company established a $30.2 million valuation allowance to reduce to zero the carrying value of deferred tax assets previously established in 1991.
- - Gross margin declines occurred throughout the year resulting from increases in sales to professional customers, growth in Contractors' Warehouse store sales, increasingly competitive market conditions and rising lumber prices.
- - Operating income improved by $2.9 million in the fourth quarter, reflecting Eastern Division overhead reductions and increased comparable store sales in each month during the quarter.
The Company's two principal operating strategies are to reposition Grossman's stores to strengthen their appeal to target customers and to grow the Contractors' Warehouse concept, both of which emphasize sales to the professional customer. During 1992, within Grossman's stores, sales growth in the professional segment offset a decline in the retail segment. In 1993,
sales to the retail segment continued to decline, and the growth in professional sales was not sufficient to cover this shortfall. Sales in the first four months of 1993 were affected negatively by severe weather conditions and prolonged wet ground conditions. In May and June, both total sales and comparable store sales increased. This trend did not continue into the third quarter, when sales declines occurred in all months. Total fourth quarter sales, which included one additional week in 1993, declined in the Eastern Division, reflecting closed stores, and continued to grow in Contractors' Warehouse stores. Eastern Division comparable store sales in the fourth quarter rose by 17.2%, partially due to the transfer of professional customers from closed stores to stores continuing to operate within these markets. Contractors' Warehouse comparable store sales in the fourth quarter rose by 0.7%.
Gross margin declined from 26.8% in 1992 to 25.3% in 1993. Throughout 1993, margin declines occurred as the result of the increase in sales to professional customers, who receive discounts from normal retail pricing, and the growth in Contractors' Warehouse stores, which operate at higher per store sales volume with lower gross margins and lower expenses. Margin declines were also due to competitive market conditions and rising lumber prices. Economic and competitive conditions did not fully allow these price increases to be passed on to customers. Gross profit declined from $223.4 million in 1992 to $212.9 million in 1993, reflecting the overall sales decline, partially due to closed stores, and gross margin declines.
Operating losses during the first quarter, which are normal due to the seasonality of the Company's business, were high due to the severe weather conditions in the Northeast and West, the Company's two principal operating markets. In the first quarter of 1993, the operating loss was $11.3 million, compared to a $4.8 million loss in the comparable period of 1992. In the 1993 second quarter, as conditions improved, operating income of $11.7 million compared favorably to the 1992 level of $10.7 million.
In the third quarter of 1993, the Company's operating income prior to recognition of store closing expense was $2.9 million, as compared to $9.8 million for the same period in 1992. The decline in operating income was principally due to declining Eastern Division store results, as previously discussed. Steps taken to react to diminishing store performance, including price reductions, inventory management and promotional activities, did not counterbalance the declining operational results, particularly in those stores affected most by competition. As the third quarter progressed, management reviewed each Eastern Division store and decided to close 22 marginally performing stores. Store closing expense of $34.3 million was recorded at the end of the quarter to cover costs related to the leases in 11 of the stores, severance and outplacement expenses, inventory write downs, other anticipated expenses and the net unrecoverable amount of property, plant and equipment.
Selling and administrative expenses in 1993 approximated the 1992 level, but varied significantly by quarter, with a first quarter increase of $3.6 million, a second quarter decrease of $2.6 million, a third quarter increase of $2.2 million and a fourth quarter decrease of $3.3 million. The first quarter increase was primarily due to activities in support of strategic
initiatives. Expenses related to these activities were higher in the second quarter of 1992 than in the same period in 1993, the principal reason for the second quarter decline. At the end of the second quarter, the Company announced a restructuring of the Eastern Division, largely as a result of the continued implementation of the automated, integrated replenishment system. Staff reductions were effected in the third quarter, with additional reductions anticipated when further efficiencies from the system are attained. In the third quarter of 1993, selling and administrative expenses included severance payments, outplacement services and other expenses related to the restructuring, resulting in the overall expense increase. In 1994, the Company expects the restructuring to yield continuing savings in operating expenses. The fourth quarter decline in selling and administrative expenses reflects the reduced overhead as a result of closed stores and Eastern Division staff reductions.
Although selling and administrative expenses in 1994 will be favorably impacted by the Eastern Division downsizing, pension expense will rise significantly as a result of changes in assumptions used to determine actuarially the pension liability and expense. Pension expense is expected to increase from $1.8 million in 1993 to approximately $5 million in 1994.
Depreciation and amortization increased by $1.8 million in 1993, related to ongoing capital spending in support of strategic initiatives. Future capital spending will continue in support of the Contractors' Warehouse expansion and Eastern Division replenishment system. Preopening expense, associated with the development, opening, expansion and modernization of stores, decreased from $3.5 million in 1992 to $630 thousand in 1993 as the result of a curtailment of the repositioning of Eastern Division stores. Remodeling of Eastern Division stores planned for the 1993 fourth quarter was not undertaken due to the poor nine-month operating results. In 1992, fourth quarter preopening expenses totalled $2.4 million.
Interest expense remained relatively constant from 1992 to 1993. Interest expense savings related to the retirement of high-interest rate debt were offset by $1.3 million of interest expense on borrowings under the Company's revolving credit agreement. There were no revolving credit borrowings in 1992.
At September 30, 1993, based on unanticipated operating losses and a reassessment of future expectations, the Company established a valuation allowance to reduce the carrying value of deferred tax assets to zero. Tax credits recorded earlier in 1993 were also reversed, resulting in a total provision for income taxes of $30.2 million. The Company has not recognized any future tax benefits that may be realized from taxable losses incurred in 1993.
Other than the effects of rising lumber prices, as previously discussed, the Company's business was not materially affected by inflation in any of the years presented.
1992 COMPARED WITH 1991
Net income of $6.2 million for the year ended December 31, 1992 exceeded the 1991 level of $4.3 million by 45%. The earnings improvement represents a 7.1% improvement in operating income, supplemented by a reduction in interest expense and gains on the sale of real estate.
An overall 0.2% decline in Eastern Division sales resulted from an 11.6% decline in retail sales, virtually offset by a 39.1% increase in professional sales. The retail segment in the Eastern Division continued to reflect the effects of a prolonged slump in the housing sector, coupled with increased competition. Western Division sales increased as the result of new store openings combined with comparable store sales increases.
Gross margin decreased from 27.2% to 26.8% as a result of changes in sales mix toward lower margin professional sales. An increase in retail margin was offset by this change in mix. In 1991, aggressive promotion of the Company's private label credit card was undertaken coincident to the sale of the credit card portfolio, which reduced gross margins.
Economic conditions in the Northeast housing sector affected negatively sales growth in both years. Throughout 1992, the Company continued to counter the effects of the recession and increased competition with more aggressive pricing and marketing to target customers. Sales to professionals, who receive discounts from normal retail pricing, grew as a percent of overall Eastern Division sales. Further offsetting the increase in retail gross margin was the continued growth in Contractors' Warehouse store sales as a percent of total Company sales. Also favorably impacting both retail and professional margins in 1992 was improved inventory shrinkage results throughout the chain.
Selling and administrative expenses increased by $1.6 million, or 0.9%, but decreased as a percent of sales from 23.8% to 23.2%. During the first six months of 1992, operating expenses increased as a percent of sales, primarily in support of the operating strategies. During the second half of the year, the Company was successful at reducing operating expenses during a period when sales increased by 4.8%, thereby reducing selling and administrative expenses as a percent of sales. Within selling and administrative expenses, payroll expense increased by 4.8%, slightly higher than the overall sales increase and reflective of the activities in support of the Company's strategies. Advertising expense decreased by 14.6%, reflective of more targeted marketing efforts. In addition, the provision for losses on accounts receivable declined by $2.0 million, the result of continued tightened credit policies and stronger collection efforts.
Depreciation and amortization increased by 4.8% in 1992, related to capital spending. Preopening expense, which included expenses related to stores scheduled for 1993 openings, totalled $3.5 million as compared to $2.3 million in 1991.
Interest expense declined by $1.2 million, or 12.4%. Savings related to retirement of high-interest debt were partially offset by financing secured in the second and fourth quarter of 1991, as well as interest expense related to
the $4.9 million mortgage on the Company's Eastern Division distribution center, entered into in September 1992. Included in interest expense in 1991 was $364 thousand of interest on revolving credit borrowings. There were no borrowings in 1992.
Interest and other income increased by $1.0 million from 1991 to 1992, which includes net gains of $4.2 million on sales of property, less other non-operating expenses and other declines due to the receipt in 1991 of state income tax refunds, and interest income in 1991 related to the Company's private label revolving credit card accounts receivable portfolio, which was sold in May 1991.
ITEM 8. | 33798 | 1993 |
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Item 6.01 of Regulation S-K:
Exhibit Reference
(3) Certificate of Incorporation and By-Laws:
(a) Certificate of Incorporation and Amendments Incorporated by reference to Exhibit 3(a) of Form 10-K filed for the year
ended December 31, 1991, Commission File Number 0-8135.
(b) By-Laws as amended February 1993 Incorporated by reference to Exhibit 3(b) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(4) Instruments Defining the Rights of Shareholders, Including Indentures:
(a) Certificate of Incorporation and Amendments See Exhibit 3(a) above.
(b) By-Laws as amended February 1993 See Exhibit 3(b) above.
(c) The Company agrees to furnish to the Securities and Exchange Commission upon request pursuant to Item 601(b)(4)(iii) of Regulation S-K copies of instruments defining the rights of holders of long-term debt of the Company and its consolidated subsidiaries.
(10) Material Contracts:
(a) Incentive Stock Bonus Plan* Incorporated by reference to Exhibit 10(a) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(b) First Amendment to Incentive Incorporated by reference to Exhibit Stock Bonus Plan* 10(b) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(c) Second Amendment to Incentive Incorporated by refence to Exhibit Stock Bonus Plan* 10(c) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(d) Share Option Plan of 1987* Incorporated by reference to Exhibit 10(d) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(e) First Amendment to Share Option Incorporated by refence to Exhibit Plan of 1987* 10(e) of Form 10-K filed for the year ended December 31, 1992, Commission File Number 0-8135.
(f) Employment Agreement with Carl T. Incorporated by reference to Exhibit Cori* (Similar Employment Agreements 10(f) of Form 10-K filed for the also exist with Peter A. Gleich, year ended December 31, 1992, David R. Harvey, Kirk A. Richter Commission File Number 0-8135. and Thomas M. Tallarico) (g) Letter re: Consultation Services Incorporated by reference to Exhibit with Dr. David M. Kipnis* 10(g) of Form 10-K field for the year ended December 31, 1992, Commission File Number 0-8135.
(11) Statement Regarding Computation Incorporated by reference to the of Per Share Earnings information on net income per share included in Note 1 to the Company's 1993 financial statements filed as Exhibit 13 below.
(13) Pages 11-24 of the Annual Report to Shareholders for the year ended December 31, 1993
(21) Subsidiaries of Registrant
(23) Consent of Independent Public Accountants
*Represents management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. | 90185 | 1993 |
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ITEM 6. SELECTED FINANCIAL DATA
Required information is included in "Summary of Selected Consolidated Financial Data" (Page 16) in the Financial Review section of the Corporation's Annual Report 1993, and is incorporated herein by reference thereto.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Required information is included in "Management's Discussion and Analysis of Financial Condition and Results of Operations" (Pages 17 through 32) in the Financial Review section of the Corporation's Annual Report 1993, and is incorporated herein by reference thereto.
ITEM 8. | 36377 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
- --------------- (a) In March 1993, the Company sold its DDS business to Halliburton resulting in income from discontinued operations of $73.6 million. This amount includes the gain from the sale of the DDS business of $80.1 million. As a result, the financial data for the periods 1989 through 1992 has been restated to report the results of the DDS business as discontinued operations. The Company used a portion of the proceeds from the DDS sale to repay its bank debt and $49.0 million of notes payable to insurance companies. The Company's remaining debt, totaling $46.0 million, is presented as long-term debt at December 31, 1993 and 1992. See Notes 2 and 6 of Notes to Consolidated Financial Statements.
(b) In September 1993, the Company agreed to settle a class action civil lawsuit which alleged violations of Section 1 of the Sherman Act. As a result, the Company recorded a special charge of $19.9 million to cover the cost of the settlement and related legal fees and other costs and expenses. See Note 16 of Notes to Consolidated Financial Statements. (Notes continued on following page)
(c) During the first quarter of 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." As a result of adopting SFAS No. 106, the Company recorded the total outstanding liability related to such retiree benefits of $1.3 million as the cumulative effect of a change in accounting principle in the Consolidated Statements of Operations. See Note 11 of Notes to Consolidated Financial Statements.
(d) In 1991, the Company recorded $22.2 million of non-recurring charges related primarily to the restructuring of its worldwide operations in response to a decline in U.S. drilling activity. The non-recurring charges consisted of $21.2 million of charges related to the restructuring and an additional $1.0 million tax provision to reflect expected tax settlements of prior year foreign tax liabilities of certain of the Company's subsidiaries. The amount of restructuring charges related to the continuing operations of the Company of $18.4 million in 1991 was charged to income (loss) from continuing operations before interest and taxes. The amount of restructuring charges related to the DDS business of $2.8 million is recorded in the results of discontinued operations in 1991. See Notes 3 and 8 of Notes to the Consolidated Financial Statements.
(e) In 1991, the Company paid off its Series B Notes totaling $44.7 million from the $50.0 million proceeds of its temporary warrant reduction offers and its issuance of 992,000 shares of additional common stock. See Notes 6 and 9 of Notes to Consolidated Financial Statements.
(f) In accordance with APB No. 11, the Company recognized an extraordinary tax credit of $7.5 million in 1990 resulting from utilization of operating loss carryforwards of which approximately $5.2 million related to continuing operations.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Substantially all of the products and services of the Company are used in the process of drilling an oil or natural gas well. Consequently, drilling activity is closely followed by the oil service industry as it is an indicator of the overall market demand for the Company's products and services. Although the average active drilling rig count is one indicator of the Company's potential market, another important factor is the mix of natural gas and oil wells being drilled.
During 1993, the United States average rig count increased by 5.0% from 1992 activity levels while the 1993 international average rig count increased slightly from 1992 levels. The United States drilling activity rebounded from the record low activity levels experienced during 1992 as a result of the improvement in natural gas prices experienced during 1993. Although the average international rig count did not change substantially from 1992 levels, there were significant activity changes between international drilling markets, as all international areas experienced drilling activity declines except Canada and the Middle East.
Management anticipates drilling activity in 1994 to approximate 1993 activity levels and intense competition to continue. Some additional drilling for natural gas is expected to occur during 1994 in the Gulf of Mexico region of the U.S. due to the increase in natural gas prices during the prior year, the decline in natural gas reserves and the general emphasis utilizing natural gas as an environmentally preferred fuel. Management believes that the Company is well positioned to benefit from increases in worldwide oil and gas exploration drilling which may develop in 1994 and beyond and that greater drilling activity will positively impact the Company's results in the future.
SALE OF DIRECTIONAL DRILLING BUSINESS
On March 29, 1993, the Company sold its directional drilling systems and services (DDS) business and certain of its subsidiaries and other affiliates to Halliburton Company (Halliburton) for 6,857,000 shares of Halliburton common stock. In April 1993, the Halliburton common stock was sold for $247.7 million. As a result, the Company recorded income from discontinued operations of $73.6 million including the gain from the sale of the DDS business of $80.1 million. The gain includes provisions for various fees, expenses and taxes related to the DDS sale. The DDS business reported revenues of approximately $36.3 million in the first three months of 1993, $158.7 million in 1992 and $151.1 million in 1991.
The Company used a portion of the proceeds of the DDS sale to repay certain debt of the Company. For further discussion, refer to "Liquidity and Capital Resources" below.
ACQUISITIONS OF A-Z/GRANT AND LINDSEY
On December 22, 1993, the Company acquired the product line assets of A-Z International, Grant Oilfield Tools and Lindsey Completion Systems (A-Z/Grant and Lindsey) from Masex Energy Services Group, Inc. for $19.0 million in cash. A-Z/Grant and Lindsey are leading providers of downhole tools, remedial services and liner hangers to the oil and gas industry. A-Z/Grant and Lindsey reported unaudited revenues of $31.6 million in 1993, $29.0 million in 1992, and $31.0 million in 1991. The acquisition was accounted for as a purchase effective December 22, 1993. The results of A-Z/Grant and Lindsey from December 22, 1993 to December 31, 1993 were not significant to the operations of the Company.
ACQUISITION OF M-I DRILLING FLUIDS COMPANY IN 1994
Effective February 28, 1994, the Company acquired a 64% interest in M-I Drilling Fluids Company (M-I) from Dresser Industries, Inc. (Dresser) for $160 million. M-I was owned 64% by Dresser and 36% by Halliburton prior to the acquisition. M-I is a leading provider of environmentally sensitive drilling fluids and systems to the oil and gas drilling industry. The Company purchased the 64% interest in M-I using $80 million of its cash and issuing a note payable to Dresser for $80 million due on August 28, 1994. The acquisition will
be accounted for as a purchase. M-I reported unaudited revenues of $405.8 million in 1993, $382.6 million in 1992 and $435.5 million in 1991.
PRO FORMA DATA
The unaudited pro forma revenues and income from continuing operations for the year ended December 31, 1993 assuming the acquisitions of A-Z/Grant and Lindsey and M-I had been made on January 1, 1993 are as follows:
Refer to page 22 for a more complete presentation of the unaudited pro forma statement of income (loss) from continuing operations and unaudited pro forma balance sheet.
RESULTS OF OPERATIONS
Revenues
The tools and equipment manufactured and the services provided by the Company fall into two major product and service groups that are marketed throughout the world. The following table sets forth the amounts and percentages of revenues by major product group and by area:
Drill Bits
Drill bit revenues are generated from the sale of petroleum drill bits and mining bits. Petroleum drill bit revenues increased $18.3 million or 14.4% from $127.5 million in 1992 to $145.8 million in 1993 due primarily to higher sales and improved pricing in the United States and Canada resulting from the increase in North American drilling activity and increased sales into the former Soviet Union. These increases were partially offset by reduced sales in the North Sea area due to lower drilling activity and reduced volume in Mexico and Italy. Petroleum drill bit revenues declined $18.0 million or 12.4% from $145.5 million in 1991 to $127.5 million in 1992 due primarily to the decline in worldwide drilling activity, principally in the U.S. and Canada, and price reductions resulting from competitive pressures. This decrease was partially offset by an increase of 16.0% in diamond bit sales.
Mining drill bit revenues decreased $1.5 million or 8.3% from $18.0 million in 1992 to $16.5 million in 1993 due to reduced sales to Canadian iron ore producers. Mining drill bit revenues decreased $2.6 million or 12.6% from $20.6 million in 1991 to $18.0 million in 1992 due to lower domestic and export activity.
Drilling and Completion Services
Drilling and completion services revenues decreased $6.8 million or 10.4% from $65.2 million in 1992 to $58.4 million in 1993 due to lower international drilling activity primarily in the Europe/Africa region, the Middle East and Mexico. These declines were partially offset by increased sales in Canada. Drilling and completion services revenues decreased $20.7 million or 24.1% from $85.9 million in 1991 to $65.2 million in 1992 due to reduced worldwide drilling activity, primarily the U.S., and lower sales in Australia, the Middle East, Africa and the United Kingdom. The Company also discontinued its inspection business in the United Kingdom and closed certain service centers in the U.S. in 1992.
For the periods indicated, the following table summarizes the results of continuing operations of the Company and presents results as a percentage of total revenues of the continuing operations:
1993 Versus 1992
Revenues for 1993 increased $10.0 million or 4.7% from $210.7 in 1992 to $220.7 in 1993. Revenues in the United States and Canada increased due primarily to increased drilling activity. These increases were partially offset by lower revenues outside of North America due to lower drilling activity. Domestic revenues increased $16.2 million, or 18.4%, from $88.2 million in 1992 to $104.4 million in 1993 due to a 5.0% increase in the average U.S. rig count and improved pricing. International revenues decreased by $6.2 million or 5.1% from $122.5 million in 1992 to $116.3 million in 1993 due to the 9.7% decline in international drilling activity which was partially offset by revenues in Canada and the former Soviet Union.
Product sales increased $10.4 million or 6.2% from $166.6 in 1992 to $177.0 million in 1993 due primarily to the increase in drilling activity in the United States and Canada partially offset by lower sales in the North Sea, the Middle East and Mexico. Rentals, services and other revenues decreased $0.4 million or 0.9% from $44.1 million in 1992 to $43.7 million in 1993 as a result of lower drilling activity in the Europe/Africa region and the Middle East.
Gross profit increased $8.4 million or 11.3% from $74.1 million in 1992 to $82.5 million in 1993. Gross profit on product sales increased $5.7 million or 8.5% from $66.9 million in 1992 to $72.6 million in 1993 due to higher sales and improved pricing in the United States and Canada. Gross profit on rentals, services and other revenues increased $2.7 million or 37.5% from $7.2 million in 1992 to $9.9 million in 1993 due to lower operating costs in the United States and Canada.
Operating expenses, comprised of selling expenses and general and administrative expenses, increased by $0.1 million or 0.2% from $63.8 million in 1992 to $63.9 million in 1993. The increase was due primarily to higher variable selling expenses relating to the higher North American sales and higher legal expenses associated with the drill bit litigation. These increases were reduced by lower personnel levels due to cost reduction actions and lower foreign currency translation losses. Operating expenses as a percentage of revenues decreased from 30.3% in 1992 to 29.0% in 1993.
On August 27, 1993, without admitting any form of liability, the Company entered into an agreement to settle a class action civil lawsuit pending in the federal district court in Houston. The lawsuit alleged that the Company and other defendants violated Section 1 of the Sherman Act. The Company recorded a special charge of $19.9 million to cover the cost of the settlement and related estimated legal fees and other costs and expenses. On October 28, 1993, an order was entered which gave final approval to this settlement.
Interest expense decreased $4.6 million or 43.4% from $10.6 million in 1992 to $6.0 million in 1993 due to the refinancing of long-term debt in the fourth quarter of 1992 and the repayment of debt from the proceeds of the DDS sale. Interest income increased due to a higher level of short-term investments resulting from the investment of the proceeds of the DDS sale.
The tax provision of $0.5 million for 1993 consists primarily of foreign taxes on income. The tax benefit of $1.0 million in 1992 relates primarily to a $2.5 million benefit related to the settlement of a U.S. tax claim with the IRS. The Company provides for U.S. taxes at the statutory rate offset by tax benefits related to the U.S. net operating loss (NOL) carryforwards, available to the Company as well as foreign taxes. During 1993, the Company adopted Statement of Financial Accounting Standard No. 109 for accounting for income taxes. The adoption did not materially affect the 1993 results.
1992 Versus 1991
Revenues for 1992 decreased $41.3 million or 16.4% from $252.0 million in 1991 to $210.7 million in 1992 due primarily to an 11.5% decline in the average worldwide rig count. International revenues decreased $19.3 million or 13.6% from $141.8 million in 1991 to $122.5 million in 1992 due primarily to lower Canadian drilling activity, lower volume in the Middle East, France, the U.K. and Australia and reduced revenues in the Far East due to increased competition and pricing pressure. Domestic revenues decreased $22.0 million, or 20.0%, from $110.2 million in 1991 to $88.2 million in 1992 due to a 16.2% decline in the average U.S. rig count and competitive pricing pressures.
Product sales decreased $28.5 million or 14.6% from $195.1 million in 1991 to $166.6 million in 1992 due primarily to the decline in U.S. and Canadian drilling activity and competitive pricing pressures in the U.S. and Far East. Rentals, services and other revenues decreased $12.8 million or 22.5% from $56.9 million in 1991 to $44.1 million in 1992 due to reduced U.S. drilling activity, lower demand in Africa, Australia and the Middle East and the closing of certain service centers in the United States and the discontinuance of the inspection business in the United Kingdom.
Gross profit decreased $25.9 million or 25.9% from $100.0 million in 1991 to $74.1 million in 1992. Gross profit on product sales decreased by $23.8 million or 26.2% from $90.7 million in 1991 to $66.9 million in 1992 due to lower volumes in aforementioned areas and competitive pricing pressures principally in the U.S. and
Far East. Gross profit on rentals, services and other revenues decreased by $2.1 million or 22.6% from $9.3 million in 1991 to $7.2 million in 1992 due primarily to lower U.S., Australia and the United Kingdom revenue levels.
Operating expenses, comprised of selling expenses and general and administrative expenses, decreased by $7.1 million or 10.0% from $70.9 million in 1991 to $63.8 million in 1992. This decrease was due primarily to lower variable selling expenses associated with reduced revenues offset by currency translation losses in 1992 compared to currency translation gains in 1991. Operating expenses as a percentage of revenues increased from 28.1% in 1991 to 30.3% in 1992.
In 1991, the Company recorded $22.2 million of non-recurring charges related primarily to the restructuring of its worldwide operations in response to the decline in U.S. drilling activity. The non-recurring charges consisted primarily of $21.2 million of restructuring charges composed of $9.9 million for estimated severance and relocation costs, a writedown of $5.7 million related to fixed assets of closed and downsized locations, a provision of $3.7 million to expense certain manufacturing inefficiencies and $1.9 million related to other non-recurring restructuring charges. The Company also recorded an additional $1.0 million tax provision to reflect expected tax settlements of prior year foreign tax liabilities of certain of the Company's subsidiaries. The amount of restructuring charges related to the continuing operations of the Company of $18.4 million was charged to income from continuing operations before interest and taxes. The amount of the restructuring charges related to the DDS business in 1991 of $2.8 million was recorded in the results of discontinued operations. The $1.0 million tax provision was charged against continuing operations.
Interest expense decreased $3.2 million or 23.2% from $13.8 million in 1991 to $10.6 million in 1992 due primarily to lower long-term debt resulting from the repayment of the Series B Notes in December, 1991, the refinancing of long-term debt in the fourth quarter of 1992 and lower short-term interest rates. Interest income decreased $0.5 million or 50.0% from $1.0 million in 1991 to $0.5 million in 1992 due primarily to lower short-term interest rates.
The tax benefit of $1.0 million at December 31, 1992 relates primarily to a $2.5 million benefit related to the settlement of a U.S. tax claim with the IRS. See Note 8 to the Notes to Consolidated Financial Statements. The Company provides for U.S. taxes at the statutory rate offset by tax benefits related to the U.S. NOL carryforwards available to the Company as well as foreign taxes.
In addition to the $1.0 million foreign tax provision discussed above, the tax provision of $2.9 million at December 31, 1991 provides for U.S. taxes at the statutory rate offset by tax credits related to the U.S. NOL carryforwards available to the Company as well as foreign taxes. During 1991, the Company adopted Statement of Financial Accounting Standard No. 96 for accounting for income taxes. The adoption did not materially affect the 1991 results.
LIQUIDITY AND CAPITAL RESOURCES
General
The Company's cash position at December 31, 1993 totaled $101.6 million or an increase of $85.3 million from the Company's cash position at December 31, 1992. The Company's current ratio increased to 3.20 to 1 at December 31, 1993 from 1.77 to 1 at December 31, 1992. The improvement in cash and the current ratio arises due to proceeds received from the sale in 1993 of the DDS business to Halliburton offset by debt repayment of $102.6 million, payments of $19.9 million related to a litigation settlement and the payment of $19.0 million to acquire A-Z/Grant and Lindsey.
The Company was required to repay its bank debt in connection with the DDS sale. The Company also granted options which expired on July 23, 1993 to its insurance company lenders for early repayment of their debt at a reduced make whole premium. On April 12, 1993, the Company used a portion of the proceeds of the DDS sale to retire its domestic credit facility totaling $37.2 million, its domestic bank term loan totaling $16.4 million and $39.0 million of notes payable with insurance companies. On July 23, 1993, the Company repaid an additional $10.0 million of notes payable with insurance companies. The Company's remaining debt totaling $46.0 million at December 31, 1993 is classified as long-term. The accompanying December 31, 1992
balance sheet has also been restated to classify the $46.0 million of debt as long-term. The Company has renegotiated its loan agreements with the insurance companies to amend certain financial covenants as well as to release the collateral under the loan indenture. The Company was in compliance with its loan covenants under the amended loan indenture at December 31, 1993. See Note 6 of the Notes to Consolidated Financial Statements.
Certain of the Company's foreign subsidiaries have short-term lines of credit with various foreign banks totaling approximately $1.7 million. At December 31, 1993, the Company had borrowed $0.7 million under these lines. The majority of these lines are unsecured.
The Company has annual interest requirements of approximately $4.5 million under its existing long-term debt. The Company's indenture relating to its long-term debt contains covenants restricting the payment of cash dividends to the Company's common stockholders based on net earnings and operating cash flow formulas as defined in the indenture. The Company has not paid dividends on its Common Stock since the first quarter of 1986. In addition to compliance with the covenants of the indenture, the determination of the amount of future cash dividends to be declared and paid on the Common Stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deem relevant.
On March 2, 1994, the Company used $80.0 million of its cash and issued a note payable totaling $80.0 million to Dresser to acquire its 64% interest in M-I. The note payable to Dresser bears interest at LIBOR +2% and is due on August 28, 1994. The Company has commitments to refinance the Dresser note payable with a $40 million term loan from its insurance company lenders and a $65 million revolving line of credit from a bank group. The term loan will bear interest at 6.02 percent and be payable over a period ending in January 1998. The revolving line of credit will be due in March 1997 and bear interest at a rate ranging from LIBOR + 3/4 percent to LIBOR +1 1/2 percent based upon the debt-to-total capitalization of the Company. Management believes that such financing will be completed by the end of March 1994.
The Company believes that it has sufficient existing manufacturing capacity to meet current demand for its products and services. Projected capital expenditures in 1994, excluding M-I capital expenditures, will approximate $14 million.
The Company currently expects to be able to meet its ongoing working capital and capital expenditure requirements from existing cash on hand, operating cash flow and existing credit facilities or credit facilities to be arranged as discussed above.
The Company has been named as a potentially responsible party in connection with three sites on the U.S. Environmental Protection Agency's National Priorities List. At December 31, 1993, the remaining recorded liability for estimated future clean-up costs for Superfund sites as well as properties currently or previously owned or leased by the Company was $3.6 million. As additional information becomes available, the Company may be required to provide for additional environmental clean-up costs. However, the Company believes that none of its clean-up obligations will result in liabilities having a material adverse effect on the Company's consolidated financial position or results of operations. See Item 3. "Legal Proceedings -- Superfund" for further discussion.
Because of its substantial foreign operations, the Company is exposed to currency fluctuations and exchange risks. The Company tries to limit these risks by matching, to the extent possible, assets and liabilities denominated in foreign currencies and using hedging instruments to cover certain unmatched positions.
Inflation has not had a material effect on the Company in the last few years, and the effect is expected to be minor in the near future. In general, the Company has been able to offset most of the effects of inflation through productivity gains, cost reductions, and price increases.
Net Operating Loss Carryforwards
As of December 31, 1993, for U.S. tax reporting purposes, the Company had NOL carryforwards of approximately $148.5 million, expiring between 2001 and 2007, which should be available to offset future U.S. taxable income. Upon certain changes in equity ownership of the Company, however, the Company's ability to utilize its NOL carryforwards may become subject to limitation under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"). Management believes that the application of Section 382 will not materially limit the availability of the NOL carryforwards.
UNAUDITED PRO FORMA FINANCIAL STATEMENTS
The following unaudited pro forma statement of income (loss) from continuing operations for the year ended December 31, 1993 presents the acquisitions of M-I and A-Z/Grant and Lindsey as though the acquisitions were effective January 1, 1993. The unaudited pro forma statement of income (loss) from continuing operations gives effect to the acquisitions under the purchase method of accounting and the assumptions included in the accompanying unaudited notes to pro forma financial statements. The unaudited pro forma statement of income (loss) from continuing operations reflect the amortization of estimated goodwill, additional depreciation expense related to the estimated write-up of fixed assets and rental tools of A-Z/Grant and Lindsey and estimated adjustments to interest, taxes and minority interest.
The following unaudited pro forma balance sheet as of December 31, 1993 presents the acquisition of M-I as if the acquisition had occurred at December 31, 1993. The unaudited pro forma balance sheet reflects the acquisition under the purchase method of accounting and the assumptions included in the accompanying unaudited notes to pro forma financial statements. The unaudited pro forma balance sheet reflects only those adjustments relating to the acquisition of M-I, the consolidation of the Company's 64% interest in M-I and certain estimated asset and liability valuation adjustments anticipated to result from the Company's allocation of the purchase price to the accounts of M-I at February 28, 1994.
Management has not fully evaluated all of the consequences of the acquisition of M-I including assessing the fair market value of the assets acquired and the total amount of costs that may be necessary to consolidate the operations of M-I with the Company. As a result, the current estimate of the excess of the purchase price over net assets acquired in the acquisition of M-I totaling $51.2 million has been reflected as goodwill in the unaudited pro forma balance sheet. Upon completion of these evaluations during 1994, any additional asset and liability adjustments and the adjusted excess purchase price over net assets acquired will be recorded in accordance with purchase accounting rules and principles.
The unaudited pro forma financial statements are not intended to be indicative of the results that would have occurred if the acquisitions had been effective as of the dates indicated or that may be obtained in the future. The unaudited pro forma financial statements should be read in conjunction with the Consolidated Financial Statements and notes thereto of the Company included elsewhere in this Form 10-K.
SMITH INTERNATIONAL, INC.
UNAUDITED PRO FORMA STATEMENT OF INCOME (LOSS) FROM CONTINUING OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)
See accompanying unaudited notes to pro forma financial statements.
SMITH INTERNATIONAL, INC.
UNAUDITED PRO FORMA BALANCE SHEET AS OF DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)
See accompanying unaudited notes to pro forma financial statements.
SMITH INTERNATIONAL, INC.
UNAUDITED NOTES TO PRO FORMA FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) STATEMENT OF INCOME (LOSS) FROM CONTINUING OPERATIONS --
(a) To reclassify M-I freight expenses from selling expense to cost of sales to be consistent with the policies of the Company.
(b) To record annual amortization of goodwill which will be amortized over 40 years
(c) To record additional depreciation expense as a result of adjustments to increase the book value of the A-Z/Grant and Lindsey rental tools and property and equipment to estimated fair value and depreciate the assets over the estimated remaining lives of the respective assets.
(d) To record annual amortization of debt issuance costs which will be amortized over the 4 year life of the debt.
(e) To record interest expense at an interest rate of 6.0 percent on the acquisition-related debt, as refinanced (see Note j below), assuming no principal reduction.
(f) To reduce interest income at an interest rate of 4.0 percent as approximately $101.5 million of the Company's cash was used to fund the acquisitions and, therefore, would not have been available to earn interest income.
(g) To record additional income tax expense related to the earnings of A-Z/Grant and Lindsey, the Company's portion of M-I earnings and the effects of the aforementioned adjustments at the U.S. Alternative Minimum Tax Rate of 2.0 percent. Additional taxes would not be required because of the Company's net operating loss carryforward position.
(h) Income (loss) from continuing operations is presented excluding the cumulative effect of change in accounting principle. The Smith and unaudited pro forma income (loss) from continuing operations of ($3,995) and $1,652, respectively, include the special charge for a litigation settlement of $19,900 ($0.53 per common share). The Smith and unaudited pro forma income from continuing operations excluding the litigation settlement would increase to $15,905 and $21,552, respectively, or $0.40 and $0.55 per common share, respectively. The preferred stock dividends of $868 must be deducted from the applicable income (loss) from continuing operations amounts in order to compute these amounts per common share.
BALANCE SHEET --
(i) The historical balance sheet of the Company includes the accounts of A-Z/Grant and Lindsey on an estimated basis acquired by the Company on December 22, 1993 for $19.0 million. Management has not fully evaluated all of the consequences of the acquisition of A-Z/Grant and Lindsey including completing the appraisals of the assets acquired and assessing the total amount of costs that may be necessary to consolidate the operations of A-Z/Grant and Lindsey with the Company. Upon completion of these evaluations, any additional asset and liability adjustments will be recorded and the excess purchase price over net assets acquired, if any, will be recorded in accordance with purchase accounting rules and principles.
(j) To record the purchase of the 64% interest in M-I using $80.0 million in cash and $80.0 million in debt. The Company has reflected $10.0 million of debt as current portion of long-term debt and $70.0 million of debt as long-term because the Company has commitments to refinance the Dresser note payable with a $40 million term loan from its insurance company lenders and a $65 million revolving line of credit from a bank group. The term loan will bear interest at a rate of 6.02 percent and be payable over a period ending in January 1998. The revolving line of credit will be due in March 1997 and bear interest at a rate ranging
SMITH INTERNATIONAL, INC.
UNAUDITED NOTES TO PRO FORMA FINANCIAL STATEMENTS -- (CONTINUED)
from LIBOR + 3/4 percent to LIBOR +1 1/2 percent based upon the debt-to-total capitalization of the Company. Management believes that such financing will be completed by the end of March 1994.
(k) To record $1.8 million of estimated acquisition costs in connection with the M-I acquisition and $0.7 million of debt issuance costs in connection with the refinanced acquisition debt.
(l) To eliminate the investment in M-I of $160.0 million against the Company's estimated portion of its equity in M-I of $122.7 million with the remaining balance of $37.3 million reported tentatively as goodwill.
(m) To reclassify the minority interest ownership in M-I by Halliburton of $69.0 million from shareholders' equity to minority interest.
(n) To record the Company's portion of the current estimate of adjustments to asset reserves and liabilities required at the acquisition date in connection with the purchase of M-I with the corresponding adjustment recorded as goodwill. Management has not fully evaluated all of the consequences of the acquisition of M-I including assessing the fair market value of the assets acquired and the total amount of costs that may be necessary to consolidate the operations of M-I with the Company. Upon completion of a full evaluation of the Company's purchase price allocation of M-I accounts, additional adjustments may become necessary to the preliminary allocation of the purchase price. The Company expects this evaluation process will be completed in 1994.
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ITEM 8. | 721083 | 1993 |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net income in 1993 was $138.3 million on operating revenues of $1.113 billion, compared to $135.7 million on operating revenues of $1.025 billion in 1992 and $132.8 million on operating revenues of $956.8 million in 1991. Income for common stock was $121.9 million, $121.8 million and $122.7 million for 1993, 1992 and 1991, respectively.
Earnings per share in 1993 were $2.00 on 60.9 million weighted average common shares outstanding during the period compared to $2.16 on 56.3 million weighted average common shares in 1992 and $2.21 on 55.6 million weighted average common shares in 1991.
Return on the average book value of the Company's common equity in 1993 was 11.0%, compared to 12.6% in 1992 and 13.2% in 1991. The dividend payout ratio was 91.5% in 1993, compared to 82.9% in 1992 and 79.6% in 1991.
Total kilowatt-hour sales to ultimate consumers in 1993 were 19.2 billion, compared with 18.4 billion in 1992 and 18.3 billion in 1991. Kilowatt-hour sales to other utilities were 0.9 billion in 1993, 1.2 billion in 1992 and 1.9 billion in 1991.
The preferred stock dividend accrual increased $2.6 million in 1993 and $3.8 million in 1992 compared to 1991 primarily due to the issuance of the 7.75% Series Preferred Stock in March 1992 and the 7.875% Series Preferred Stock in July 1992. This was partially offset by the reacquisition of the Series A Flexible Dutch Auction Rate Transferable Securities $100 Par Value Preferred Stock ("FLEX DARTS") in April 1992. The 1993 increase was also partially offset by the reacquisition of the Series B FLEX DARTS in July 1993. Lower dividend rates associated with the FLEX DARTS were also an offsetting factor during 1992. In 1991, the preferred stock dividend accrual decreased $2.4 million compared to 1990 levels. A decrease of $1.8 million was due to lower dividend rates associated with the FLEX DARTS and a decrease of $0.7 million was attributed to the reacquisition of shares of the 9.36% Series Preferred Stock. The Company reacquired 162,000 shares of its 9.36% Series Preferred Stock in March 1990 and the remaining 324,000 shares over the subsequent twelve months.
Years Ending December 31 Increase (Decrease) Over Preceding Year (Dollars in Millions)
1993 1992 1991 - ----------------------------------------------------------------------- Operating revenues General rate increase $ 14.2 $ -- $ 9.1 PRAM surcharge billed 48.8 44.8 9.6 Accrual of Revenue under the PRAM - Net -- 41.5 0.7 BPA Residential Purchase and Sale Agreement (15.0) (25.1) (10.6) Sales to other utilities (6.8) (0.8) 0.4 Load and other changes 46.7 7.8 12.3 - ----------------------------------------------------------------------- Total operating revenue changes 87.9 68.2 21.5 - ----------------------------------------------------------------------- Operating expenses Purchased and interchanged power 81.5 18.2 4.0 Fuel (4.4) 11.9 0.9 Other operation expenses 5.9 9.9 16.3 Maintenance (1.8) (0.4) 5.0 Depreciation and amortization (7.2) 6.6 5.1 Taxes other than federal income taxes 6.1 4.8 (0.3) Federal income taxes 11.5 16.3 (7.9) - ----------------------------------------------------------------------- Total operating expense changes 91.6 67.3 23.1 - ------------------------------------------------------------------------ Allowance for funds used during construction ("AFUDC") 1.5 (1.0) (0.4) Other income (5.5) 12.3 3.4 Interest charges (10.3) 9.3 1.0 - ----------------------------------------------------------------------- Net income changes $ 2.6 $ 2.9 $ 0.4 =======================================================================
The following information pertains to the changes outlined in the table above:
OPERATING REVENUES
Revenues since October 1, 1993 increased as a result of rates authorized by the Washington Utilities and Transportation Commission (the "Washington Commission") in its general rate order issued on September 21, 1993. Revenues since October 1, 1992, increased as a result of rates authorized by the Washington Commission under the second Periodic Rate Adjustment Mechanism ("PRAM") filing. Revenues since October 1, 1991, increased as a result of rates authorized under the first PRAM filing. (See "Rate Matters.")
Revenues have been reduced by virtue of the credit which the Company received through the Residential Purchase and Sale Agreement with the Bonneville Power Administration ("BPA"). This agreement enables the Company's residential and small farm customers to receive the benefits of lower-cost federal power. A related reduction is included in purchased and interchanged power expenses.
Revenues in 1992 were higher as a result of the recognition of $6.7 million of revenues in September 1992 related to incentive payments authorized by the Washington Commission for meeting energy conservation targets during 1991. These revenues were collected in rates beginning October 1, 1992. Revenues from the PRAM rate adjustments and continuing load growth contributed to higher revenues in 1991.
Although the Company is dependent on purchased power to meet customer demand, it may, from time to time, have energy available for sale to other utilities, depending principally upon water conditions for the generation of hydroelectric power, customer usage and the energy requirements of other utilities.
OPERATING EXPENSES
Purchased and interchanged power expenses increased $81.5 million in 1993. Higher purchased power expenses of $95.8 million were due to new firm power purchase contracts with PURPA (Public Utility Regulatory Policies Act) qualifying facilities and higher secondary power purchases from other utilities. This increase was partially offset by the Residential Purchase and Sale Agreement with BPA, which resulted in a reduction of $14.4 million. (See discussion of the Residential Purchase and Sale Agreement under "Operating revenues.")
Purchased and interchanged power expenses increased $18.2 million in 1992. Higher purchased power expenses of $42.3 million were influenced by new firm power purchase contracts with PURPA qualifying facilities and higher costs on certain firm power purchase contracts with other utilities. The Residential Purchase and Sale Agreement with BPA resulted in a reduction of $23.9 million.
Purchased and interchanged power expenses increased $4.0 million in 1991. Higher levels of purchased power accounted for a $14.3 million increase. The Residential Purchase and Sale Agreement with BPA resulted in a reduction of $10.1 million.
Fuel expense decreased $4.4 million in 1993 due to decreased use of the coal-fired plants. Fuel expense increased $11.9 million in 1992 over the previous year due to increased usage of the coal-fired and gas turbine plants.
Other operation expenses increased $5.9 million in 1993 due primarily to a $5.1 million increase in the amortization of conservation expenditures. Also influencing 1993 expenses was an increase of $1.8 million in steam generation expenses and a decrease of $2.3 million in administration and general expenses.
Other operation expenses increased $9.9 million in 1992. Transmission expense accounted for $5.3 million of the increase. Also contributing was a $2.2 million rise in customer service expenses and a $1.5 million increase in administration and general expenses.
Other operation expenses increased $16.3 million in 1991. Contributing to this increase was a $8.1 million rise in administrative and general expenses; a $3.9 million increase in customer service expenses; and a $2.2 million increase in transmission and distribution expenses.
Maintenance expense in 1993 declined $1.8 million compared to 1992 due primarily to a $2.2 million decrease in distribution maintenance expense. Maintenance expense in 1992 fell $0.4 million from 1991 levels due primarily to a decrease of $2.8 million in administration and general maintenance expenses. This was partially offset by a $2.0 million increase in steam plant expense. Maintenance expense in 1991 increased $5.0 million due primarily to $2.7 million for remedial action of Company owned facilities and a $1.5 million rise in transmission and distribution maintenance expenses.
Depreciation and amortization expense declined $7.2 million in 1993 compared to the prior year. This decrease was due in part to a change in depreciation rates approved by the Washington Commission staff in the second quarter of 1993 which was made retroactive to the beginning of 1993. This adjustment had the effect of decreasing depreciation expense by $10.5 million during 1993. This adjustment was partially offset by the effects of additional plant being placed into service. Depreciation and amortization expense increased $6.6 million in 1992 and $5.1 million in 1991 as a result of additional plant being placed into service.
Taxes other than federal income taxes increased $6.1 million in 1993 compared to 1992. Excise and municipal taxes, which are primarily revenue- based, increased $6.1 million.
Taxes other than federal income taxes increased $4.8 million in 1992. An increase in Washington State property taxes of $2.2 million accounted for much of the increase. Taxes other than federal income taxes decreased $0.3 million in 1991. Contributing to the decrease was a $1.1 million decrease in property taxes. Excise and municipal taxes contributed increases of $2.1 million and $1.1 million in 1992 and 1991, respectively.
Federal income taxes on operations increased $11.5 million in 1993. The increase was due in part to higher pre-tax operating income in 1993 and an increase in the corporate tax rate from 34 to 35 percent, retroactive to January 1, 1993. Federal income taxes on operations increased $16.3 million in 1992 due to an increase in pre-tax operating income and a change in the method in which energy conservation expenditures are deducted for federal tax purposes. (See Note 11 to the Consolidated Financial Statements.) Federal income taxes on operations decreased $7.9 million in 1991 due to tax benefits associated with energy conservation expenditures and lower taxable income.
AFUDC
(See Note 1 to the Consolidated Financial Statements.)
OTHER INCOME
Other income decreased $5.5 million in 1993. The decrease was due in part to a charge totaling $1.4 million as a result of the Washington Commission's September 1993 general rate case ruling and a $1.4 million decrease in excess AFUDC over the FERC maximum allowed by the Washington Commission. Also contributing to the 1993 decrease was a non-recurring $2.3 million decrease in non-operating federal income taxes in the second quarter of 1992 as a result of an IRS settlement.
Other income increased $12.3 million in 1992 over 1991 levels. This increase was due in part to an increase of $4.2 million in Allowance for Funds Used to Conserve Energy ("AFUCE"). The Washington Commission, in its April 1, 1991 order authorizing the PRAM, ordered the Company to start accruing carrying costs on energy conservation expenditures until such investments are included in ratebase. These accruals commenced in May 1991 but did not become significant until the third quarter of 1991. The AFUDC allowed by the Washington Commission in excess of the FERC maximum contributed $2.0 million to the increase over 1991. In addition, other income increased $3.8 million because of net income from subsidiaries of $1.0 million in 1992 versus losses of $2.8 million in 1991 and $1.1 million from lower non-operating federal income taxes.
Other income, which increased $3.4 million in 1991, included $2.0 million due to capitalized interest expense relating to construction activities of a subsidiary. Also contributing to the increase were lower non-operating federal income taxes of $1.6 million.
INTEREST CHARGES
Interest charges, which consist of interest and amortization on long-term debt and other interest, decreased $10.3 million in 1993 compared to the prior year. Interest and amortization on long-term debt decreased $3.5 million. Contributing $29.1 million in reduced interest expense were 11 issues of First Mortgage Bonds totaling $510 million redeemed or retired over the previous 21 months. Partially offsetting this was $23.7 million in new interest expense associated with 22 issues of Secured Medium-Term Notes totaling $549 million issued over the previous 23 months.
Other interest expense decreased $6.8 million in 1993 compared to the prior year. Much of the decrease was the result of a $5.3 million non-recurring interest charge in 1992 relating to a federal income tax assessment. Also contributing were lower average daily short-term borrowings and lower weighted average interest rates in 1993.
Interest charges increased $9.3 million in 1992 compared to the prior year. Interest and amortization on long-term debt increased $4.7 million. Contributing $24.0 million of new interest expense were 19 issues of Secured Medium-Term Notes totaling $645 million issued over the previous 19 months. Partially offsetting this were $21.1 million in interest reductions from First Mortgage Bond retirements or redemptions of $451 million over the same period. Also contributing an increase of $1.5 million were the effects of three issues of fixed rate pollution control bonds that were used to refund floating rate pollution control bonds of identical amounts. Other interest expense increased $4.6 million in 1992 compared to 1991. An interest charge of $5.3 million relating to a federal income tax assessment was partially offset by lower short-term interest rates in 1992.
Interest charges increased $1.0 million in 1991 compared to 1990. Interest and amortization on long-term debt increased $3.0 million. This increase included $3.9 million attributable to a First Mortgage Bond issue in October 1990. Also contributing to the increase were four issues of Secured Medium-Term Notes that added $4.6 million of interest in 1991. Partially offsetting these increases was a decrease of $1.4 million due in part to lower interest rates on pollution control bonds. In addition, the effects of bond retirements decreased interest expense by $4.2 million in 1991. Other interest expense decreased $2.0 million in 1991 compared to the prior year due to lower weighted average interest rates and lower average daily short-term borrowings.
CONSTRUCTION AND FINANCING PROGRAM
Current construction expenditures are primarily transmission and distribution-related, designed to meet continuing customer growth. Expenditures on energy conservation resources have also taken on increased importance in recent years as the Company seeks to manage the growth in demand for electricity. Construction expenditures, which include energy conservation expenditures and exclude AFUDC and AFUCE, were $211.5 million in 1993 and are expected to be $261 million in 1994 and $200 million in 1995. The ratio of cash from operations (net of dividends, AFUDC and AFUCE) to construction expenditures (excluding AFUDC and AFUCE) was 59.1% in 1993. The Company expects to fund an average of 68% of its total 1994 and 1995 estimated construction expenditures (excluding AFUDC and AFUCE) from cash from operations (net of dividends, AFUDC and AFUCE) and the balance through the sale of securities, the nature, amount and timing of which will be subject to market and other relevant factors. The Company made an initial payment of $8.0 million in 1993 for capacity rights to BPA's third A.C. transmission line to the southwestern United States and expects to pay the remaining cost of $72 million in 1994. Construction expenditure estimates are subject to periodic review and adjustment.
In April 1991, the Company filed a shelf registration statement with the Securities and Exchange Commission for the offering, on a delayed or continuous basis, of up to $450 million principal amount of First Mortgage Bonds. The First Mortgage Bonds were issued as Secured Medium-Term Notes, Series A, in 14 separate issues. The Company issued the last of the $450 million of Secured Medium-Term Notes, Series A, in September 1992. The weighted average coupon rate of the Series A Notes was 7.84%.
In October 1992, the Company filed a shelf registration statement with the Securities and Exchange Commission for the offering, on a delayed or continuous basis, of up to an additional $450 million principal amount of First Mortgage Bonds. The First Mortgage Bonds can be issued as Secured Medium-Term Notes, through underwritten offerings, pursuant to delayed delivery contracts or any combination thereof. These Secured Medium-Term Notes were designated Series B. As of February 28, 1994, the Company has issued $334 million Series B Notes having an average coupon rate of 6.82%.
On February 9, 1993, the Company issued a total of $50 million principal amount of Secured Medium-Term Notes which included the following: $10 million principal amount of Secured Medium-Term Notes, Series B, due February 9, 1998, bearing interest at 6.17% per annum; $10 million principal amount of Secured Medium-Term Notes, Series B, due February 9, 2000, bearing interest at 6.61% per annum; and $30 million principal amount of Secured Medium-Term Notes, Series B, due February 10, 2003, bearing interest at 7.02% per annum. Proceeds of these issues were used to redeem $20 million principal amount of First Mortgage Bonds, 7.50% Series due 1999 and $30 million principal amount of First Mortgage Bonds, 7.75% Series due 2002, on March 8, 1993.
On March 5, 1993, the Company issued a total of $20 million principal amount of Secured Medium-Term Notes which consisted of $15 million principal amount of Secured Medium-Term Notes, Series B, due March 5, 1996, bearing interest at 4.85% per annum and $5 million principal amount of Secured Medium-Term Notes, Series B, due March 5, 1998, bearing interest at 5.70% per annum. Proceeds of these issues were used to redeem $20 million principal amount of First Mortgage Bonds, 6.625% Series due 1997, on April 2, 1993.
On November 29, 1993, the Company issued a total of $14 million principal amount of Secured Medium-Term Notes which consisted of $3 million principal amount of Secured Medium-Term Notes, Series B, due December 1, 2003, bearing interest at 6.20% per annum and $11 million principal amount of Secured Medium-Term Notes, Series B, due December 2, 2003, bearing interest at 6.40% per annum. Proceeds of these issues were used to pay down short-term debt.
On February 1, 1994, the Company issued $55 million principal amount of Secured Medium-Term Notes, Series B, due February 1, 2024, bearing interest at 7.35% per annum. Proceeds of this issue were used to extinguish $50 million principal amount of the Company's First Mortgage Bonds, 9.625% Series due 1997. The Company redeemed $24.5 million through a tender offer completed February 7, 1994. A portfolio of U.S. Government Treasury Securities was purchased to defease the remaining $25.5 million of the bonds.
On April 29, 1993, the Company issued $23.46 million principal amount of Pollution Control Revenue Refunding Bonds, 5.875% Series due 2020. The proceeds were used to refund, on April 29, 1993, $16.46 million principal amount of Pollution Control Revenue Bonds, 5.90% 1973 Series and $7.0 million principal amount of Pollution Control Revenue Bonds, 6.30% 1977 Series.
In February 1992, the Company filed a shelf registration statement with the Securities and Exchange Commission for the offering, on a delayed or continuous basis, of up to $200 million of preferred stock. Either $25 par value or $100 par value preferred stock may be issued. In 1992, the Company issued an aggregate of $150 million of preferred stock from this shelf. On February 3, 1994, the Company issued $50 million, Adjustable Rate Cumulative Preferred Stock, Series B ($25 par value). The proceeds were used to retire the $40 million principal amount of its Adjustable Rate Cumulative Preferred Stock, Series A ($100 par value)and to pay down short-term debt.
On July 1, 1993, the Company sold 3.45 million shares of common stock. The stock was priced at $27.875 per share and resulted in proceeds to the Company of approximately $93 million. The proceeds were used to redeem the $50 million principal amount FLEX DARTS Series B Preferred Stock on July 6, 1993 with the balance used to pay down short-term debt.
Short-term borrowings from banks and the sale of commercial paper are used to provide working capital for the construction program. At December 31, 1993, the Company had in place $152 million in lines of credit with several banks, which provide liquidity support for outstanding commercial paper of $70.0 million, effectively reducing the available borrowing capacity under these lines of credit to $82.0 million. (See Note 7 to the Consolidated Financial Statements.)
RATE MATTERS
On September 21, 1993, the Washington Commission issued two rate orders, one regarding the Company's request for an increase in general rates, the other relating to an annual rate adjustment under the Company's Periodic Rate Adjustment Mechanism ("PRAM"). In its revised general rate request, the Company had requested a $97 million increase and in its $76.3 million PRAM request it had requested a first year recovery of between $27.6 and $38.1 million of previously deferred costs under the PRAM.
The Washington Commission authorized a general rate increase of $21.9 million, reflecting increased costs of service, and collection of $35.7 million in the first year to recover previously deferred costs under the PRAM. The Washington Commission authorized full recovery of the Company's PRAM request within two years from the end of the year in which the costs were deferred. The total increase in rates of $57.6 million was effective October 1, 1993. The Washington Commission also authorized the Company to increase rates by an additional $3.9 million effective October 1, 1993 to recognize, prospectively, the effect of the increase in the Federal corporate income tax rate from 34 to 35 percent.
While the Washington Commission's order allowed only $57.6 million of the total requested rate relief, an additional amount of approximately $33.1 million remains eligible for deferral and future recovery through the continued operation of the PRAM. This amount includes such items as the Tenaska purchase power contract (a 245 megawatt cogeneration facility scheduled for operation in April of 1994), costs associated with the impact of hydro conditions and costs associated with fuel costs at the Colstrip plant in Montana.
The Washington Commission authorized a 10.5 percent return on common equity and a common equity component of 45 percent, compared to the Company's request for a 12.25 percent return on common equity and a 45 percent common equity component. This lower return on equity reduced the amount the Washington Commission granted by approximately $30 million.
Prior to October 1, 1993, provision was made for uninsured storm damage, with the approval of the Washington Commission, on the basis of the amount of outside insurance in effect and historical losses. To the extent actual costs varied from the provision, the difference was deferred for incorporation into future rates. The general rate order terminated, prospectively, the provision for deferral of uninsured storm damage except for certain losses associated with major catastrophic events. At December 31, 1993, the Company had no insurance coverage for storm damage.
The general rate order also required the Company to file a case by November 1, 1993, demonstrating the prudency of its eight new power purchase contracts acquired since its last general rate case. Pending the resolution of the prudency review case, the Washington Commission ordered that the Company's new rates, effective October 1, 1993, would be collected subject to refund to the extent this proceeding demonstrates any of those contracts to be imprudent. The Washington Commission calculated the annual revenue requirement at risk to be up to $86.1 million. This amount is the difference between the Company's power costs under the new power purchase contracts and the Washington Commission's estimated cost of purchasing equivalent power on the secondary market. The Company filed its prudency case on October 18, 1993, and expects the Washington Commission to enter a final order before October 1, 1994.
The decrease in allowed return on equity from 12.8 percent in the last general rate case to 10.5 percent approved in the present rate case has put downward pressure on earnings since the order became effective on October 1, 1993. In addition, it will be difficult for the Company to earn its full allowed rate of return because of changes made by the rate orders in the recovery methods of certain costs. Therefore, the Company continues to place strong emphasis on its ongoing improvement efforts designed to increase operating efficiencies.
As a regulated electric utility, the Company's financial condition is largely dependent on continued cost-recovery regulation by the Washington Commission. Adverse action by the Washington Commission in regulatory matters involving the Company, including the pending prudency review case, could adversely impact the Company's financial condition and threaten its ability to maintain the dividend on its common stock at current levels.
OTHER
The Company and BPA have entered into a letter of intent, subject to various conditions, regarding pursuit of construction of a joint transmission project in Whatcom and Skagit counties in northern Washington state, the northernmost portion of the Company's service territory. The joint project is intended to provide the Company and BPA with certain transfer capacity with Canadian utilities and is intended to relieve certain transmission constraints on the respective systems of BPA and the Company. The joint project would involve a combination of existing facility upgrades and new construction and is currently under environmental review. The Company's efforts in this project are preliminary in nature and, as such, the Company cannot give assurance that any construction will result.
The Company also continues to seek reasonable terms for acquiring capacity rights to BPA's planned third A.C. line, which would provide additional transmission capacity between the Pacific Northwest and the Southwestern states. The Company expects to receive 371 MW of southbound capacity on the line from BPA and 284 MW of northbound capacity. The price of participation is expected to be $215 per KW for each KW of rated southbound capacity or a total capital cost of $80 million.
The Company is in the process of replacing the High Molecular Weight ("HMW") underground distribution cable installed during the 1960s and 1970s. The Company installed about 4,800 miles of industrial standard HMW cable between 1964 and 1979, but the Company and other utilities have experienced increasing cable failures in recent years. The Company is continuing to analyze cable failure trends to find ways to mitigate the long term effect of cable failures on customer service, within budgetary constraints. To minimize the impact of increasing cable failures, the Company replaces an increasing amount of HMW cable each year. The Company estimates that the total cost of replacing all 4,800 miles of cable will be about $550 million over a 15 to 20-year period. With 310 miles of cable replaced to date, the Company expects to spend $66 million during the period 1994-1997 for replacement of this cable.
The Company presently has no plans for major diversification outside of the electric utility field and expects revenues in the near future to be generated almost entirely by electric utility operations. Investments in and advances to subsidiaries increased $14.2 million in 1993 primarily as a result of advances to a subsidiary developing small hydro projects.
The electric utility industry in general is experiencing intensifying competitive pressures, particularly in wholesale generation and industrial customer markets. The National Energy Policy Act of 1992 was designed to increase competition in the wholesale electric generation market by easing regulatory restrictions on producers of wholesale power and by authorizing the FERC to mandate access to electric transmission systems by wholesale power generators. The potential for increased competition at the retail level in the electric utility industry through state-mandated retail wheeling has also been the subject of legislative and administrative interest in a number of states, including the state of Washington. Electric utilities, including the Company, now face greater potential competition for resources and customers from a variety of sources, including privately owned independent power producers, exempt wholesale power generators, industrial customers developing their own generation resources, suppliers of natural gas and other fuels, other investor-owned electric utilities and municipal generators. All four of the major credit rating agencies have expressed the view that competitive developments in the electric utility industry are likely to increase business risks, with resulting pressure on utility credit quality. One of the rating agencies has stated that it is revising its financial ratio guidelines for electric utilities to reflect the changing risk profiles within the industry. These rating agency actions may result in higher capital costs and more limited access to capital markets for electric utilities, including the Company.
Although the Company to date has not experienced any significant adverse impact on its business from these industry trends, the Company has taken a number of steps to prepare for a more competitive business environment. These include programs to become a lower-cost producer by improving productivity and reducing the work force.
The Company decided in January 1994 to offer an early separation plan to all officers, senior and middle managers and eligible professional staff. Benefits offered to those electing the program include a severance package based on years of service and enhanced retirement benefits for employees over 55 years of age. The number of employees that will accept the offer is presently not known. The Company has not set any specific job reduction targets.
The Company, based on studies performed, currently estimates the total severance cost will not exceed $10 million. However, the total severance cost is dependent on the number of employees ultimately accepting the plan. The accrual for costs of this program will be recognized in the first quarter of 1994. Subsequent periods' expense will benefit from the savings associated with the reduced workforce. While the program will result in a net cost to the Company in 1994, the Company expects to see net savings in 1995 and beyond.
The Company is also reviewing the extent of its investment in regulatory assets that may not be readily marketable to others in a competitive marketplace. The Company is seeking state legislation to provide a firm statutory basis for recovery of demand-side management regulatory assets associated with the Company's conservation programs.
For a discussion of Environmental obligations, see Note 14 to the Consolidated Financial Statements.
ITEM 8. | 81100 | 1993 |
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ITEM 6. SELECTED FINANCIAL DATA
Information in response to the disclosure requirements specified by this Item 6 appears on pages 42 and 43 of the Union Camp 1993 Annual Report and is incorporated by reference in this Item 6.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information in response to the disclosure requirements specified by this Item 7 appears in the text under the caption "Financial Review" on pages 26 to 30 of the Union Camp 1993 Annual Report and is incorporated by reference in this Item 7.
ITEM 8. | 100783 | 1993 |
766829 | 1993 |
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Item 6. Selected Financial Data
The information appearing under the caption "Selected Financial Data" in the Company's 1993 Annual Report to Stockholders is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The information appearing under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" in the Company's 1993 Annual Report to Stockholders is incorporated herein by reference.
Item 8. | 88204 | 1993 |
Item 7. Management's Discussion and Analysis of Results of Operations
The following is a discussion of certain significant factors which have affected operating revenues, expenses and net income during the periods included in the accompanying statements of income and is presented to facilitate an understanding of the results of operations. This discussion should be read in conjunction with the Notes to Financial Statements filed under Item 8 | 16906 | 1993 |
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ITEM 6. SELECTED FINANCIAL DATA.
The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1993 on page 42 under the caption "Selected Financial Data," and is incorporated herein by reference, pursuant to General Instruction G(2).
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required by this item is included in the Registrant's Annual Report to Stockholders for the year ended December 31, 1993 on pages 43 through 50 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," and is incorporated herein by reference, pursuant to General Instruction G(2).
ITEM 8. | 766701 | 1993 |
Item 6. Selected Financial Data
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Net sales for 1993 were $258.9 million, or 4% less than the $270.1 million reported for 1992. About 2% of 1992's sales were attributable to it being a 53-week year, versus the normal 52-week year. In 1992, sales decreased 5% from the $285.3 million in 1991, which in turn was 4% less than the $297.7 million in 1990.
For the last three years, business conditions have been difficult. Industry sales data for manifold business forms show a sales decline from 1990 to 1991 of 2%, and from 1991 to 1992 of 3%. For 1992 to 1993, the industry forecast is for a decrease of 2%. Certain segments of the forms-related market, however, continue to provide steady growth. This Includes forms management services, preprinted cut sheets, and pressure-sensitive labels.
In response to this maturing market, the Company has taken significant steps to adjust its manufacturing capacity, reorganize and change its management team, retrain its sales force and improve its focus for functioning in this highly competitive marketplace. This is expected to result in a gain of market share.
The Company continued to reduce its dependence on commodity products while focusing on custom forms, pressure-sensitive labels, and value-added services. Strategic alliances were developed to supplement product offerings and improve margins. The sales of continuous stock forms, a commodity-type product, were down 20% in 1993. This product, in combination with the extra week in 1992, accounted for most of 1993's sales decline. The sales of continuous stock forms were down 19% in 1992, in comparison with 1991. In 1993, sales of continuous stock forms represented slightly less than 11% of total revenues.
Average selling price increases are very difficult to determine for the Company's various products. However, inflation is estimated to have had minimal impact on sales in the past three years.
Paper is the Company's primary raw material, and it accounts for a significant percentage of the cost of most business forms. In 1993, the cost of white paper was volatile throughout the year, as it had been in 1992 and 1991. The LIFO provision was a credit in 1993, 1992, and 1991, respectively, of $.1 million, $.7 million, and $2.0 million.
The gross profit percentage in 1993 was affected by a midyear increase in paper prices. It was 24.7%, 25.3%, and 25.7%, for 1993, 1992, and 1991, respectively. The closing of two plants in May of 1993, and subsequent increased utilization of the remaining plants, allowed the Company to hold manufacturing expense percentages despite a decline in manufactured sales.
As part of a strategy to expand product and service capabilities and improve margins, the Company is developing a program of partnering for procurement of products the Company cannot produce and/or are not cost-competitive. Out-sourcing represented 18% and 15% of sales in 1993 and 1992, respectively. This is expected to increase and should have a positive effect on gross profit in the future.
In 1993, selling and administrative expenses were $61.0 million, down $2.1 million or 3%, from the $63.1 million reported in 1992. Administrative expenses in the second half of 1993 were lower because of a corporate restructuring which reduced administrative staffing by approximately 30%. In 1992, selling and administrative expenses of $63.1 million were also down from the $64.6 million in 1991. Earnings in 1993, 1992, and 1991 were reduced by a pretax restructuring charge of $1.5 million, $7.0 million, and $2.0 million, respectively. This represents the cost associated with reducing administrative expenses, closing plants, consolidating distribution facilities, and the scaling back of other operations. These actions reflect the impact of the weak economy and excess capacity in the business forms industry. Savings from these cost-reduction efforts are expected to exceed the charges.
Lower interest rates in 1993 and 1992 resulted in reduced interest expense and investment income. In 1993, miscellaneous income increased due to the gain on sale of real estate and equipment associated with the closing of certain plants. The sum of other income and expense items was income of $.9 million, $.6 million, and $.1 million, respectively, in 1993, 1992, and 1991.
The effective tax rate was 35% in 1993, compared to a credit of 57% in 1992, and a charge of 37% in 1991. See Notes to the Consolidated Financial Statements for a reconciliation of effective income tax rates to the statutory rate.
During the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Adoption resulted in an increase of $1.0 million and $.13 per share in income in the first quarter of 1993. This was attributable to a reduction in deferred tax rates to the current, lower, federal tax rate.
Net earnings (loss) were $2.5 million, ($.6) million, and $4.3 million in 1993, 1992, and 1991, respectively. Earnings (loss) as a percentage of sales were .9% in 1993, compared with (.2%) in 1992 and 1.5% in 1991.
Liquidity and Capital Resources
Working capital was $83.4 million at the end of fiscal 1993, as compared with $77.5 million and $81.4 million at the end of fiscal 1992 and 1991, respectively. The current ratio remained strong at 4.3 to 1 at the end of 1993, despite the fact that net cash of $1.3 million was used in operations. In 1992 and 1991, cash was provided by operations in the amounts of $10.2 million and $16.3 million, respectively.
A significant factor in the 1993 use was strong billings at the end of the fourth quarter resulting in an increase in Accounts and Notes Receivable. Receivables increased to $76.0 million at the end of fiscal 1993, as compared to $68.0 million and $71.4 million at the end of fiscal 1992 and 1991, respectively. It is projected that operations will provide cash in fiscal 1994.
Capital expenditures, dividend, and working capital requirements of the Company for the past seven years have been generated internally. The Company has made no short-term borrowings over the past 13 years.
Long-term debt as a percentage of total capitalization was 6% at the end of fiscal year 1993, as compared with 7% and 8% for the previous two years. No long-term financings are planned for 1994.
Stockholders' equity at October 30, 1993, was $117.3 million, as compared with $114.4 million at the end of fiscal 1992. At the end of fiscal year 1993, equity per common share was $15.24.
Capital expenditures in 1993 were $3.7 million, compared to $4.9 million and $7.6 million in 1992 and 1991, respectively.
Dividend and Common Stock Data
No cash dividends were paid in fiscal 1993, as compared to $3.7 million and $5.4 million in 1992 and 1991, respectively.
Duplex common stock is traded on the American Stock Exchange. As of October 30, 1993, the Company had 1,451 common shareholders of record, excluding beneficial owners whose stock was held in nominee name.
Item 8. | 30547 | 1993 |
ITEM 6 - -SELECTED FINANCIAL DATA
The information called for by this item is incorporated herein by reference to the table titled Summary of Selected Financial Data on page 24 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1993.
ITEM 7 | ITEM 7 - -MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information called for by this item is incorporated herein by reference to Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 24 through 39 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1993.
ITEM 8 | 73124 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA ----------------------- The information required by this item is included in Selected Financial Data in Exhibit 13 to this Report and is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS ------------------------- The information required by this item is included in Management's Review in Exhibit 13 to this Report and is incorporated herein by reference.
ITEM 8. | 46080 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION (Amounts in thousands, except per share amounts)
The following table presents selected consolidated financial data of the Company as of and for the five fiscal years ended December 31, 1993. The selected consolidated financial data have been derived from audited consolidated financial statements of the Company. Such selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements of the Company and the notes thereto included elsewhere herein. The comparability of the results for the periods presented is significantly affected by certain events, as described in "Management's Discussion and Analysis of Financial Condition and Results of Operations--General."
EXCEL INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
Excel Industries, Inc. (Company) is engaged in the manufacture and sale of a broad line of window assemblies, manual and electric window regulators, upper door frames, and injection molded thermoplastic parts. The Company's products are used in the manufacture of automobiles, heavy and light trucks, buses and recreational vehicles.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions, profits and balances are eliminated.
Net income per share
Primary net income per share is computed using the weighted average number of shares outstanding during the period. Shares used to compute primary net income per share were 10,122,000 for 1993, 7,553,000 for 1992, and 6,488,000 for 1991.
Fully diluted earnings per share assumes, when dilative, the conversion of the 10% convertible subordinated notes which were issued on January 2, 1990.
Stock dividends and splits are given retroactive effect in computing the weighted average number of shares outstanding during the period.
Short-term investments and marketable securities
Short-term investments amounting to $5,771,000 at December 31, 1993 consist of investments generally in money market funds.
Marketable securities consist of U.S. Government securities, tax- free municipal securities and municipal fund par value preferred shares with maturities generally longer than 90 days.
Such investments are carried at cost which approximates market.
Other income includes interest income of $1,916,000 in 1993, $1,010,000 in 1992, and $674,000 in 1991.
Inventories
Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for domestic inventories and the first-in, first-out (FIFO) method for Canadian inventories.
Properties
Plant and equipment are carried at cost and include expenditures for new facilities and those which substantially increase the useful lives of existing plant and equipment.
Depreciation
The Company provides for depreciation of plant and equipment using methods and rates designed to amortize the cost of such equipment over its useful life. Depreciation is computed principally on accelerated methods for new plant and equipment and the straight-line method for used equipment. The estimated useful lives range from 10 to 40 years for buildings and improvements and 2 to 20 years for machinery and equipment.
Goodwill
The excess of purchase price over the fair value of net assets of acquired businesses (goodwill) is amortized on a straight-line basis over 20 to 40 years.
Income taxes
Deferred income taxes are provided using the liability method in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes".
3. RESEARCH, ENGINEERING AND DEVELOPMENT
Research, engineering and development expenditures charged to operations approximated $7,913,000 in 1993, $5,518,000 in 1992, and $5,200,000 in 1991.
4. RESTRUCTURING CHARGE
In the fourth quarter of 1992, the Company provided a reserve of $4,500,000 for restructuring costs. The charge was equivalent to $2,900,000 or 34 cents per share after taxes. This charge represented estimated costs to downsize its Aurora, Ontario, Canada plant and relocate production of certain light truck and van windows to other manufacturing plants of the Company. A total of $1,010,000 was incurred in 1993 to transfer a portion of the planned production.
5. INVENTORIES
Inventories consist of the following:
December 31, 1993 1992 (000 Omitted) Raw materials $17,948 $15,302 Work in process and finished goods 12,378 11,699 LIFO reserve (459) (255)
$29,867 $26,746
6. PENSION AND OTHER EMPLOYEE BENEFIT PLANS
Pension and profit sharing plans
The Company and its subsidiaries provide retirement benefits to substantially all employees through various pension, savings and profit sharing plans. Defined benefit plans provide pension benefits that are based on the employee's final average salary for salaried employees and stated amounts for each year of credited service for hourly employees. Contributions and costs for the Company's various other benefit plans are generally determined based on the employee's annual salary. Total expense relating to the Company's various retirement plans aggregated $2,199,000 in 1993, $2,102,000 in 1992, $1,712,000 in 1991.
Components of net pension expense for all defined benefit pension plans are as follows: Year Ended December 31, 1993 1992 1991 (000 Omitted) Service cost $1,319 $1,312 $1,243 Interest cost 1,344 1,245 1,137 Actual return on assets (617) (1,242) (1,139) Net amortization and deferral (582) 190 222
Net defined benefit pension expense $1,464 $1,505 $1,463
The funded status of defined benefit pension plans is as follows:
December 31, 1993 1992 (000 Omitted) Plan assets at fair value $15,844 $ 14,868 Projected benefit obligations 20,421 17,869
(4,577) (3,001) Unrecognized costs 1,862 472
Net accrued pension costs $(2,715) $(2,529)
Actuarial present value of: Vested benefit obligations $15,644 $13,853
Accumulated benefit obligations $16,655 $14,815
Major assumptions: Discount rate 7.5% 8% Rate of increase in compensation 5% 5% to 8% Expected rate of return on plan assets 8 8%
It is generally the Company's policy to fund the ERISA minimum contribution requirement. Plan assets are invested primarily in corporate equity securities and bonds and insurance annuity contracts.
Supplemental and other postretirement benefits
In addition to providing pension benefits, the Company provides certain health care benefits to substantially all active employees and postretirement health care benefits to management employees. The Company is primarily self-insured for such benefits and prior to 1992 followed the practice of expensing such benefits on a pay-as-you-go basis.
In 1992, the Company adopted the provisions of SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions." The Company elected to immediately recognize the Accumulated Postretirement Benefit Obligation (APBO) as January 1, 1992 in the amount of $6,447,000 (approximately $4,000,000 after-tax or 61 cents per share).
Summary information on the Company's plan is as follows:
December 31, 1993 1992 (000 Omitted) Retirees $1,504 $1,060 Retirement-eligible actives 968 1,245 Other active participants 6,077 5,402 Unrecognized gain 407 -- Accrued liability $8,956 $7,707
Accrued postretirement benefit cost
The Company plans to continue the policy of funding these benefits on a pay-as-you-go basis. The components of net periodic postretirement benefit cost are as follows:
Year Ended December 31, 1993 1992 (000 Omitted) Service costs, benefits attributed to employee service during the year $ 821 $ 750 Interest cost on accumulated postretirement benefit obligation 578 510
Net periodic postretirement benefit cost $1,399 $1,260
The discount rate used in determining the APBO was 7.75% in 1993 and 8% in 1992. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 10.25% declining by 1% per year to a rate of 6.25%. An increase of 1% in health care cost trend rate would increase the accrued postretirement benefit cost at December 31, 1993 by $2,066,000 and the 1993 annual expense by $384,000.
7. LONG-TERM DEBT
Following is a summary of long-term debt of the Company:
December 31, 1993 1992 (000 Omitted) 10% Convertible subordinated notes $30,000 $30,000 Industrial Revenue Bonds 5,383 4,533 Capital lease obligations 1,264 1,620
36,647 36,153 Current portion (1,553) (1,561)
$35,094 $34,592
During 1992, the Company prepaid the balance owing on its guaranteed senior notes and was subject to a prepayment premium of approximately $1.3 million. Such amount is included in the accompanying income statement in interest expense.
The convertible notes are due on December 1, 2000 and require aggregate prepayments of $8,000,000 in 1996, $7,000,000 in 1997, $6,000,000 in 1998, $5,000,000 in 1999 and $4,000,000 in 2000. The holders of the notes have the option to convert their notes at any time into common shares of the Company at a current conversion price of $13.214 per share. The Notes are subject to prepayment at the option of the Company if the market value of the Company's common shares equals or exceeds 150% of the conversion price for a specified period. The note agreements provide for maintaining a current ratio of 1.5 to 1, restrict the amount of additional borrowings and limit the amount of dividends that can be paid. Currently the Company has available for payment of dividends $19,615,000 of retained earnings.
The Industrial Revenue Bonds bear interest at rates of interest tied to short-term Treasury rates. Certain plant and equipment purchased with the proceeds of the bonds collateralize these obligations.
The Company had available unused lines of credit of approximately $6,300,000 at December 31, 1993.
Long-term debt maturities are $1,553,000 in 1994, $1,358,000 in 1995, $9,557,000 in 1996, $8,072,000 in 1997, $6,580,000 in 1998, and $9,527,000 thereafter.
8. CONTINGENCIES
A chemical cleaning compound, trichlorethylene (TCE), has been found in the soil and groundwater on the Company's property in Elkhart, Indiana, and in 1981, TCE was found in a well field of the City of Elkhart in close proximity to the Company's facility. The Company has been named as one of nine potentially responsible parties (PRPs) in the contamination of this site.
The United States Environmental Protection Agency (EPA) and the Indiana Department of Environmental Management (IDEM) have conducted a preliminary investigation and evaluation of the site and have undertaken temporary remedial action in the nature of air-stripping towers.
In early 1992, the EPA issued a Unilateral Order under Section 106 of the Comprehensive Environmental Response, Compensation and Liability Act which required the Company and other PRPs to undertake remedial work. The Company and the other PRPs have reached an agreement regarding the funding of groundwater monitoring and the operation of the air-strippers as required by the Unilateral Order. The Company was required to install and operate a soil vapor extraction system to remove TCE from the Company's property. As of February 1, 1994, the Company has installed and is operating the equipment pursuant to the Unilateral Order. In addition, the EPA and IDEM have asserted a claim for reimburesement of their investigatory costs and the costs of installing and operating the air-strippers on the munipal well field (the EPA Costs). On February 22, 1993, the United States filed a lawsuit in the United States District Court for the Northern District of Indiana against eight of the PRPs, including the Company. On July 20, 1993, IDEM joined in the lawsuit. The lawsuit seeks recovery of the costs of enforcement, prejudgment interest and an amount in excess of $6.8 million, which represents costs incurred to date by the EPA and IDEM, and a declaration that the eight defendant PRPs are liable for any future costs incurred by the EPA and IDEM in connection with the site.
The Company does not believe the annual cost to the Company of monitoring groundwater and operating the soil vapor extraction system and the air-strippers will be material. Each of the PRPs, including the Company, is jointly and severally liable for the entire amount of the EPA Costs. Certain PRPs, including the Company, are currently attempting to negotiate an agreed upon allocation of such liability. The Company believes that adequate provisions have been recorded for its costs and its anticipated share of EPA Costs and that its cash on hand, unused lines of credit or cash from operations are sufficient to fund any required expenditures.
The EPA has also named the Company as a PRP for costs at three other disposal sites. It has also asked the Company for information about contamination at other sites. The Company believes it either has no liability as a responsible party or that adequate provisions have been recorded for any costs to be incurred.
There are claims and pending legal proceedings against the Company and its subsidiaries with respect to taxes, workers' compensation, warranties and other matters arising out of the ordinary conduct of the business. The ultimate result of these claims and proceedings at December 31, 1993 is not determinable, but, in the opinion of management, adequate provision for anticipated costs has been made or insurance coverage exists to cover such costs.
9. LEASES
The Company leases certain of its manufacturing facilities, sales offices, transportation and other equipment. Total rental expense for all leases was approximately $3,416,000 in 1993, $2,998,000 in 1992, and $2,123,000 in 1991. Future minimum lease payments under noncancellable operating leases are $1,341,000 in 1994, $1,055,000 in 1995, $826,000 in 1996, $753,000 in 1997 and $143,000 in 1998.
10. INCOME TAXES
Effective January 1, 1992, the Company adopted SFAS No. 109, "Accounting for Income Taxes". This statement mandates the liability approach for computing deferred income taxes similar to SFAS No. 96 previously followed by the Company. The cumulative effect of the change was to increase first quarter 1992 earnings by $800,000 (12 cents per share). The change had no impact on the 1992 income tax provision. Prior year financial statements have not been restated.
Pre-tax income (loss) reported by U.S. and foreign subsidiaries was as follows:
Year Ended December 31, 1993 1992 1991 (000 Omitted) United States $17,933 $8,688 $1,835 Foreign 2,292 (2,677) (1,562) $20,225 $6,011 $ 273
The provision (benefit) for income taxes is summarized below:
Year Ended December 31, 1993 1992 1991 (000 Omitted) Current: US federal $ 6,049 $5,007 $1,615 Foreign 465 38 -- State 645 1,226 714 7,159 6,271 2,329
Deferred: US federal (317) (1,922) (1,388) Foreign 941 (1,256) (685) State 2 (659) (134) 626 (3,837) (2,207) $ 7,785 $2,434 $ 122
Deferred income taxes are provided for the temporary differences between the financial reporting basis and tax basis of the Company's assets and liabilities. At December 31, 1993, current deferred income tax assets of $2,886,000 are classified as prepaid expenses, long-term U.S. deferred income tax assets of $6,094,000 are classified as other assets, and $627,000 of long-term foreign deferred income tax liabilities are classified as other long-term liabilities.
Deferred income taxes are comprised of the following at December 31:
1993 1992 (000 Omitted) Gross deferred tax liabilities Property, plant and equipment $ 2,257 $2,571 Inventories 436 308 Other 680 564 3,373 3,443
Gross deferred tax assets Postretirement benefit obligations 6,296 5,046 Restructuring reserve 1,103 1,655 Other accrued liabilities 3,708 4,210 Loss carryforwards 619 1,453 11,726 12,364
Net deferred tax assets $ 8,353 $ 8,921
The provision for income taxes computed by applying the Federal statutory rate to income before income taxes is reconciled to the recorded provision as follows:
Year Ended December 31, 1993 1992 1991 (000 Omitted) Tax at United States statutory rate $7,079 $2,044 $ 93 State income taxes, net of federal benefit 421 374 383 Canadian rate differential on income/(losses) 344 (134) (154) Other (59) 150 (200)
$7,785 $2,434 $ 122
Provision has been made for U.S. and Canadian taxes on undistributed earnings of the Company's Canadian subsidiary.
The Company possesses approximately $10,570,000 of U.S. state income tax loss carryforwards. U.S. state loss carryforwards expire to the extent of $1,002,000 in the year 2005, $4,758,000 in 2006, and $4,810,000 in 2007.
11. SEGMENT INFORMATION AND MAJOR CUSTOMERS
The Company operates in predominately one industry segment: the design, engineering and manufacture of certain components sold to manufacturers in the ground transportation industry.
The Company, through its subsidiaries, operates primarily in two countries: the United States and Canada. The Company's Canadian subsidiary had net sales of $36,074,000 in 1993, $29,421,000 in 1992, and $21,735,000 in 1991. Total assets of the Canadian subsidiary were approximately $9,416,000 and $12,538,000 at December 31, 1993 and 1992, respectively. Intercompany sales were insignificant.
Sales to three major customers, Ford Motor Company, Chrysler Corporation and General Motors Corporation, were approximately 72%, 11% and 4%, respectively, of the Company's net sales in 1993 as compared to 73%, 9% and 4% in 1992 and 69%, 8% and 8% in 1991. Accounts receivable from General Motors Corporation and Chrysler Corporation approximated 68% of trade accounts receivable at December 31, 1993 and 48% at December 31, 1992. Amounts due from Ford Motor Company are classified as "accounts receivable, related party" in the Company's balance sheet at December 31, 1993 and December 31, 1992. Sales to customers outside of the United States and Canada were not significant.
12. COMMON SHARES
The Company has an incentive stock option plan covering key employees which was approved by shareholders in 1984. The plan provides that options may be granted at not less than fair market value and if not exercised, expire 10 years from the date of grant. At December 31, 1993, there were reserved 48,590 shares for the granting of options and options outstanding for 19,250 shares at an average exercise price of $6.59. During 1993, options for 7,875 shares were exercised at an average exercise price of $6.44. There were no options granted nor did any options expire during 1993.
The Company has an employee stock purchase plan and has reserved 353,717 common shares for this purpose. The plan allows eligible employees to authorize payroll withholdings which are used to purchase common shares from the Company at ninety-percent (90%) of the closing price of the common shares on the date of purchase. Through December 31, 1993, 96,296 shares had been issued under the plan.
The Company has reserved 2,270,319 common shares for possible future issuance in connection with its $30,000,000 convertible notes issued on January 2, 1990.
13. RELATED PARTY TRANSACTIONS
Ford Motor Company owned 24% of the Company's common shares at December 31, 1993, 30% at December 31, 1992 and 40% at December 31, 1991. On January 11, 1994, Ford Motor Company donated 1,047,201 of the Company's common shares to the Ford Motor Company Fund. On January 13, 1994, Ford Motor Company and the Ford Motor Company Fund announced their intention to dispose of their combined 24% ownership in the Company through a secondary public offering. Ford officials stated that the disposition of common shares would not impact the customer-supplier relationship between Ford and the Company. Significant related party transactions are as follows:
Year Ended December 31, 1993 1992 1991 (000 Omitted) Product sales $373,000 $311,000 $244,000 Product purchases 124,000 77,000 58,000
14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth in summary form the quarterly results of operations for the years ended December 31, 1993 and 1992.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "ELECTION OF DIRECTORS" in the Company's proxy statement for the 1994 annual meeting of shareholders (the "Proxy Statement") is incorporated herein by reference. The Proxy Statement has previously been filed with the Securities and Exchange Commission.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the captions "Compensation of Directors," "Compensation Committee Interlocks and Insider Participation," "Compensation of Executive Officers," "Summary Compensation Table," "Pension Plan," and "Deferred Compensation Plans" in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the captions "Outstanding Shares," "Principal Shareholders," and "Security Ownership of Management" in the Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Compensation Committee Interlocks and Insider Participation" in the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements
The following consolidated financial statements of the Company and its subsidiaries are included in Item 8 | 740868 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA -------------------------------- (in thousands except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA
CONSOLIDATED BALANCE SHEET DATA
No dividends have been declared or paid during any of the periods presented.
*Other contract revenues include $5,000 and $50,000 from Lilly in 1993 and 1992, respectively and $10,000 from Wellcome in 1993.
**Costs and expenses include the following: (a) charges for acquired research and development of $70,147 and $115,475 in 1991 and 1990, respectively, (b) charges of $ 3,500, $ 64,877 and $3,518 in 1993, 1992 and 1990, respectively, related to HA-1A inventory and (c) restructuring charges of $9,387, $15,266 and $3,548 in 1993, 1992 and 1990, respectively.
***Other income (expenses) include a charge of $11,245 in 1992 related to the settlement of certain litigation and gains of $12,976 in 1990 from the sale of certain investments.
****Cash and investments at December 31, 1993 included equity investments of $11,230. Additionally, the Company maintained $26,375 of investments at certain banks as collateral for certain debt outstanding at December 31, 1993.
The data above does not reflect the increase in cash and investments of $51,494, and an increase in shareholders' equity of $38,198, which would have resulted if the Tocor II Exchange Offer were consummated as of December 31, 1993. Further in connection with the consummation of the Tocor II Exchange Offer the Company will record a charge to earnings of $36,454 in the first quarter of 1994 representing principally the cost of acquired research and development. See Note 18 to the Company's Consolidated Financial Statements.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - ---------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS -----------------------------------
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
The Company's future financial condition is highly dependent upon the reduction of the Company's rate of net cash outflows and, ultimately, upon the achievement of significant and sustained levels of pharmaceutical product sales. The Company will need to secure significant additional capital in the future from collaborative arrangements with pharmaceutical companies or from the capital markets until significant and sustained levels of pharmaceutical sales are achieved. There can be no assurance that significant additional capital will be available to the Company. There also can be no assurance that the Company will materially reduce its current rate of net cash outflows or generate significant and sustained levels of pharmaceutical product sales. The FDA has not approved any of the Company's pharmaceutical products for marketing. There can be no assurance that FDA or other regulatory approvals of any of the Company's products will be obtained. Failure to obtain timely FDA or other regulatory approvals of pharmaceutical products will have a material adverse effect on the Company. The status of the Company's major pharmaceutical products is discussed below.
The Company has been implementing a business plan employing a collaborative strategy utilizing, among other things, alliances with established pharmaceutical companies. The
Company's ability to further reduce its current rate of net cash outflows is also dependent upon the extent to which it can expand collaborations with established pharmaceutical companies and achieve milestones under such collaborative agreements. No assurance can be given that such collaborations can be expanded or that such milestones can be achieved.
At December 31, 1993, the Company had cash, cash equivalents and investments of $140,028,000, including equity investments of $11,230,000. During the year ended December 31, 1993, the Company had negative cash flows from operations of $42,297,000. The Company's total cash flows in 1993 included $30,000,000 received from Wellcome of which $20,000,000 was received for the purchase of 2,000,000 shares of the Company's Common Stock. Additionally, cash flows in 1993 included the proceeds of $11,900,000 from the sale of the Company's St. Louis facility and the repayment of $5,800,000 of mortgage debt related to that facility. If the exchange offer which is discussed in Note 18 to the Company's Consolidated Financial Statements had been consummated as of December 31, 1993, the Company's cash and investment balance at December 31, 1993 would have been $191,522,000.
At December 31, 1992, the Company had cash, cash equivalents, and investments of $163,083,000, including equity investments of $12,924,000. During the year ended December 31, 1992, the Company had negative cash flows from operations of $109,818,000 and acquired $23,309,000 of fixed assets. Cash flows from operations for the year ended December 31, 1992 included $50,000,000 received from Lilly primarily for reimbursement of expenses associated with HA- 1A. Additionally, during 1992, the Company expended $12,375,000 to purchase the limited partnership interests in CPII, $8,700,000 to acquire all the outstanding shares of capital stock of Mercia Diagnostics Limited ("Mercia"), a European diagnostics manufacturing and sales company, and $10,000,000 in connection with the settlement of certain class action securities litigation. These cash outflows were partially offset by cash inflows which included the receipt of $50,000,000 from Lilly for the purchase of 2,000,000 shares of the Company's Common Stock and $15,931,000 from borrowings under loan agreements. During the year ended December 31, 1991, the Company had negative cash flows from operations of $137,039,000 and acquired $31,129,000 of fixed assets. Also during 1991, the Company received significant cash inflows from financing activities, principally the net proceeds of $224,537,000 from the issuance of the Company's 7-1/4 percent Notes and 6-3/4 percent Debentures. During the years ended December 31, 1992 and 1991, the Company received $17,726,000 and $80,272,000, respectively, from the exercise of warrants and options to purchase shares of the Company's Common Stock. The extent and timing of future warrant and option exercises, if any, are primarily dependent upon the market price of the Company's Common Stock and general financial market conditions, as well as the exercise prices and expiration dates of the warrants and options.
Agreements covering $20,402,000 of the Company's outstanding debt balances contain certain financial and non-financial covenants, including the maintenance of minimum equity and cash balances and compliance with certain financial ratios. The Company has obtained waivers of certain of such covenants on the condition that it maintain certain investments at the lending bank, which at December 31, 1993 totalled $20,000,000. There can be no assurance that the Company will be able to continue to collateralize such loans and, accordingly, the Company has classified $20,402,000 of debt as short-term. Additionally, $6,186,000 of the Company's short-
term debt is secured by investments at the lending bank of $6,375,000. If cash flows continue to be negative, the Company's ability to service its debt may be impaired.
See Note 2 to the Company's Consolidated Financial Statements for a discussion of litigation and other factors which may affect the Company's future liquidity and capital resources.
STATUS OF CENTORX
The Company's therapeutic products under development include CentoRx, a product intended to treat or prevent the formation of blood clots in the cardiovascular system. In the first quarter of 1993, the Company completed a randomized, double-blinded, placebo-controlled Phase III trial in high-risk coronary angioplasty patients that enrolled 2,099 patients at 56 medical centers. The Company filed product license applications for CentoRx in the United States and Canada in 1993 and has filed product license applications in several countries in Europe in 1994. There can be no assurance that CentoRx will be approved for commercial sale in the United States, Europe or elsewhere. See Part I Item 1 "Business - Research and Development." During the second quarter of 1993, Lilly exercised its option to become the exclusive worldwide distributor of CentoRx and the Company and Lilly amended their Sales and Distribution Agreement to reflect such event. See Part I Item 1 "Business - Marketing and Sales." Pursuant to that amendment, Lilly has assisted the Company and will continue to assist the Company in the regulatory filings and continued development of CentoRx for various clinical indications.
STATUS OF PANOREX
Panorex, a product intended to treat colorectal cancer, has been tested in a Phase III trial at six German medical centers which enrolled 189 colorectal cancer patients who were subsequently monitored for the accumulation of five- year survival data. The Company expects to complete the filing of an application in 1994 requesting marketing approval for Panorex in Germany. There can be no assurance that Panorex will be approved for commercial sale in Germany or elsewhere. During 1993, the Company and Wellcome entered into an alliance agreement for the development and marketing of certain of the Company's monoclonal antibody-based cancer therapeutic products, including Panorex. See Part I Item 1 "Business - Marketing and Sales."
STATUS OF HA-1A
HA-1A is a product intended for the treatment of patients with severe sepsis who are dying from endotoxemia. The Company has filed product license applications in the United States, Europe, and other countries seeking approval to market HA-1A. Regulatory approvals to market HA-1A were received in several European countries. In April 1992, the FDA advised the Company that there was insufficient evidence of efficacy for approval of HA-1A at that time. In June 1992, the Company initiated a second randomized, double-blinded, placebo- controlled, Phase III U.S. clinical trial of HA-1A in the treatment of patients with Gram-negative bacteremia and septic shock. The Company terminated this trial in 1993 after concluding that there was no reduction in the mortality rate among HA-1A-treated patients who did have Gram-negative
bacteremia in comparison with placebo-treated patients in the same group. The Company and its principal distributor of HA-1A, Lilly, also voluntarily suspended sales and conducted a recall of the drug in Europe and elsewhere where the drug is authorized for sale. The regulatory approvals to market HA-1A currently remain in effect pending the results of further clinical trials. The Company is currently conducting a randomized, double-blinded, placebo-controlled Phase III European clinical trial of the efficacy of HA-1A in the treatment of patients with fulminant meningococcemia. There can be no assurance that any further trials of HA-1A will be initiated or will be successful.
The Company is supplying HA-1A on a limited compassionate-use basis in certain countries in Europe. There can be no assurance that any commercial sales of HA-1A will resume in Europe.
ASSETS
The decrease in the aggregate amount of cash and investments at December 31, 1993 as compared to December 31, 1992 is discussed under Liquidity and Capital Resources. The decrease in the Company's inventory balance at December 31, 1993 as compared to December 31, 1992 is primarily due to the recording of reserves for HA-1A inventories.
Gross fixed assets at December 31, 1993 decreased as compared to December 31, 1992 principally due to the sale of the Company's St. Louis manufacturing facility in July 1993. The Company expects investments in fixed assets of approximately $6,000,000 in 1994. As a result of the downsizing of the Company's staff and present level of operations, the Company currently maintains idle facilities and equipment. The Company continually evaluates the future needs for its facilities and equipment. There can be no assurance that reserves to further reduce the carrying value of certain fixed assets will not be required in the future.
LIABILITIES AND SHAREHOLDERS' EQUITY
Shareholders' equity at December 31, 1993 decreased as compared to December 31, 1992 principally as a result of the Company's loss for the year ended December 31, 1993, partially offset by an increase in additional paid-in capital due to the issuance of Common Stock to Wellcome and the receipt of the proceeds from the exercise of options and warrants. The extent and timing of future warrant and option exercises, if any, are primarily dependent upon the market price of the Company's Common Stock and general financial market conditions, as well as the exercise prices and expiration dates of the warrants and options.
At December 31, 1993, the Company's liabilities exceeded its assets, resulting in a negative shareholders' equity balance. Shareholders' equity will decrease further in future periods unless and until the Company is successful in securing additional capital from collaborative arrangements with pharmaceutical companies or the capital markets or significant and sustained levels of pharmaceutical product sales are achieved. There can be no assurance that significant and sustained levels of pharmaceutical products sales will be achieved or that any additional capital will be available to the Company. If the exchange offer, as described in Note 18 to the Company's Consolidated Financial Statements had been consummated as of December
31, 1993, the Company's shareholders' equity position at December 31, 1993 would have been approximately $19,004,000.
RESULTS OF OPERATIONS
SPECIAL CHARGES
The results of operations for the year ended December 31, 1993 include restructuring charges of $4,273,000 related to reserves for certain fixed assets no longer used or subsequently disposed and $5,114,000 principally related to severance. A charge of $3,500,000 related to HA-1A inventory was recorded in the fourth quarter of 1993. The results of operations for the year ended December 31, 1992 included a charge of $64,877,000 representing reserves for HA- 1A inventories and a charge of $11,245,000 related to the settlement of certain class action securities litigation. Additionally, during the year ended December 31, 1992, the Company recorded a restructuring charge of $15,266,000 related to the downsizing of its operations. The results of operations for the year ended December 31, 1991 included a charge to earnings of $70,147,000 for acquired research and development as a result of the Company's purchase of all of the callable common stock of Tocor. Excluding the items described above, the Company incurred losses for each of the years in the three year period ended December 31, 1993. There can be no assurance that additional charges will not be required in the future.
In the first quarter of 1994, the Company will record a charge to earnings of $36,454,000 for acquired research and development as a result of an exchange offer which is described in Note 18 to the Company's Consolidated Financial Statements.
REVENUES
Product sales have not produced sufficient revenues to cover the Company's operating expenses. The decrease in sales for 1993 as compared to 1992 is principally due to HA-1A sales recorded during 1992 which did not recur in 1993 (see Status of HA-1A). There were no HA-1A sales for 1993 whereas 1992 sales of HA-1A totalled $12,545,000.
Contract revenues for the year ended December 31, 1993 include $10,109,000, net of warrant amortization costs, recognized pursuant to the Company's agreements with Tocor II as compared to $16,071,000 for the year ended December 31, 1992. Revenues from Tocor II for the year ended December 31, 1992 included a $2,500,000 non-refundable fee from Tocor II in connection with the license of certain technology by the Company to Tocor II. The decrease in such revenues for the year ended December 31, 1993 is principally due to a reduction in the Company's antibody research program costs allocated to the Tocor II research program. Contract revenues for the years ended 1993 and 1992 also included $5,000,000 and $50,000,000, respectively, of revenues recognized pursuant to the Company's agreements with Lilly and $10,000,000 of revenues recognized in 1993 pursuant to the Company's agreements with Wellcome. For the year ended December 31, 1991, contract revenues consisted principally of revenues from research and development agreements with CPII, CPIII, and Tocor. The Company acquired all of the callable common stock of Tocor in 1991 and the limited partnership interests in CPII in 1992. Funding for the CPIII research and development agreement was
exhausted in 1991. As a result of an exchange offer which is more fully described in Note 18 to the Company's Consolidated Financial Statements, the revenues under the Tocor II research programs will terminate in 1994.
The level of contract revenues in future periods will primarily depend upon the extent to which the Company enters into other collaborative contractual arrangements, if any, and the achievement of milestones under current arrangements.
COSTS AND EXPENSES
Cost of sales decreased in 1993 as compared to 1992 due to decreased sales, principally sales of HA-1A as discussed above. Cost of sales increased in 1992 as compared to 1991 due to increased sales, principally sales of HA-1A. The Company manufactures its pharmaceutical products at its manufacturing facility in Leiden, The Netherlands. Consequently, the strength of the Dutch Guilder in relation to the U.S. dollar may have an impact on the costs of production and, therefore, the profit margin from sales. Additionally, the Company's antibody- based products are produced through the growth of living cells in culture, which cells secrete the desired antibody. The production cost per unit and, consequently, the profit margin from sales, are highly dependent upon the antibody yields. As further described in Note 2 to the Company's Consolidated Financial Statements, the Company is required to make certain royalty payments based on sales of products, which payments are reflected in cost of sales. Royalty costs represent a significant percentage of sales.
Research and development expenses decreased in 1993 as compared to 1992 due principally to a decrease in costs associated with clinical trials of products under development. Research and development expenses increased in 1992 as compared to 1991 principally due to an increase in the allocation of certain resources to research and development efforts due to a decrease in the level of inventory production, and increased costs associated with clinical trials of products under development. The Company expects an increased level of clinical trial expenses in 1994 as compared to 1993.
Marketing, general and administrative expenses for the year ended December 31, 1993 decreased as compared to the year ended December 31, 1992, due principally to reductions in sales and administrative staffs, marketing costs and legal costs. Marketing, general and administrative expense for the year ended December 31, 1992 decreased as compared to 1991 due principally to reduced legal costs combined with decreased costs from selective reductions in staff and other cost reduction efforts. The Company expects to maintain current levels of marketing, general and administrative expenses in 1994.
OTHER INCOME AND EXPENSES
Interest income decreased in 1993 as compared to 1992 due principally to a reduction in the Company's cash and investment balances and reduced interest rates on investment. Interest income in future periods will depend primarily on the level of the Company's investments and the interest rates obtained on such investments. During 1993 and 1992, the Company recorded unrealized losses of $2,477,000 and $2,296,000, respectively, due to the other than temporary reduction in the market value of marketable equity investments below the Company's cost for
such investments. During the year ended December 31, 1992, the Company recorded a gain of $1,170,000 from the sale of certain securities.
PER SHARE CALCULATIONS
At December 31, 1993, approximately 18,962,000 shares of the Company's Common Stock were issuable upon exercise of outstanding options and warrants and upon vesting of restricted stock awards. Options, warrants, and stock awards are considered Common Stock equivalents for purposes of per share data. The Company uses the modified treasury stock method of calculating per share data since the number of shares of the Company's Common Stock issuable upon the exercise of Common Stock equivalents is in excess of 20 percent of the Company's outstanding Common Stock. Under the modified treasury stock method, the effect of Common Stock issuable upon the exercise of Common Stock equivalents is reflected in the per share data calculation only if the aggregate effect would be dilutive. The 3,843,000 shares issuable upon conversion of the 7-1/4 percent Notes and the 2,049,000 shares issuable upon conversion of the 6-3/4 percent Debentures are not considered Common Stock equivalents and are not included in the calculation of primary per share data but are included in the calculation of fully diluted per share data if their effect is dilutive.
No Common Stock equivalents or shares issuable upon conversion of the 7-1/4 percent Notes and 6-3/4 percent Debentures were included in the per share calculations for any periods presented since to do so would have been antidilutive as the Company has recorded net losses in all periods presented. In future periods, depending upon the market value of the Company's Common Stock and its results of operations for such periods, the Company may be required to include its then outstanding Common Stock equivalents as well as shares issuable upon the conversion of the 7-1/4 percent Notes and the 6-3/4 percent Debentures in its calculations of per share data for such periods if the effect would be dilutive.
ITEM 8. | 708823 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
(1) Funds from operations is defined as net income (loss) before gains or losses from the sale of properties and debt restructurings plus depreciation and amortization. FUNDS FROM OPERATIONS DOES NOT REPRESENT CASH AVAILABLE TO FUND THE TRUST'S OPERATIONS.
ITEM 6. SELECTED FINANCIAL DATA (Continued)
Share and per share data have been restated to give effect to the 10% share distribution declared in July 1993 and the one-for-three reverse share split effected March 26, 1990.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
National Income Realty Trust (the "Trust") invests in real estate through acquisitions, leases and partnerships and in mortgages on real estate. The Trust was organized on October 31, 1978 and commenced operations on March 27, 1979.
Liquidity and Capital Resources
Cash and cash equivalents aggregated $1.1 million at December 31, 1993 compared with $1.8 million at December 31, 1992. The Trust's principal sources of cash have been and will continue to be property operations, proceeds from property sales, the collection of mortgage notes receivable and borrowings. The Trust expects that funds from operations, collection of mortgage notes receivable and from anticipated external sources, such as property sales and refinancings, will be sufficient to meet the Trust's various cash needs, including debt service obligations, property maintenance and improvements and continuation of regular distributions, as more fully discussed in the paragraphs below.
The Trust's cash flow from property operations (rentals collected less payments for property operating expenses) has increased from $10.1 million for 1992 to $14.4 million for 1993. This increase in cash flow from property operations is primarily attributable to four apartment complexes purchased in November 1992 and two apartment complexes obtained through foreclosure in March 1993. Cash flows from property operations decreased from $10.7 million in 1991 to $10.1 million in 1992, primarily attributable to an increase in payments for property taxes in 1992.
The Trust's interest collected decreased from $3.2 million in 1991 to $2.1 million in 1992 and $1.5 million in 1993. The decrease from 1991 to 1992 is primarily attributable to interest of $849,000 collected in 1991 on a revolving loan to National Operating, L.P. ("NOLP"), which was paid in full in September 1991. In addition, $166,000 of the decrease relates to other loans which were paid in full in 1991 and 1992. Of the decrease from 1992 to 1993, $245,000 is due to a note which was paid in full in March 1993 and $221,000 is due to interest payments received in 1992 on a cash flow mortgage, but not received in 1993. Interest collections are expected to continue to decline due to the $2.4 million in loans paid off in 1993.
Interest paid on the Trust's indebtedness increased from $7.7 million in 1992 to $9.3 million in 1993. Of this increase, $1.3 million is due to interest paid on mortgages secured by properties acquired by the Trust
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
during 1992 and 1993 and an additional $723,000 of the increase is attributable to interest paid on the mortgage secured by the Century Centre II Office Building, on which the Trust made a $1.0 million payment of accrued interest in accordance with the confirmed Plan of Reorganization as discussed in NOTE 6. "NOTES, DEBENTURES AND INTEREST PAYABLE." These increases were partially offset by a decrease in interest of $314,000 due to the mortgage secured by Pinecrest Apartments, whose variable interest rate decreased from 1992 to 1993. An additional decrease of $213,000 is attributable to two mortgages on which the Trust stopped making payments in 1993 also as discussed in NOTE 6. "NOTES, DEBENTURES AND INTEREST PAYABLE."
The Trust was not involved in significant investing activities during 1993. The Trust did however, make $3.1 million of improvements to its properties in 1993. The Trust anticipates making capital improvements to its properties of approximately $4 million in 1994. The Trust received $410,000 in net cash from the sale of three foreclosed properties during 1993. In addition, the Trust also received payment in full on three notes receivable resulting in cash of $2.4 million. Principal payments of $113,000 on other notes were also received.
In the second quarter of 1993, Sacramento Nine ("SAC 9"), a joint venture partnership in which the Trust owns a 70% interest, sold 3 of its office buildings for $2.5 million in cash, of which the Trust's equity share was $1.7 million.
In October 1992, the Trust borrowed $1.6 million from a bank secured by a $1.6 million unsecured note receivable of the Trust. The note payable was paid in full on its maturity date in March 1993 from the collection of the note receivable.
In June 1993, the Trust obtained first mortgage financing secured by the Bayfront Apartments in the amount of $2.1 million, of which the Trust received net cash of $1.8 million from the financing proceeds. In January 1994, the Trust obtained first mortgage financing secured by the Bay West Apartments in the amount of $5.1 million. The Trust received net cash of $1.0 million after the payoff of $3.9 million in existing debt. In March 1994, the Trust also obtained first mortgage financing on both the Carlyle Towers Apartments and the Woodcreek Apartments totaling $7.5 million. The Trust received net cash of $3.5 million after the payoff of $4.0 million in existing debt. The Trust intends to increase its emphasis on obtaining financing or refinancing of its properties. However, there is no assurance that the Trust will continue to be successful in its efforts in this regard.
Principal payments on the Trust's notes payable of $11.9 million are due in 1994. Of this amount, $1.6 million relates to a nonrecourse debt which had matured December 31, 1993. The Trust is currently negotiating a modification and extension of this debt secured by an apartment complex in Miami, Florida. However, in the event that the Trust is
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Liquidity and Capital Resources (Continued)
unsuccessful in extending this note, the Trust is prepared to payoff the mortgage debt. See NOTE 6. "NOTES, DEBENTURES AND INTEREST PAYABLE."
During 1993, the Trust repurchased 280,038 of its shares of beneficial interest at a cost of $2.4 million pursuant to the repurchase program originally announced by the Trust on December 5, 1989. The Trust's Board of Trustees has authorized the repurchase of a total of 1,026,667 shares under such repurchase program of which 177,036 shares remain to be purchased as of March 11, 1994.
Based on the performance of the Trust's properties, the Trust's Board of Trustees voted in July 1993 to resume the payment of regular quarterly distributions to shareholders. The Trust paid distributions totaling $617,000 ($0.20 per share) to its shareholders in 1993, and also paid a 10% stock dividend to its shareholders in 1993.
On a quarterly basis, the Trust's management reviews the carrying value of the Trust's mortgages, properties held for investment and properties held for sale. Generally accepted accounting principles require that the carrying value of an investment held for sale cannot exceed the lower of its cost or its estimated net realizable value. In those instances in which estimates of net realizable value of the Trust's properties are less than the carrying value thereof at the time of evaluation, a provision for loss is recorded by a charge against operations. The estimate of net realizable value of the mortgage loans is based on management's review and evaluation of the collateral properties securing the mortgage loans. The review generally includes selective property inspections, a review of the property's current rents compared to market rents, a review of the property's expenses, a review of the maintenance requirements, discussions with the manager of the property and a review of the surrounding area.
Results of Operations
1993 compared to 1992. For the year ended December 31, 1993, the Trust had net income of $5.8 million, as compared to a net loss of $8.3 million for the year ended December 31, 1992. The primary factors contributing to the improvement in the Trust's operating results are discussed in the following paragraphs.
Net rental income (rental income less property operating expenses) increased from $9.4 million in 1992 to $14.6 million in 1993. Of this increase, $1.3 million is due to four apartment complexes acquired in November 1992 and an additional $654,000 is due to two apartment complexes obtained through foreclosure in 1993. An additional $618,000 is due to a decrease in the amortization of free rent at the Century Centre Office Building and $295,000 is due to a decrease in replacements at Park Dale Gardens, the renovation of which was completed in 1992. The remaining increase is due to increased occupancy and rental rates at
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
the Trust's apartment complexes, primarily in the Southeast and Southwest regions, and overall expense control at certain of the Trust's apartment and commercial properties.
Interest income decreased from $2.5 million in 1992 to $1.6 million in 1993. Of this decrease, $553,000 is due to loans which were placed on nonaccrual status or loans on which the collateral securing the loan was foreclosed in 1993. In addition, a decrease of $245,000 is due to a note which was paid in full in March 1993 and a decrease of $221,000 is due to interest payments received in 1993 compared to 1992 on a mortgage where interest is recognized on the cash flow basis. Interest income is anticipated to decline further in 1994 due to notes which were paid off in 1993.
The Trust's equity in income of partnerships was income of $204,000 in 1992 compared to a loss of $34,000 in 1993. This decrease in operating results is primarily due to the sale of three properties by the SAC 9 partnership in the second quarter of 1993.
Interest expense decreased from $10.4 million in 1992 to $9.7 million in 1993. A decrease of $1.2 million is attributable to a reduction in the interest rate on the first mortgage secured by the Century Centre II Office Building and the purchase of the second mortgage at a significant discount. An additional decrease of $163,000 is due to a reduction in the variable interest rate on the note payable secured by Pinecrest Apartments and $414,000 is due to interest expense on the underlying note payable associated with one of the Trust's wraparound mortgage notes receivable, which was concurrently foreclosed and sold in 1993. These decreases were partially offset by an increase of $857,000 due to interest expense recorded on mortgages secured by four apartment complexes which were acquired in November 1992 and an additional $416,000 attributable to interest expense recorded on the underlying mortgage secured by a property acquired through foreclosure in March 1993. See NOTE 6. "NOTES, DEBENTURES AND INTEREST PAYABLE."
Depreciation expense increased from $4.0 million in 1992 to $4.6 million in 1993, primarily due to the acquisition of four apartment complexes in November 1992 and two additional apartment complexes through foreclosure in March 1993.
Advisory fees increased from $1.4 million in 1992 to $1.5 million in 1993, as a result of increase in the average monthly gross assets of the Trust, calculated in accordance with the terms of the advisory agreement.
Commencing April 1, 1994, Tarragon Realty Advisors, Inc. ("Tarragon") will become the Trust's advisor. The terms of the Trust's advisory agreement with Tarragon are substantially the same as those with Basic Capital Management, Inc., the Trust's current advisor, except for the annual base advisory fee and the elimination of the net income fee. If the
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
Tarragon advisory agreement had been in effect in 1993 the Trust's annual base advisory fee would have been reduced by approximately $1.0 million. See NOTE 8. "ADVISORY AGREEMENT."
General and administrative expenses decreased from $2.2 million in 1992 to $1.8 million in 1993. Of this decrease, $250,000 is due to a reduction in legal fees, an additional $123,000 is related to the Trust's March 1992 annual meeting of shareholders and the February 1992 Rights redemption and $198,000 is due to a decrease in professional fees related to the reduced level of property acquisitions in 1993 compared to 1991 and 1992.
For the year 1993, the Trust expensed $1.0 million for the issuance of a $1.0 million convertible subordinated debenture to John A. Doyle, Trustee and Executive Vice President of the Trust, in exchange for his 10% participation in the profits of the Consolidated Capital Properties II ("CCP II") assets, which were acquired in November 1992, over a year before Mr. Doyle's affiliation with the Trust. This participation was granted as consideration for Mr. Doyle's services to the Trust in connection with the CCP II portfolio. See NOTE 6. "NOTES, DEBENTURES AND INTEREST PAYABLE."
For the year 1993, the Trust recorded a provision for losses of $1.4 million to provide for estimated losses on one of the Trust's properties held for sale and one of the Trust's first lien mortgage notes. A provision for losses of $2.4 million was recorded in 1992 to reserve against certain junior mortgage notes receivable.
For the year ended December 31, 1993, the Trust recognized gains on sales of real estate of $851,000 related to the sale of three properties by SAC 9 and $94,000 on the sale of the Plaza Jardin Office Building. No gains on sales of real estate were recognized in 1992.
Also for the year 1993, the Trust recorded an extraordinary gain on the forgiveness of debt of $8.9 million related to the discounted purchase of the second lien mortgage secured by Century Centre II Office Building, which was purchased by the Trust for $300,000 as part of a bankruptcy Plan of Reorganization. The Trust recorded no extraordinary gain in 1992.
1992 compared to 1991. For the year ended December 31, 1992, the Trust had a net loss of $8.3 million as compared with a net loss of $3.1 million for the year ended December 31, 1991. The primary factors contributing to the increase in the Trust's net loss are discussed in the following paragraphs.
Net rental income (rental income less property operations expenses) increased from $8.5 million in 1991 to $9.4 million in 1992. Of this increase $1.7 million is the result of net rental income recorded on properties purchased in 1992 and the fourth quarter of 1991 and an
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
additional $776,000 is attributable to increased net rental income at Pinecrest Apartments, where a major renovation was substantially completed during 1992. In addition, net rental income also increased $800,000 due to increased rental and occupancy rates at certain of the Trust's apartment complexes, primarily in the Southeast and Southwest. These increases were partially offset by a decrease in net rental income of $1.4 million at the Century Centre II Office Building, attributable to the temporary increases in vacancy coincident with the bankruptcy filing in October 1991. In addition, net rental income decreased $279,000 due to the transfer of the Afton Aero Business Park to the senior lienholder in August 1991, decreased $378,000 due to properties sold during 1992 and the fourth quarter of 1991 and decreased $340,000 due to a decrease in occupancy and rental rates at Rancho Sorrento Business Park related to weakness in the San Diego office market.
Interest income on mortgage receivables decreased from $2.8 million in 1991 to $2.4 million in 1992. Of this decrease, $415,000 is attributable to interest recognized in 1991 on a $7.0 million revolving loan to NOLP, which was paid in full in September 1991. An additional $393,000 is due to interest income not being recognized on notes receivable classified as nonperforming and $190,000 of the decrease is related to notes which were paid off in 1991 and 1992. These decreases were partially offset by an increase of $332,000 attributable to interest income on mortgage loans funded or acquired during 1991 and $128,000 attributable to a note classified as nonperforming in 1991 which was brought current in 1992.
Equity in results of operations of partnerships produced income of $204,000 in 1992 as compared to a loss of $171,000 in 1991. The 1991 loss was attributable to Adams Properties Associates ("APA"), a partnership in which the Trust has a 40% interest, recording a $1.2 million charge against earnings for the permanent write-down of three of the partnership's warehouses to their estimated net realizable value. The Trust's equity share of such charge was $480,000. In addition, SAC 9, a partnership in which the Trust has 70% interest, recorded a $1.1 million charge against earnings in 1991 relating to a property which was transferred to the senior lienholder. The Trust's equity share of such charge was $770,000. Neither partnership incurred similar charges in 1992.
Interest expense increased from $9.4 million in 1991 to $10.4 million in 1992. Of this increase, $2.0 million is attributable to interest expense on notes payable secured by properties which were acquired in 1991 and 1992. This increase is partially offset by a decrease of $531,000 in the interest accrual rate, attributable to a decrease in the interest rate, on the Century Centre II first mortgage, a decrease of $222,000 related to the Afton Aero Business Park, which was returned to the senior lienholder in August 1991, and a decrease of $135,000 due to the restructuring of the mortgage secured by Emerson Center, which emerged from bankruptcy in March 1992.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Results of Operations (Continued)
General and administrative expenses decreased from $2.4 million in 1991 to $2.2 million in 1992. This decrease is due to a decrease of $200,000 in legal fees paid in 1992 in connection with the Olive litigation discussed in NOTE 15. "COMMITMENTS AND CONTINGENCIES - Olive Litigation." In addition, $104,000 was recorded in 1991 for the settlement of the adversary proceedings with Southmark Corporation.
For the year ended December 31, 1992, the Trust recorded a provision for losses of $2.4 million to reserve against certain junior mortgages. No such provision for losses was recorded in 1991.
For the year ended December 31, 1991, the Trust reported gains on sales of real estate of $257,000 related to APA and SAC 9 partnerships and $205,000 on the sale of Coronado Village Apartments. No gains on sales of real estate were recognized in 1992.
The Trust also recognized an extraordinary gain on the extinguishment of debt of $2.2 million for 1991 related to the return of one of the SAC 9 office buildings to the senior lienholder. None was recorded in 1992.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and regulations, the Trust may be potentially liable for removal or remediation costs, as well as certain other potential costs relating to hazardous or toxic substances (including governmental fines and injuries to persons and property) where property-level managers have arranged for the removal, disposal or treatment of hazardous or toxic substances. In addition, certain environmental laws impose liability for release of asbestos- containing materials into the air, and third parties may seek recovery from the Trust for personal injury associated with such materials.
The Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, assets or results of operations.
Inflation
The effects of inflation on the Trust's operations are not quantifiable. Revenues from property operations fluctuate proportionately with increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties and, correspondingly, the ultimate gains to be realized by the Trust from property sales. Inflation also has an effect on the Trust's earnings from short-term investments.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
Tax Matters
For the years ended December 31, 1993, 1992 and 1991, the Trust elected, and in the opinion of the Trust's management, qualified to be taxed as a Real Estate Investment Trust ("REIT") as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). The Code requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, as defined in Section 857 of the Code, on an annual basis to shareholders.
Recent Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") has recently issued Statement of Financial Accounting Standards ("SFAS") No. 114 - "Accounting by Creditors for Impairment of a Loan", which amends SFAS No. 5 - "Accounting for Contingencies" and SFAS No. 15 - "Accounting by Debtors and Creditors for Troubled Debt Restructurings." The statement requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. SFAS No. 114 is effective for fiscal years beginning after December 15, 1994. The Trust's management has not fully evaluated the effects of implementing this statement, but expects that they will not be material as the statement is applicable to debt restructurings and loan impairments after the earlier of the effective date of the statement or the Trust's adoption of the statement.
At its January 26, 1994 meeting, the FASB directed its staff to prepare an exposure draft, that if approved, would eliminate the provisions of SFAS No. 114 that describe how a creditor should recognize income on an impaired loan and add disclosure requirements on income recognized on impaired loans. The effective date of SFAS No. 114 is not anticipated to change.
(THIS SPACE INTENTIONALLY LEFT BLANK.)
ITEM 8. | 277577 | 1993 |
49071 | 1993 |
||
ITEM 6. SELECTED FINANCIAL DATA
A summary of selected financial data for the five years ended 10/31/93 appears on pages 30 and 31 of the registrant's 1993 Annual Report to Stockholders under the caption "11-Year Summary", and is incorporated by reference herein.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information under this caption is in the registrant's 1993 Annual Report to Stockholders on pages 14 through 19, under the caption "Financial Review", and on pages 25 and 26 under the captions "Acquisitions, Short-Term Borrowings and Lines of Credit, and Long-Term Debt" and is incorporated by reference herein. The registrant continued its program to cease manufacturing operations at its Webster Groves, Missouri facility to coincide with an expansion of its La Porte, Texas facility. As and when such operations cease, the registrant expects that appropriate reserves will be established. This program will increase manufacturing capacity, efficiency and flexibility, and ultimately will allow for any necessary additions to sales, administrative and research facilities at Webster Groves. On January 27, 1993, the registrant announced that it adopted Statement of Financial Accounting Standard No. 106 related to medical and other postretirement benefits. The adoption of this rule resulted in a one-time, non-cash charge of $6.5 million, or $0.58 per share, to net income in fiscal 1993's first quarter ending January 31.
During the first quarter of fiscal 1994, the registrant will adopt Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes." Statement 109 will change the company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. The estimated cumulative effect of implementing the new standard, using current tax rates, will be a one-time, non-cash credit of $2.0 million, or $0.18 per share, to net income in fiscal 1994's first quarter ending January 31.
ITEM 8. | 77943 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The tabular information under "Financial Summary-Operating Results, Earnings per Share and Year-End Financial Position" and the amounts of Dividends per Share, all appearing on page 52 of the 1993 Annual Report, are incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
The tabular and narrative information appearing under "Review of Consolidated Results of Operations" on pages 23 through 26, "Operating Unit Segment Data" on pages 27 through 33, "Review of Changes in Financial Position" on page 37, and "Review of Cash Flow" on pages 39 through 41 of the 1993 Annual Report is incorporated herein by reference.
ITEM 8. | 67686 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
Selected financial data for Duquesne Light Company for each year of the six-year period ended December 31, 1993 are set forth on page 67. The financial data is incorporated here by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management's discussion and analysis of financial condition and results of operations are set forth in Item 1. BUSINESS and on pages 10 through 17 of the DQE Annual Report to Shareholders for the year ended December 31, 1993. The discussion and analysis are incorporated here by reference.
ITEM 8. | 30573 | 1993 |
Item 6. SELECTED FINANCIAL DATA
Reference is made to the Company's Annual Report to Stockholders for the year ended December 31, 1993. The information set forth on page 32 of such Annual Report entitled "Selected Quarterly Financial Data (unaudited)" is hereby incorporated by reference.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Reference is made to the Company's Annual Report to Stockholders for the year ended December 31, 1993. The information set forth on pages 17 through 19 of such Annual Report entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" is hereby incorporated by reference.
Item 8. | 52466 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The information below should be read in conjunction with the Company's Consolidated Financial Statements and related Notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(1)Extraordinary item reflects the write-off of the unamortized portion of costs which had been incurred in connection with extinguished bank borrowings (net of income tax benefit) of $820,000 in 1991 and $5,639,000 in 1993. (2)Earnings per share and the weighted average common shares outstanding have been adjusted to reflect the payment of a 5% Common Stock dividend declared and paid by the Company during each of 1991 and 1992 and the 3.15-to-one Common Stock split in the form of a 215% Common Stock dividend paid on February 4, 1994.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and related Notes.
General
The following table shows the percentage relationship to total revenues of certain items included in Selected Financial Data for each of the periods indicated:
Results of Operations
The Company derived 1993 revenues principally from international private line and public switched long distance telephone services, radio and television transmission services, mobile communications and systems integration services provided on the Company's domestic and international communications network. See "Business."
1993 Compared to 1992
Operating results for 1993 resulted in the highest revenues and income before extraordinary item and preferred stock dividend in the Company's history. Total revenues and income before extraordinary item and preferred stock dividend for 1993 were $310,708,000 and $20,139,000, respectively, versus $155,344,000 and $8,528,000, respectively, for 1992.
Revenues for 1993 increased $155,364,000 or 100% over 1992 revenue principally from an increase of $130,638,000 in international private line and international public switched long distance telephone services resulting from the acquisitions of WorldCom on December 31, 1992 and TRT on September 30, 1993 (the "Acquisitions", See Note 9 of Consolidated Financial Statements of the Company) and the growth in IDB Mobile's communications services of $19,205,000. These services comprised 67% of total revenues in 1993 compared to 35% in 1992. Broadcast revenues, which declined slightly in 1993 compared to 1992 due to the Company's decision not to renew certain less profitable customer contracts, comprised 24% of total revenue in 1993 compared to 49% in 1992. The Company also earned fees of $8,000,000 and $7,700,000 in 1993 and 1992, respectively, from operational assistance and other consulting services provided to WorldCom during 1992 and TRT during 1993. The fees earned in connection with the operational assistance and consulting services ended upon completion of the acquisition of TRT in September 1993.
Costs of sales increased $102,383,000 in 1993 or 100% over 1992 due to higher levels of revenue provided by the Acquisitions. Cost of sales as a percentage of revenue improved slightly due to the Company's changing revenue mix. The fastest growing revenue element, international long distance services, has lower cost of sales than the private line and broadcast services historically provided by the Company. This is somewhat offset by higher cost of sales related to IDB Mobile and IDB Systems integration activities.
Selling, general and administrative expenses increased to $37,381,000 in 1993 from $18,889,000 in 1992 principally due to the Acquisitions. Selling, general and administrative expenses as a percentage of revenue declined slightly due to economies of scale resulting from higher revenue levels and the Company's efforts to control administrative costs during the integration of the WorldCom and TRT acquisitions offset by higher selling and marketing costs related to the Company's efforts to further expand its international private line and long distance telephone services.
Depreciation expense as a percentage of revenues decreased to 5.6% in 1993 from 6.2% in 1992 as a result of increased utilization of the Company's network facilities. Depreciation expense increased from $9,587,000 in 1992 to $17,269,000 principally due to the Acquisitions.
Amortization expense increased to $4,669,000 in 1993 from $3,507,000 in 1992 principally due to the amortization of additional intangible assets acquired in connection with the Acquisitions. Amortizable assets consist primarily of intangibles including goodwill, bank loan fees and satellite transmission and customer contracts.
Streamlining charge represents $5,920,000 of charges related to the Company's plans approved in the fourth quarter of 1993 to reduce the number of employees and dispose of certain assets.
Interest expense net of interest income for 1993 of $6,350,000 remained consistent with 1992 due to higher average outstanding debt ($142,807,000 in 1993 versus $90,542,000 in 1992) offset by a lower effective interest rate (8.1% in 1993 versus 10.9% in 1992) and the Company's ability to invest excess cash in interest earning investments ($2,055,000 increase in interest income in 1993).
Extraordinary item in 1993 represents a $7,949,000 charge, net of $5,639,000 income tax benefit, redemption premiums and the unamortized portion of debt issuance costs associated with the repayment and defeasance of substantially all of the Company's then existing debt.
The Company's provision for income taxes as a percentage of income before taxes increased to 41.5% in 1993 from 40.5% in 1992 primarily as a result of the increase in the federal statutory income tax rate to 35%.
1992 Compared to 1991
Revenues in 1992 increased $50,907,000, or 48.7%, to $155,344,000. This increase was primarily attributable to a $15,964,000 increase in revenues from IDB Mobile, resulting from its first full year of operations and its success in capturing a growing share of the maritime communications market. IDB Systems' revenues increased $11,167,000 in 1992 primarily from increased sales activity in Europe, China and Africa. Additionally, in it's first year of providing international long distance telephone services, IDB generated approximately $8,000,000 in such revenues in 1992. IDB Broadcast's revenues, which accounted for approximately 49% of total revenues in 1992 and 66% in 1991, increased $6,500,000 in 1992 principally due to additional fulltime video transmission services. The Company also earned $5,000,000 in fees generated from services provided under an operational assistance agreement with WorldCom and $2,700,000 in fees earned from sales and engineering support and management provided to WorldCom during 1992.
Cost of sales has historically included a relatively high percentage of fixed costs, consisting primarily of employee salaries, satellite transponder costs and satellite and telephone line charges provided through the facilities of outside vendors. Cost of sales as a percentage of revenues increased from 63.7% in 1991 to 66.0% in 1992. The increase reflects a change in the mix of the Company's business during 1992. The Company's systems integration activities, mobile communications services to the maritime market and certain fulltime video services carry higher cost of sales than the services historically provided by the Company. In addition, a joint venture agreement which had provided for reduced rates on satellite transponder capacity expired in March 1992. These factors are partially offset by relatively lower cost of sales on international long distance services.
Selling, general and administrative expenses increased to $18,889,000 in 1992 from $14,688,000 in 1991, primarily from the consolidation of IDB Mobile and Houston International Teleport, Inc. and the investment the Company made in 1992 in enhancing its internal systems. However, selling, general and administrative expenses decreased as a percentage of revenues from 14.1% in 1991 to 12.2% in 1992 due to economies of scale from higher revenue levels and improved operating efficiencies.
Depreciation expense as a percentage of revenues decreased to 6.2% in 1992 from 7.0% in 1991 as a result of increased utilization of the Company's network facilities. Depreciation expense increased from $7,305,000 in 1991 to $9,587,000 in 1992 principally due to the addition of network facilities (including undersea fiber optic cable and earth stations) to support the Company's revenue growth.
Amortization expense increased by $662,000 from 1991 to 1992 primarily as a result of amortization of foreign carrier license costs incurred by IDB Mobile and public switched long distance telephone services. Amortizable assets consist primarily of intangibles, bank loan fees and satellite transmission and customer contracts. Amortization expense as a percentage of revenues decreased to 2.2% in 1992 from 2.7% in 1991 as a result of increased revenues and the fixed nature of these costs.
Interest expense decreased by $2,026,000 from 1991 to 1992 primarily as a result of lower effective interest rates (10.9% in 1992 versus 11.5% in 1991) and a decrease in the average debt outstanding ($90,542,000 in 1992 versus $93,792,000 in 1991). In addition, capitalized interest increased in 1992 due to a greater level of construction in progress on the Company's transmission and related facilities.
The Company's provision for income taxes as a percentage of income before taxes remained relatively constant at 40.5% in 1992 as compared to 39.0% in 1991. See Note 6 of Notes to Consolidated Financial Statements of the Company.
Seasonality and Inflation
Historically, the Company's business has been seasonal because its transmission services have been purchased in larger volumes during periods of favorable weather when more sporting and special events are held. Increases in full-time radio and television distribution services, private line telephone and data services, satellite-based mobile services and international public switched long distance telephone services have substantially lessened the impact of this seasonality.
Since its inception, the Company's results of operations have not been materially affected by inflation.
Liquidity and Capital Resources
The Company has financed growth through borrowings, cash generated from profitable operations and sales of shares of its Common Stock and 5% Convertible Subordinated Notes due 2003 (the "Subordinated Notes"). Prior to August 20, 1993, the Company borrowed funds under a $25,000,000 revolving credit facility (the "Revolver"), issued $50,000,000 of senior secured notes (the "Senior Notes") and $26,000,000 principal amount of 13% Senior Subordinated Notes due 1998 (the "1998 Notes"). On December 21, 1992, the Company also assumed a $15,000,000 loan payable by WorldCom to TeleColumbus U.S.A., Inc (the "Assumed Loan"). Substantially all outstanding borrowings of the Company were repaid and defeased by September 1993, using a portion of the proceeds of the public offering of $195,500,000 in aggregate principal amount of Subordinated Notes in August 1993 and the public offering of an aggregate of 4,724,997 shares of Common Stock in May 1993. The Assumed Loan was repaid by the Company upon the consummation of the acquisition of WorldCom Europe in December 1993.
The Subordinated Notes issued in August 1993 are convertible at any time prior to maturity, unless previously redeemed, into Common Stock of the Company at a conversion price of $18.15 per share, as adjusted to reflect the 3.15-to- one Common Stock split in the form of a 215% Common Stock dividend paid on February 1994 and subject to further adjustment in certain events. The Subordinated Notes bear interest at a rate of 5% per annum and interest is payable on February 15 and August 15 of each year. The Subordinated Notes are redeemable at any time after August 15, 1996, in whole or in part, at the option of the Company, at declining redemption prices plus accrued interest. The Subordinated Notes are unsecured and subordinated to all existing and future senior indebtedness of the Company and will be effectively subordinated to all indebtedness and other liabilities of subsidiaries of the Company. The Subordinated Notes contain no limitation on the incurrence of additional indebtedness by the Company and its subsidiaries.
In November 1993, Bank of America National Trust and Savings Association agreed to make a $15,000,000 line of credit available to the Company (the "Line of Credit"). Advances made pursuant to the Line of Credit bear interest at a floating rate based, at the option of the Company, on a domestic index or an offshore index. All advances and letters of credit made under the Line of Credit mature on October 31, 1995 and the Line of Credit expires on such date. The Company may at any time terminate the Line of Credit by payment of all outstanding advances and other obligations under the Line of Credit and cash collateralization of all letters of credit existing at that time. As of December 31, 1993, there were no amounts outstanding under the Line of Credit. In addition, the Company has ongoing discussions with several financial institutions regarding credit facilities, committed and uncommitted.
During 1993, the Company's capital expenditures, including improvements, replacements and additions of communications equipment and facilities, were approximately $48,300,000. The Company historically has invested significantly to build its communications network. See "Business -- The IDB Communications Network" and "Business -- Facilities."
Net cash provided by operating activities in 1993 decreased to $2,040,000, compared to net cash provided by operating activities of $27,763,000 in 1992 principally due to increases in accounts receivables associated with the Acquisitions. Cash provided by financing activities in 1993 was $129,576,000, as compared to cash provided by financing activities of $16,694,000 in 1992 and principally relate to the sale of Subordinated Notes offset by the repayments or defeasance of substantially all of the Company's then existing debt. Net cash used in investing activities in 1993 was $78,323,000, as compared to $45,900,000 in 1992, principally due to property and equipment expenditures for additional facilities in the IDB network, the purchase of short-term investments, and costs incurred in connection with the
Acquisitions.
In May 1990, the Company entered into an agreement with Comsat, Inc. ("Comsat") under which it may obtain satellite transponder capacity for maritime and aeronautical services offered or to be offered by IDB Mobile, at long-term fixed rates over a five-year period that commenced in September 1991. As of December 31, 1993, IDB's minimum remaining total commitment under the agreement was to purchase 8 million minutes of transponder capacity (representing aggregate costs of approximately $20,400,000, calculated at the rate set forth in the agreement, which the Company would pay in 1996 to satisfy any remaining volume commitment under the agreement that the Company did not purchase by that time). Based on current and projected usage, the Company believes that it will meet the minimum purchase commitment under the agreement. If the Company were to materially breach the agreement (including provisions relating to interference with the operation of the satellites), the Company would not be entitled to the rates set forth in the agreement, but would be required, from the date of such material breach, to pay higher rates for satellite transponder capacity for maritime and aeronautical services. See "Business -- Facilities" and Note 7 of Notes to Consolidated Financial Statements of the Company.
The Company's capital commitments, as of March 16, 1994, consisted primarily of outstanding purchase orders (some of which are cancelable at the Company's option) to acquire approximately $30,900,000 of equipment, including long term commitments on undersea fiber optic cables of $20,500,000, which will be financed by cash from operations and bank borrowings. It is anticipated that the Company's 1994 expenditures will exceed that amount. The Company expects that cash flow from operations, its current holdings of cash and marketable securities and its borrowing capabilities under its current credit facility will satisfy its projected working capital and capital expenditure requirements through fiscal 1994. The Company may seek additional debt or equity financing from time to time to supplement cash generated from operations and finance future growth opportunities.
ITEM 8. | 799319 | 1993 |
Item 6. Selected Financial Data
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Consolidated Sales and Program Profits
Consolidated sales were $13.1 billion in 1993, a 29 percent increase over 1992 due to the 1993 acquisition of Lockheed Fort Worth Company (LFWC), the former tactical military aircraft business of General Dynamics Corporation. Total sales increased three percent in 1992 compared with the previous year. Revenues from U.S. government defense customers continued to decline as a percentage of total sales, to 64 percent in 1993 from 67 percent in 1992 and 70 percent in 1991, while sales to foreign governments increased to 13 percent of total sales in 1993, largely due to the LFWC acquisition, compared with eight percent in 1992 and six percent in 1991. Sales made to foreign governments through the U.S. government are included in sales to foreign governments. Sales to commercial customers increased as an absolute amount, but held steady as a percentage of total sales. The table below illustrates the changing customer mix.
Sales by customer 1993 1992 1991 - ---------------------------------------------------------------- U.S. government Defense 64% 67% 70% Nondefense 13 15 15 - ---------------------------------------------------------------- 77 82 85 Foreign governments 13 8 6 Commercial 10 10 9 - ---------------------------------------------------------------- 100% 100% 100% - ----------------------------------------------------------------
Total program profits increased by 31 percent in 1993 following growth of about 12 percent in 1992. Program profit margins for 1993, 1992, and 1991 were 6.5 percent, 6.4 percent, and 5.9 percent, respectively. The 1993 results reflected, among other factors, the LFWC acquisition, the favorable settlement of a major dispute with a customer, a reduction in accrued future retiree medical costs due to reduced employment levels (reflected in varying degrees in the program profits of each business segment), as well as charges related to Aeronautical Systems Burbank property and the closure of the Norton maintenance operation. The 1992 improvement compared with 1991 reflected better performance in most business areas partly offset by higher investment in certain emerging lines of business.
Operations by business segment are discussed beginning on page 18.
Interest Expense
Interest expense in 1993 increased by about 41 percent over 1992's amount due to substantially higher debt outstanding during most of the year. The higher debt was incurred to finance the purchase of LFWC. The average interest rate on outstanding borrowings was lower in 1993 than in the previous year. Interest expense was about the same in 1992 as in 1991, as both average outstanding borrowing levels and the company's effective borrowing rate showed little fluctuation from year to year.
Other Income, Net
Net other income was negligible in 1993, lower than in 1992 primarily due to lower interest income from the temporary investment of excess cash. Net other income was higher in 1992 compared with 1991 primarily due to higher interest income and the absence of costs associated with the 1991 stockholder proxy contest, partly offset by higher other costs.
Provision for Income Taxes
Income tax expense was higher in 1993 than in 1992 primarily due to the effect of higher pretax earnings, with a higher effective tax rate (nearly 38 percent in 1993 versus close to 37 percent in 1992) also having an impact. The increase in the effective tax rate was due to the settlement of certain tax issues outstanding from prior periods for a higher amount than had been accrued, and a higher nondeductible amount of intangible asset amortization related to the purchase of LFWC. Congress enacted an increase in the federal statutory tax rate from 34 percent to 35 percent in 1993, but the effect of this rate increase was offset by a related favorable one-time adjustment of the company's net deferred tax assets.
Income tax expense was higher in 1992 compared with 1991, also due to higher pretax earnings and a higher effective tax rate. The effective rate (about 37 percent in 1992, compared with 35 percent in 1991) was higher primarily because certain tax credits used in 1991 were not available to the company in 1992.
Earnings Before Cumulative Effect of Change in Accounting Principle
Earnings increased 21 percent in 1993 compared with 1992 due to higher program profits, partly offset by higher interest expense, lower other income, and higher income tax expense. The per-share increase in earnings was slightly lower (19 percent) due to the higher average number of shares and equivalents outstanding in 1993.
Earnings growth in 1992 came primarily from higher program profits. Higher other income also contributed, while higher income tax expense partly offset the effect of these improvements. Earnings per share before the effect of the change in accounting was higher in 1992 compared with 1991 as a result of these same factors, plus a lower average number of common and common equivalent shares outstanding during 1992, the result of the company's common stock repurchase program under way at that time.
If inflation were taken into account, earnings would differ from the reported results due to the recognition of additional depreciation expense. Contracts in the aerospace industry generally reflect the impact of anticipated inflation in the selling price, and often contain price escalation clauses that protect against abnormal inflation. In the case of depreciation, however, regulations that determine U.S. government contract revenues do not allow inflation-adjusted depreciation to be taken into account. Therefore, earnings would have been lower than reported if inflation had been considered. Income taxes would not have been adjusted because tax laws do not permit deduction of such additional inflationary cost. Inflation rates in the United States have been relatively low in recent years.
Net Earnings (Loss)
The net loss in 1992, caused by the effect of a change in accounting principle, was related to the company's adoption of the accrual method of accounting for retiree medical costs specified by Statement of Financial Accounting Standards No. 106 (SFAS 106). The company's 1992 adoption of a new standard related to accounting for income taxes, SFAS 109, did not have a significant impact.
Results of Operations by Business Segment
Aeronautical Systems
Aeronautical Systems sales more than doubled in 1993, reflecting the acquisition of LFWC during the first quarter. Revenues grew about 12 percent in 1992 compared with 1991.
In millions 1993 1992 1991 - ---------------------------------------------------------------- Sales Fighter aircraft programs $3,661 $ 363 $ 49 Airlift aircraft programs 915 1,169 1,150 Aircraft modification and maintenance programs 517 538 431 Other aircraft programs and support activities 917 887 1,005 - ---------------------------------------------------------------- Total $6,010 $2,957 $2,635 - ---------------------------------------------------------------- Program profits $ 465 $ 193 $ 153 - ----------------------------------------------------------------
The approximately ten-fold increase in fighter aircraft sales in 1993 was primarily due to the acquisition of LFWC, whose business included the fighter program and one third of the advanced tactical fighter engineering and manufacturing development (EMD) program. Also contributing to the increase compared with 1992 were higher program revenues from the original one-third portion of the program held by Lockheed. The substantial growth in fighter aircraft revenues in 1992 compared with 1991 reflected the first full year of activity of the EMD program. Prior to mid-1991, effort was limited to the design development and prototype phase of the program.
Airlift aircraft sales were 22 percent lower in 1993 than in 1992, principally due to five fewer deliveries of C-130 aircraft (30 versus 35 in 1992). Airlift aircraft sales were about the same in 1992 as in 1991. Although fewer C-130 aircraft were delivered in 1992 (35 versus 43 in 1991), the effects of increased spares sales and changes in contract pricing made up the difference.
Revenues from aircraft modification and maintenance activities were down four percent in 1993 due to lower military and commercial aircraft modification sales. Aircraft modification and maintenance sales were up about 25 percent in 1992 over the prior year, primarily due to higher military aircraft modification activities, with higher commercial revenues also contributing.
Other aircraft programs and support activities sales were up three percent in 1993 over 1992, mostly due to the delivery of two P-3/CP-140 maritime patrol aircraft (compared with one aircraft in 1992). Higher S-3 patrol aircraft upgrade sales were more than offset by other programs and spares sales which, on balance, were lower in 1993. Sales from other aircraft programs and support activities dropped by about 12 percent in 1992 from 1991's level, mostly due to the end of significant commercial aircraft subcontract activity in 1991. The sales increase associated with the delivery of one P-3/CP-140 aircraft in 1992 (there were none in 1991) was offset by lower S-3 aircraft upgrade revenues and lower spares sales.
Program profits in Aeronautical Systems in 1993 were more than twice the 1992 amount, reflecting the LFWC acquisition. Other factors essentially offset one another. The sales variances described above had corresponding effects on program profits. In addition, negative cost adjustments on certain programs recorded in 1992 were absent in 1993. Program profit margins generally improved in most program areas. However, C-130 airlifter margins were lower in 1993, reflecting a change in customer mix. Also, 1993 saw higher spending on the development of an improved version of the C-130 aircraft (the C-130J) than in 1992. Intangible asset amortization related to the purchase of LFWC, reflected in program profits, amounted to $84 million in 1993.
In addition, the following 1993 developments were significant. The U.S. Navy and the company settled their dispute related to the termination of the company's fixed-price contract for the P-7A aircraft development program. The contract was terminated for default by the U.S. Navy in July 1990. The settlement provided that the termination for default be converted to a termination of the contract by mutual agreement of the parties. After adjustment for final resolution of subcontractor claims and closure costs, the settlement amount of $111 million resulted in a reversal of approximately $90 million of the pretax losses recognized on this program in the fourth quarter of 1989. This reversal was reflected in program profits for the third quarter of 1993.
The company recorded a charge to program profits in the third quarter of 1993 of $35 million, representing an expected excess of costs over anticipated sales proceeds related to its Burbank, California, property. (See Note 3 to the consolidated financial statements.)
Also during the third quarter of 1993, the company concluded that its wide- body commercial aircraft modification and maintenance operations at Norton Air Force Base would be discontinued, and recorded a charge to program profits of $30 million related to the discontinuance.
Program profits in Aeronautical Systems grew about 26 percent in 1992 over the 1991 level, primarily due to the first full year of the EMD program, more favorable contract pricing resulting in higher margins on the C-130 program, and improvements and favorable adjustments on certain other aircraft programs. Partly offsetting these increases were higher costs associated with the development of the C-130J airlifter, negative cost adjustments to several programs and, to a lesser extent, higher costs related to commercial aircraft maintenance operations.
Missiles and Space Systems
Missiles and Space Systems sales declined by about eight percent in 1993 following a six percent reduction in 1992.
In millions 1993 1992 1991 - ---------------------------------------------------------------- Sales Fleet ballistic missiles $1,281 $1,503 $1,563 Other missile systems 579 429 442 Space and other programs 2,378 2,655 2,854 - ---------------------------------------------------------------- Total $4,238 $4,587 $4,859 - ---------------------------------------------------------------- Program profits $ 348 $ 401 $ 360 - ----------------------------------------------------------------
Fleet ballistic missiles sales declined 15 percent in 1993, primarily reflecting the completion of the development portion of the Trident II program. Fleet ballistic missiles revenues were down four percent in 1992 compared with 1991 as Trident II development activities wound down and production was relatively stable.
Other missile systems sales were 35 percent higher in 1993 than in 1992, mostly due to the Theater High Altitude Area Defense (THAAD) defensive missile program, which was just getting under way in 1992. This increase was partly offset by lower revenues from most other missile programs, including the Advanced Solid Rocket Motor (ASRM) program which was cancelled in 1993. Other missile systems sales were three percent lower in 1992 compared with 1991, as slight increases in defensive missiles and the ASRM program were more than offset by decreases in other programs.
Space and other programs sales were down 11 percent in 1993 compared with 1992 due to lower revenues from certain classified space programs and, to a lesser extent, lower NASA sales. Higher sales from the Milstar military communications satellite program partly offset the declines. Sales in space and other programs declined by about seven percent in 1992 compared with one year earlier, primarily due to reductions in certain classified space programs partly offset by slight increases in Milstar, tactical command and control, and NASA programs.
Missiles and Space Systems program profits were down about 13 percent in 1993 compared with 1992. The reduction reflected the impact of the lower sales volume, the absence in 1993 of significant amounts of reliability incentive fees from the Trident II program recognized in 1992 as testing under the development portion of the program neared completion, and negative cost adjustments on several programs. Higher operating margins in most other programs, and the initial recognition of profits related to the IRIDIUM TM/SM commercial satellite program, partly offset the declines.
Program profits in Missiles and Space Systems were up about 11 percent in 1992 over 1991, primarily due to the recognition of significantly higher Trident II reliability incentive fees in 1992, and to the resumption of the recording of profits on the Milstar program. The recognition of Milstar profits had been deferred in 1991 while the program was being restructured. In addition, operating margins were better in most business areas in 1992 than in 1991 and a prior year contract issue was favorably resolved, but
these developments were mostly offset by initial development costs related to the IRIDIUM TM/SM program.
Electronic Systems
Sales in Electronic Systems were about eight percent higher in 1993, com- pared with a 15 percent increase registered in 1992.
In millions 1993 1992 1991 - ---------------------------------------------------------------- Sales Defense electronics programs $ 619 $ 622 $ 603 Commercial product manufacturing 388 413 408 Commercial distribution activities 389 254 111 - ---------------------------------------------------------------- Total $1,396 $1,289 $1,122 - ---------------------------------------------------------------- Program profits (loss) $ (1) $ 32 $ 21 - ----------------------------------------------------------------
Revenues from defense electronics programs in 1993 were approximately equal to 1992's level. Increases in countermeasures, information systems, and avionics product lines were offset by decreases in defense system and surveillance system programs. Defense electronics sales grew about three percent in 1992 compared with 1991, mostly due to increases in antisubmarine warfare, countermeasures, and other electronic support programs, partly offset by reductions in surveillance systems revenues.
Sales from commercial product manufacturing dipped six percent in 1993, principally due to further weakness and competitive pricing pressures in the computer peripherals market. Commercial product manufacturing sales were about the same in 1992 compared with 1991.
Commercial distribution sales grew 53 percent in 1993, reflecting expansion of the Access Graphics subsidiary's business. Revenues from commercial distribution activities more than doubled in 1992 compared with 1991, mostly due to Access Graphics being included for the full year of 1992 versus only a portion of 1991.
A small program loss was incurred by Electronic Systems in 1993, compared with program profits in 1992, due primarily to losses at CalComp. This commercial manufacturing unit suffered significant operating losses due to market weakness and pricing pressures, and also recorded charges related to downsizing and restructuring. Program profits from defense programs increased in 1993 due to improved operating performance at Sanders, and profits from commercial distribution activities were higher in 1993 than in 1992 due to improved performance and higher sales.
In addition, Electronic Systems program profits were negatively affected in 1993 when the company recognized expense for future environmental remediation costs that are expected to be allocated to the company's commercial business. (See Notes 1 and 11 to the consolidated financial statements for additional information on the company's accounting policies related to environmental matters and the status of environmental matters now before the company.)
Electronic Systems program profits grew 52 percent in 1992 compared with 1991, with the defense and commercial business sectors contributing about equally to the increase. In defense, the greater profits resulted from improved performance as well as higher volume at Sanders. Commercial distribution activities, included for the full year, were the primary cause of the commercial profit improvement.
Purchase cost amortization related to the acquisition of Sanders and CalComp, reflected in program profits each year, was $25 million in 1993 and in 1992, and $26 million in 1991.
Technology Services
Technology Services sales increased by 13 percent in 1993, after growing about six percent in 1992.
In millions 1993 1992 1991 - ---------------------------------------------------------------- Sales Space shuttle processing services $ 609 $ 600 $ 638 Engineering and scientific services 335 349 342 State and municipal government services 180 88 58 Other services 303 230 155 - ---------------------------------------------------------------- Total $1,427 $1,267 $1,193 - ---------------------------------------------------------------- Program profits $ 32 $ 18 $ 42 - ----------------------------------------------------------------
Space shuttle processing revenues increased about two percent in 1993, following a decrease of about six percent in 1992. Fluctuations in levels of activity in support of space shuttle operations were responsible for the variances.
Sales from engineering and scientific services were down about four percent in 1993 compared with 1992 mostly due to lower levels of NASA support work, partly offset by higher environmental services revenue. Sales in 1992 were relatively stable compared with 1991, up about two percent.
Revenues from state and municipal government services doubled in 1993, mostly due to the expansion of children and family services and transportation systems and services provided to state and local government agencies. Sales in this business area were up by about one-half in 1992 compared with 1991, mostly from growth in the children and family services and other municipal services business lines.
Other services revenues were 32 percent higher in 1993 compared with 1992, and nearly 50 percent higher in 1992 compared with 1991, in both cases due to significantly increased levels of contract field support services provided to the military.
Program profits increased substantially in 1993, primarily due to higher revenues and improved performance on contract field support programs, improved performance in airport management and consulting operations, and a reduction in accrued future retiree medical costs due to reduced employment levels. Elsewhere in this segment, program profits were approximately the same in 1993 as in 1992, reflecting both similar performance and a similar
level of new business investment in each year. Program profits dropped by about 57 percent in 1992 compared with 1991, mostly because of higher investment in new business initiatives, particularly in state, county, and municipal services and environmental lines of business.
FINANCIAL CONDITION
Liquidity and Cash Flows
Liquidity is primarily provided by cash generated from operating activities. Net cash provided by operating activities during 1993 was $795 million, over 35 percent higher than in 1992, due to higher earnings plus noncash-expending depreciation and amortization, partly offset by higher operating capital requirements.
Operating cash flow was negatively impacted in 1993 by the withholding of a portion (currently approximately $170 million) of certain progress billings at LFWC by agreement with a U.S. government customer. These billings are being withheld pending resolution of issues pertaining to LFWC's manufacturing cost allocation system. The system issues are currently being addressed and withheld amounts are expected to be substantially reduced during 1994. With the exception of the temporary delay in cash flows from operating activities and higher net inventories, management expects the issues to be ultimately resolved with little, if any, effect on the company's financial statements.
The company borrowed approximately $1.5 billion for the purchase of LFWC during the first quarter of 1993. Initially in the form of short-term obligations, these borrowings were subsequently refinanced with intermediate and long-term debt. By the end of the year, operating and other cash flows were sufficient to allow the company to reduce debt by over $400 million from the high point reached at the end of the first quarter.
Additions to property, plant, and equipment were $321 million in 1993, approximately the same as in 1992. The amount expended on additions compared favorably with the company's 1993 depreciation expense of $328 million. The company continually monitors its capital spending in relation to current and anticipated business needs. As circumstances dictate, facilities are added, consolidated, disposed of, or modernized. Note 3 to the consolidated financial statements provides additional information regarding the disposal of excess Aeronautical Systems property.
Significant numbers of employee stock options were exercised in 1993. The cash inflow from these exercises amounted to about $71 million and resulted in the issuance of approximately 1.6 million shares of company stock.
Cash dividends amounted to $2.12, $2.09, and $1.95 per share in 1993, 1992, and 1991, respectively.
Capital Resources
Total debt, including the guarantee of salaried ESOP obligations, increased to $2,596 million at December 26, 1993, up from $1,681 million outstanding one year earlier, due to the financing of the purchase of LFWC. As discussed above, debt was reduced subsequent to the acquisition date. Cash flows are expected to allow a steady reduction of the higher debt levels over the next few years.
Most of Lockheed's debt at the end of 1993 and 1992 was in the form of publicly issued fixed-rate notes. Total debt represented approximately 52 percent and 45 percent of the company's total capitalization at the respective year-end dates, about 43 percent and 34 percent if the effect of the guarantee of certain obligations of the salaried ESOP (accounted for as a component of debt and an offset to stockholders' equity) is excluded. The calculation of the debt ratio ex-ESOP reflects the fact that the assets of the salaried ESOP trust, not reflected on the company's balance sheet, are available for the service and repayment of the ESOP obligations guaranteed by the company. At its peak at the end of the first quarter of 1993, total debt was about 59 percent of total capitalization, 51 percent ex-ESOP.
The "net debt" ratio consists of total debt, net of cash, as a percentage of total capitalization. Using this approach, the measures were 50 percent, 57 percent, and 40 percent at December 1993, March 1993, and December, 1992. Ex-ESOP, the amounts were 42 percent, 48 percent, and 28 percent, respectively.
At December 26, 1993, the company had available committed credit lines aggregating $1.3 billion from groups of domestic and foreign banks. Generally, these lines are maintained to back up the company's commercial paper borrowings. There were no commercial paper borrowings, nor any borrowings outstanding under the committed lines, at year-end.
The company receives advances on certain contracts and uses them to finance the inventories required to complete the contracted work. The amount of such advances in excess of costs incurred on these contracts was $606 million at December 26, 1993, and was mostly related to contracts with foreign government and commercial customers. These funds may be used for working capital requirements and other general corporate purposes until needed to complete the contracts.
Cash on hand and temporarily invested, internally generated funds, and available financing resources are sufficient to meet anticipated operating and debt service requirements and discretionary investment needs.
Stockholders' equity at December 26, 1993 was up by about $400 million or 20 percent compared with a year earlier due to the retention of earnings in excess of cash dividends paid, the issuance of new shares upon the exercise of employee stock options, and accounting benefits related to the salaried ESOP (the reduction of guaranteed debt and certain tax benefits).
OTHER MATTERS
Company-Sponsored Research and Development
Spending on company-sponsored research and development is included in results from operations and amounted to $449 million in 1993, a seven percent increase over 1992. The company regularly monitors its research and development effort to assure an appropriate level of spending in relation to expected future benefits. Company-sponsored research and development is necessary to support the company's technologies and maintain its competitive position in the aerospace and electronics industries.
Backlog
Funded backlog consists of unfilled firm orders for the company's products for which funding has been both authorized and appropriated by the customer (Congress, in the case of U.S. government customers). Negotiated (total) backlog includes firm orders for which funding has not been appropriated.
The following table shows funded backlog by major category for the company's two largest segments, and totals for the other two segments, at the end of each of the last three years:
In millions 1993 1992 1991 - ----------------------------------------------------------------- Aeronautical Systems Fighter aircraft programs $ 6,229 $ 286 $ 300 Airlift aircraft programs 1,283 891 1,204 Aircraft modification and maintenance programs 460 504 514 Other aircraft programs and support activities 1,361 1,599 1,740 - ----------------------------------------------------------------- 9,333 3,280 3,758 Missiles and Space Systems Fleet ballistic missiles 1,423 2,389 2,254 Other missile systems 90 317 194 Space and other programs 1,273 1,605 1,262 - ----------------------------------------------------------------- 2,786 4,311 3,710 Electronic Systems 732 870 873 Technology Services 305 395 410 - ----------------------------------------------------------------- $13,156 $8,856 $8,751 - -----------------------------------------------------------------
Funded backlog was nearly 50 percent higher in 1993 compared with 1992 due to increases in Aeronautical Systems, the most significant of which was the acquisition of LFWC and its existing backlog. Funded backlog was lower in the other segments. In 1992, funded backlog increased slightly, about one percent, compared with 1991. An increase in Missiles and Space Systems was mostly offset by decreases in the other segments.
In Aeronautical Systems, funded backlog almost tripled in 1993. The addition of LFWC with its fighter program and one-third share of the fighter program was most responsible for the increase. However, C-130 airlifter backlog was also significantly higher, primarily reflecting more U.S. government aircraft on order. These increases were partly offset by lower backlogs related to military aircraft modification work and maritime patrol aircraft. Funded backlog in Aeronautical Systems declined by about 13 percent in 1992 compared with 1991, mostly due to the absence of foreign and commercial C-130 airlifter sign-ups, partly offset by a higher U.S. government C-130 backlog. Elsewhere in the segment, lower funded backlog related to maritime patrol aircraft upgrade programs also had an effect.
Funded backlog in Missiles and Space Systems declined by about 35 percent in 1993 compared with 1992, mostly due to a difference in the timing of the funding for the Trident II fleet ballistic missile program. Annual funding for this program, generally provided in the company's fourth quarter, was
not obtained until the first quarter of 1994. The workdown of the initial THAAD defensive missile development program backlog, reductions in certain space programs, and lower Milstar and NASA backlogs, also contributed to the decrease. These reductions were partly offset by increases related to the start of the IRIDIUM TM/SM commercial satellite program. Missiles and Space Systems backlog grew about 16 percent in 1992 compared with 1991 due to higher funding of certain military space systems and defensive missile programs, partly offset by lower funded backlog in certain other space programs.
In Electronic Systems, funded backlog is primarily related to defense electronics programs. In 1993, backlog was down about 16 percent compared with a year ago, with increases in surveillance systems and avionics programs more than offset by decreases in other defense electronics areas. Commercial backlogs grew slightly. In 1992, funded backlog remained about the same as in 1991, as increases in surveillance and avionics systems backlogs offset the decreases in other defense programs and in the commercial product sector.
In Technology Services, 1993 funded backlog was down about 23 percent from 1992, primarily due to lower backlog of contract field support services, and timing differences in NASA funding of space shuttle processing and engineering and scientific support activities. In 1992, funded backlog was about four percent lower than in 1991, with changes in the timing of NASA funding partly offset by increased funding on contract field support programs. Service contracts represent the majority of this business segment's revenues, and are generally funded with less lead time than other contracts. As a result, funded backlog figures tend to be less of an indicator of future activity for this segment than for the others.
The figures above do not include negotiated but unfunded amounts. Total negotiated backlog, both funded and unfunded, amounted to $28.9 billion in 1993, $19.4 billion in 1992, and $17.1 billion in 1991. The increase in 1993 was caused by many of the same factors responsible for the funded backlog variances described above, with the addition of LFWC in the Aeronautical Systems segment and the reductions in certain space programs in the Missiles and Space Systems segment the most prominent. The increase in 1992 compared with 1991 came from the win of the THAAD development program in the Missiles and Space Systems segment and the follow-on space shuttle processing contract in Technology Services, in addition to the funded backlog variances already discussed.
As in previous years, a substantial portion of unfunded backlog is related to programs for the U.S. government and is dependent on future governmental appropriations for funding.
Defense Industry Environment
In recent years, significant changes in the global political climate have redefined the needs of the Department of Defense (DoD). New requirements emphasize a smaller, more technologically superior military, and the industrial base to support it. In addition, initiatives to reduce the federal budget deficit have placed increased downward pressure on defense budget levels.
Defense budgets have been declining in real terms (after accounting for inflation) since 1985. Industry analysts generally expect defense spending to continue to decline through the latter part of the decade and then hold
constant in real terms at a reduced level, but the ultimate outcome is uncertain. Reduced budget levels, rapidly changing customer requirements, and increased competition are expected for the defense industry in the years to come.
The U.S. defense budget has a major impact on Lockheed's business base. In 1993, 64 percent of the company's sales were to DoD customers. The company provides a wide variety of products and services, and Lockheed's major programs have generally been well supported thus far during the budget decline. The company is a leader in advanced technologies, research and development, and limited production-rate manufacturing, all of which have been emphasized during the ongoing debate over the focus of future defense spending. However, uncertainty remains over the size and shape of future defense budgets and their impact on specific programs.
The company has responded to these conditions and is focusing attention and resources on its most promising businesses and opportunities in both the defense and nondefense markets. The 1993 acquisition of Lockheed Fort Worth Company further broadened Lockheed's portfolio of programs and increased the company's presence in the international market. Other measures, such as cost reduction efforts, are continuing. Employment levels have been reduced to reflect changing business requirements, and will continue to be monitored and adjusted where appropriate.
Management believes that the company is well-positioned for the future, with the resources and capabilities to respond appropriately to further industry developments.
Environmental Matters
The company is involved in a number of proceedings and potential proceedings relating to environmental matters. These matters and their impact on the company are discussed in Note 11 to the consolidated financial statements.
As described in Note 11, a substantial portion of currently anticipated environmental expenditures will be reflected in the company's sales and costs of sales pursuant to U.S. government agreement or regulation. However, a timing difference in cash flows is expected between incurrence of certain of the costs related to the Burbank cleanup and allocation of these costs as part of the company's general and administrative expense. At the end of 1993, expenditures that had been made but not yet allocated amounted to $52 million. This timing difference is expected to increase through the end of 1995 before declining in subsequent years.
Item 8. | 60026 | 1993 |
Item 6. Selected Financial Data
This is omitted per conditions set forth in general instructions J (1) (a) and (b) of Form 10-K for wholly owned subsidiaries (reduced disclosure format).
Item 7. | Item 7. Management Discussion and Analysis
Management's Discussion and Analysis of Financial Condition and Results of Operations is omitted per conditions as set forth in general instructions J (1) (a) and (b) of Form 10-K for wholly owned subsidiaries. It is replaced with management's narrative analysis of the results of operations set forth in general instructions J (2) (a) of Form 10-K for wholly owned subsidiaries (reduced disclosure format). This analysis will primarily forth the Company's accounting changes and compare its revenue and expens year ended December 31, 1993 with the year ended December 31, 1992.
The Company's net income for the year ended December 31, 1993 was $38.0 million, down from the $38.2 million earned in the same period of 1992. The 1993 operating income increased by $1.3 million from the 1992 level.
Accounting Changes
Postretirement Benefits See Note 5 for discussion of the 1993 change in accounting for postretirement medical and death benefits. There was no material effect on net income due to rate recovery of the expense increases.
Income Taxes The Company adopted SFAS No. 109 - Accounting for Income Taxes, effective Jan. 1, 1993. See Note 1 for discussion of the adoption of SFAS No. 109. Adoption of SFAS No. 109 had no effect on earnings and no material effect on financial condition due to its similarity to SFAS No. 96 - Accounting for Income Taxes, which the Company adopted in 1988, and which SFAS No. 109 supersedes.
1994 Changes In 1994, the Company will adopt SFAS No. 112 - Accounting for Postemployment Benefits. SFAS No. 112 requires the accrual of certain employee costs (such as injury compensation and severance) to be paid in future periods. Its adoption in 1994 is not expected to have a material effect on the Company's results of operations or financial condition.
Electric Sales and Revenues
Electric revenues for 1993 increased $17.2 million, a 5.0 percent increase from the 1992 revenues. Revenues from retail sales, which accounted for 75 percent of the electric revenues in 1993, increased $14.6 million or 5.7 percent. Included in the 1993 retail increase is $6.2 million directly related to the rate changes discussed in Part I, Item 1: Business-Regulation and Rates. Also reflected in the 1993 retail revenue increase increase of $8.4 million due to increased sales. The cool summer weather of 1992 was a major cause of this increase in sales. Our wholesale customers accounted for 4.4 percent of the total electric revenues. Wholesale revenues increased $1.3 million or 8.5 percent in 1993. This increase is also largely a result of 1992's cool summer weather. Another major component of electric revenues is charges billed to the Minnesota Company through the Interchange Agreement (see Part I, Item 1; Business-Electric Operations). Interchange Agreement billings charged to the Minnesota Company increased $1.5 million primarily as a result of added transmission investment. Other electric revenues decreased $0.2 million in 1993.
Gas Sales and Revenues
Gas revenues in 1993 increased by $11.7 million or 19.1 percent as compared with 1992. This is the net impact of increased revenues due to the rate increase effective January 1993, increased revenues due to sales growth, increased revenues due to higher gas costs passed through the purchased gas adjustment clause, and increased revenues of $8.2 million due to 1992's warm winter weather.
Operating Expenses and Other Factors
Electric Production The cost of interchange power increased $6.3 million or 4.0 percent in 1993 compared to the same period one year ago. This expense represents charges billed from the Minnesota Company through the Interchange Agreement (see Part I, Item 1: Business-Electric Operations). The company's increased electric sales during 1993 over 1992, combined with increased costs associated with the NSP system's new contract with Manitoba Hydro resulted in the company's purchased power and fuel purchased under its interchange agreement with its parent to increase by approximately $7.6 million. Total interchange power is offset by decreases in operation and maintenance expenses in the charges. Fuel for electric generation, which represents the Company's fuel generation, increased $1.2 million or 56.6 percent in 1993 from 1992. This is primarily due to increased requirements due to the increased sales in 1993.
Gas Purchased for Resale This cost increased $9.7 million or 23.2 percent. $3.5 million of this increase in 1993 is a result of increased volumes purchased. Increased transportation prices resulted in $4.2 million of the increase with the balance of the increase due to commodity and demand price increases.
Administrative and General, Other Operation and Maintenance The $5.2 million increase in administrative and general expense is partially due to the Company having had no disbursement of the employee incentive pay program (which is dependent upon corporate earnings) in 1992, but incurring its disbursement in 1993. This accounted for $1.7 million of the $5.2 million increase. An increase of $2.1 million was due to the SFAS 106 accruals of postretirement benefits. The remaining increases were general increase and general expenses.
Depreciation and Amortization The increase in depreciation between 1993 and 1992 primarily reflects higher levels of depreciable plant.
Property and General Taxes The property and general taxes increase is primarily due to higher gross receipts tax (a tax assessed on prior year revenues) as a result of 1992 revenues increasing over 1991 revenues.
Income Taxes $0.7 million of the increase in income taxes in 1993 over 1992 is the result of the Federal Rate increasing from 34% to 35% and the balance of the increase is primarily attributable to changes in pretax book income. See Note 8 to the Financial Statements for a detailed reconciliation of effective tax rates and statutory rates.
Allowances for Funds During Construction (AFC) The differences in AFC for the reported periods are attributable to varying levels of construction work in progress and lower AFC rates associated with increased use of low-cost short- term borrowings.
Other Income and Deductions The decrease in other income is primarily due to a greater number of sales of certain land and land rights in 1992 by NSP Lands, Inc., a wholly owned subsidiary of the Company.
Interest Charges On March 16, 1993 the Company issued $110.0 million of first mortgage bonds due March 1, 2023 with an interest rate of 7-1/4%. The Company entered into an interest rate swap agreement with the underwriters of this bond issue relating to $20.0 million of the principal, which effectively converted the interest cost of this debt from fixed rate to variable rate, with the variable rate changing on March 1 and September each year until March 1, 1998. The net interest rate for the entire $110 millio approximately 6.9% in 1993. The proceeds from these bonds were used to redeem $47.5 million in principal amount of its First Mortgage Bonds, Series due July 1, 2016, 9-1/4% at a redemption price of 105.78%, to redeem $38.4 million in principal amount of its First Mortgage Bonds, Series due March 1, 2018, 9-3/4%, at the redemption price of 107.31% and to repay outstanding short-term borrowings, including short - -term borrowings incurred to redeem on January 20, 1993 $7.8 million in principal amount of its First Mortgage Bonds, Series due December 1, 1999, 9-1/4%, at the redemption price of 102.2%.
On October 5, 1993 the Company issued $40.0 million of first mortgage bonds due October 1, 2003 with an interest rate of 5-3/4%. The proceeds from these bonds were used to redeem $24.3 million in principal amount of its First Mortgage Bonds, Series due October 1, 2003, 7-3/4% at a redemption price of 102.49%, to redeem $10.8 million in principal amount of its First Mortgage Bonds, Series due August 1, 1994, 4-1/2%, at the redemption price of 100.00% and to repay outstanding short-term borrowings.
These transactions had no material impact on the 1993 interest charges compared to the charges of 1992 because in 1993, all costs associated with the redemption of these bonds were treated on a basis by which all savings of interest due to refinancing was offset by the amortization of the costs.
Item 8 | 72909 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The loss from operations in 1993 includes a restructuring charge of $4,275.
Income from operations in 1992 includes $4,959 of stock distribution expenses and restructuring charges related to the Distribution of SpaceLabs.
Income from operations in 1991 includes a $6,338 award as a result of the Company's lawsuit against a competitor.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
ATL (the "Company") develops, manufactures, markets and services medical diagnostic ultrasound systems worldwide. These systems are used in radiology, cardiology, obstetrics and gynecology, and peripheral vascular diagnostic applications. The ultrasound business is competitive and market demand is influenced by a variety of factors. These include the introduction of new technologies which offer improved clinical capabilities and create demand for new products, the relative cost-effectiveness and clinical utility of competing technologies, government policies with respect to reimbursement and containment of medical costs, and changing demographics of the populations in the Company's markets.
Ultrasound systems are typically sold based on image quality, Doppler sensitivity, product reliability, upgradeability, clinical versatility, and ease of use. Price competition, however, is an important factor when the growth rate in the market slows below historical norms, when a manufacturer seeks to defend or increase market share, when products are perceived to be equivalent in terms of clinical utility, or when a product line ages. The impact of price deterioration is sometimes offset by changes in product mix, lower service costs, and lower unit manufacturing costs due to declines in component prices, manufacturing efficiencies, design changes to reduce cost, and volume increases.
REVENUES AND GROSS PROFIT
Revenues in 1993 were $304.5 million, a decrease of 6% from revenues of $323.7 million in 1992. The decrease in revenues primarily reflects changes in the U.S. medical equipment market as well as changes in the Company's product mix. Revenues from U.S. operations decreased 13% from 1992. Uncertainties in the U.S. health care industry regarding potential health care reform legislation and hospital consolidation trends significantly affected the capital equipment purchases by doctors, clinics, and hospitals. The constrained U.S. market also intensified competitive price pressures in the medical equipment industry. International revenues increased 4% to $141.7 million in 1993 or 47% of total revenues. The increase in international revenues was led by increases in the Asia, Pacific, and Latin America regions in 1993. Revenues in Europe decreased slightly in 1993, reflecting the continued weakness of the European economies, as well as the strengthening of the U.S. dollar, which adversely affected the Company's revenues. The Company opened a new sales and customer service subsidiary in Italy in 1993 and announced the opening of an Argentine subsidiary in December 1993.
The Company's product mix continues to shift toward the high performance, premium priced systems included in the Ultramark(R) 9 ("UM 9") product family. In 1993, the Company introduced the Extended Signal Processing ("ESP") option or upgrade for its Ultramark 9 High Definition(TM) Imaging ("HDI") systems. Sales of the UM 9 product family now account for three quarters of product sales, up from two thirds in 1992. The Company also sells pre-owned and clinical marketing demonstration equipment to its customers and these sales are becoming an increasing portion of the Company's UM 9 product family sales. Service revenues continued to grow in 1993, up 4% over 1992 mainly due to the growing installed base of the Company's products and the change in product mix.
In 1992, revenues increased by 16% to $323.7 million. This increase reflects higher revenues from high performance, premium priced systems, particularly the UM 9 HDI system which was introduced in April
1991. International revenues grew 19% to $136.0 million in 1992 or 42% of the total revenues compared to 41% in 1991.
Gross profit decreased to $136.7 million in 1993, compared with $149.1 million in 1992. As a percent of revenues, gross margin decreased to 44.9% from 46.1% in 1992. The decline in gross profit primarily represents the impact of competitive price pressures and lower volumes. These factors were partially offset by favorable changes in product mix toward premium priced systems, continued manufacturing efficiencies and reductions in the cost of service.
In 1992, gross profit increased to $149.1 million reflecting higher revenues and higher percentage gross margin on both product and service revenues. Product margins increased due to a higher mix of the UM 9 family product sales as a proportion of total product sales and improved manufacturing efficiencies. Improved service margins resulted primarily from cost containment measures and the change in mix of the installed base of ATL products.
RESTRUCTURING OF OPERATIONS
In August 1993, the Company restructured its operations which resulted in a reduction in its worldwide workforce of approximately 11%. The restructuring was undertaken in response to the continued uncertainty in the U.S. health care industry and to streamline the Company's operations. As a result of this restructuring, the Company reported a charge of $4.3 million which provided for severance payments and other costs associated with the restructuring.
On June 26, 1992, the Company distributed to its shareholders all of the common stock of SpaceLabs Medical, Inc., a wholly owned subsidiary, on a one- for-one basis (the "Distribution"). The Distribution had the effect of dividing the Company into two separate, publicly traded companies: Advanced Technology Laboratories, Inc. (previously named Westmark International Incorporated) and SpaceLabs Medical, Inc. In connection with the Distribution, the Company incurred two non-recurring charges totaling $5.0 million: stock distribution expenses totaling $1.2 million for legal, accounting, investment advisory, printing and other fees and a restructuring charge of $3.8 million primarily related to the closure of the former headquarters office, the severance of certain personnel as a result of the Distribution and the write- down to estimated market value of the Company's former ultrasound manufacturing facilities in Germany.
OPERATING EXPENSES
Selling, general, and administrative ("SG&A") expenses decreased 4% to $92.0 million in 1993 compared to 1992. The decrease reflects the impact of the August 1993 restructuring discussed previously, as well as other cost reduction programs. These savings were partially offset by selling and marketing activities related to the introduction of the Extended Signal Processing option for the UM 9 HDI system and expenses incurred to support the continued growth of international sales activity. In 1992, SG&A expenses increased 9% to
$95.3 million, reflecting expenses incurred to support the growth in revenues and the expansion of international sales and marketing activities.
Research and development expenses in 1993 increased 14% over 1992 to $43.8 million or 14.4% of revenues. In 1992, R&D expenses were $38.3 million or 11.8% of revenues. In 1993, ATL introduced new product features such as the Extended Signal Processing technology and four new broadband scanheads for the HDI system. Management expects to continue its investment in product development programs to enhance its position in proprietary and other technologies.
In 1993, other expense (income), net, includes a $1.1 million gain on the sale of an investment in a third party. The equity investment was sold in the fourth quarter of 1993 generating $3.2 million in cash proceeds. Other expense (income), net, also includes foreign exchange gains or losses, Washington state business and occupation (B&O) tax, and amortization of costs in excess of net assets of businesses acquired. Foreign exchange gains and losses include principally gains and losses on intercompany accounts of ATL's foreign subsidiaries and on forward foreign currency exchange contracts. Net losses on foreign currency transactions were $1.2, $1.8, and $.7 million in 1993, 1992, and 1991, respectively. B&O tax, a gross receipts tax for products manufactured in the state of Washington, amounted to $1.1, $1.1, and $1.0 million in 1993, 1992, and 1991, respectively. In 1991, other expense (income), net, includes a $6.3 million arbitration award received by the Company as a result of its lawsuit against a competitor.
INVESTMENT INCOME
Net investment income decreased to $2.2 million in 1993. The decrease reflects lower cash balances available for investment in 1993, as well as lower interest rates on invested cash. Net investment income remained at $3.4 million in 1992, comparable to 1991.
TAXES AND NET INCOME (LOSS)
The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). Under FAS 109, the provision for income taxes and the effective tax rate are subject to volatility. Changes in statutory rates and taxable income will affect the amount of net deferred tax assets which can be recognized under FAS 109 and the related provision for income taxes.
For the Company to realize its U.S. net deferred tax assets, its U.S. taxable income must be comparable to or higher than recent years. Reductions in taxable income levels will result in increased deferred income tax expense. Likewise, significant increases in taxable income will result in the recognition of deferred tax benefits, providing deferred tax assets have not previously been recognized.
Taxable income has differed from pretax earnings for financial reporting purposes in the past due to permanent differences, the timing of recognizing certain income and deductions, and deductions for stock option compensation.
Due to the restructuring charge and the slow U.S. ultrasound market in 1993, the Company has not sustained the U.S. taxable income level of recent years. This contributed significantly to the $2.2 million increase in the deferred tax asset valuation allowance which was reported as part of deferred tax expense for 1993.
During 1993, the Internal Revenue Service completed an examination of the Company's tax returns for the years 1989 and 1990. The audit resulted in a net refund of $1.1 million and allowed the Company to reduce its liability for income taxes by $2 million in 1993. The Company believes it has made adequate provision for income taxes that may become payable with respect to open tax years.
The provision for income taxes includes benefits from the utilization of foreign tax loss carryforwards. Foreign tax loss carryforwards of approximately $6.7 million remain at the end of 1993. No benefit has been recognized for the majority of these remaining benefits due to uncertainty surrounding their realization.
CAPITAL RESOURCES AND LIQUIDITY
The Company has financed operations primarily with internal resources, including its cash and short-term investment balances. Cash and short-term investments totaled $54.6 million at December 31, 1993. The Company also holds $5.0 million in a marketable debt security which matures beyond 1994. Short- term borrowings of $3.7 million at December 31, 1993 represent working capital lines of credit maintained at several of the Company's foreign subsidiaries to facilitate intercompany cash flow. The Company has no long-term debt. Shareholders' equity at December 31, 1993 was $186.4 million, or 67% of total assets.
The Company generated positive cash flow of $5.7 million from operating activities. However, the Company's investment in inventories increased to $74.7 million at December 31, 1993, reflecting slower shipment levels and the introduction of new feature upgrades for products during 1993. In the fourth quarter of 1993, the Company implemented an inventory reduction program which resulted in a $9.0 million reduction in the inventory balance during the quarter. During 1993, the Company invested $14.2 million in additions to property, plant and equipment, net of asset retirements. Total depreciation and amortization expense for 1993 was $11.9 million.
The Company repurchased 794,000 shares of its own common stock in the open market for $13.4 million under a share repurchase program which began in February 1993. The Company is authorized to purchase up to 1,000,000 shares under this program, subject to certain criteria. Shares purchased are used to service the Company's employee benefit plans. The Company also purchased 12,481 shares of its common stock under a separate, oddlot shareholder program. The oddlot program expired in December 1993.
In 1992, the Company made a $36.2 million cash contribution to SpaceLabs Medical, Inc. in connection with the Distribution and received $28.2 million from the exercise of employee stock options.
The Company has occasionally utilized its cash resources to make acquisitions of technology or small technology-related businesses. The Company may undertake further acquisitions of technology in the future.
In addition to its cash balances, the Company has available unsecured credit facilities of $25 million, including a committed line of credit of $15 million. Management expects that barring any unforeseen circumstances or events, existing cash and short-term investments together with available credit lines and funds generated from operations should be sufficient to meet the Company's operating requirements for 1994.
OTHER BUSINESS FACTORS
Companies in high technology businesses can from time to time experience difficulty with the availability of technology employed in their products. While the Company strives to develop alternate sources for the components it requires and works closely with vendors of specialty items, the Company's vendors of highly specialized and unique parts such as custom semiconductor devices can occasionally experience difficulty in the manufacture of products. Vendors can also experience difficulty in meeting quality standards the Company requires of its vendors. Such difficulties can lead to long order lead times or delays in the Company's manufacture of products. Manufacturing efforts can also be impeded by third party assertions of patent infringement by the Company's products. See ITEM 3 - -LEGAL PROCEEDINGS on Page 13.
The Company is subject to certain rules and regulations of the U.S. Food and Drug Administration ("FDA") regarding the design, documentation, manufacture, marketing, and reporting of the performance of its products. See ITEM 1 - - BUSINESS--Governmental Regulation on Page 11.
IMPACT OF NEW ACCOUNTING STANDARD
The Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which the Company will be required to adopt prospectively on January 1, 1994. Implementation of this accounting standard will not have a material effect on the Company's financial statements.
SUBSEQUENT EVENT
On February 10, 1994, the Company announced it had entered into a Merger Agreement with Interspec, Inc. ("Interspec"), a manufacturer of medical diagnostic ultrasound systems and transducers, headquartered in Ambler, Pennsylvania. Pursuant to the Merger Agreement, which is subject to approval by shareholders of both companies, Interspec would become a wholly owned subsidiary of the Company through an exchange of 0.413 shares of the Company's common stock for each share of Interspec stock. The proposed merger plan will be submitted to shareholders of Interspec and the Company at their respective shareholder meetings in May 1994. The transaction is expected to be accounted for as a pooling-of-interests.
The Company believes the merger will enable the Company and Interspec to combine resources and product lines to expand the Company's market position in the cardiology and mid-priced market segments of the ultrasound market.
The Company is filing a proxy statement with the Securities and Exchange Commission relating to the merger proposal which will more fully describe the proposed merger.
ITEM 8. | 806086 | 1993 |
Item 6. Selected Financial Data - -------------------------------
The information required by this Item is included on page 18 of the Fund's 1993 Annual Report to Shareholders and is incorporated herein by reference thereto.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - -----------------------------------------------------------------------
The information required by this Item is included on pages 20 through 23 of the Fund's 1993 Annual Report to Shareholders and is incorporated herein by reference thereto.
Item 8. | 801124 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Page No.
APS D-1 Monongahela D-3 Potomac D-5 West Penn D-7 AGC D-9
D-1
D-2
(a) Reflects a two-for-one common stock split effective November 4, 1993. (b) Capability available through contractual arrangements with nonutility generators. (c) Preliminary.
D-3
D-3
(a) Capability available through contractual arrangements with nonutility generators.
D-5
D-6
D-7
D-8
(a) Capability available through contractual arrangements with nonutility generators.
D-9
- 41 -
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Page No.
APS M-1 Monongahela M-9 Potomac M-18 West Penn M-27 AGC M-36
M-1 APS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONSOLIDATED NET INCOME Earnings per share were $1.88 in 1993 and were $1.83 and $1.80 in 1992 and 1991. Consolidated net income was $215.8 million, $203.5 million, and $194.0 million. The increase in consolidated net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses. All per share amounts have been adjusted to reflect the November 4, 1993, two-for-one stock split (See Note F to the consolidated financial statements).
SALES AND REVENUES KWh sales to and revenues from residential, commercial, and industrial customers are shown on page D-2. Such kWh sales increased 3.3% and 1.5% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following: Increase from Prior Year 1993 1992 (Millions of Dollars) Increased kWh sales $ 46.6 $ 9.1 Fuel and energy cost adjustment clauses (a) 57.0 37.9 Rate increases (b): Pennsylvania 25.2 5.8 Maryland 12.7 11.7 West Virginia 5.3 12.4 Virginia 2.5 1.8 Ohio 2.1 1.7 47.8 33.4 Other 6.2 .1 $157.6 $80.5 (a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income. (b) See ITEM 1. RATE MATTERS for further information on rate changes.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were approximately normal, cooling degree days increased 69% over 1992 and were 25% over normal, contributing to the 1993 kWh sales increases. The subsidiaries experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
M -2
KWh sales to industrial customers increased .3% in 1993 and 2.9% in 1992. The relatively flat industrial sales growth in 1993 followed record industrial sales in 1992 which occurred in almost all industrial groups. One particular group, coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items: 1993 1992 1991 KWh sales (in billions): From subsidiaries' generation 1.2 3.2 5.8 From purchased power 11.2 14.6 12.4 12.4 17.8 18.2 Revenues (in millions): From subsidiaries' generation $ 28.5 $ 91.7 $158.5 From sales of purchased power 318.2 373.8 366.5 $346.7 $465.5 $525.0
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by subsidiaries' generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the subsidiaries' ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989--a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income.
The decrease in other revenues in 1993 resulted from an agreement with the Federal Energy Regulatory Commission to record in 1993 about $14 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years.
M -3 OPERATING EXPENSES Fuel expenses decreased 4% in 1993 and 6% in 1992. Both decreases were primarily due to decreases in kWh generated. The 1992 decrease also included a 1% decrease in average coal prices. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with other utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA) and is comprised of the following items: 1993 1992 1991 (Millions of Dollars) Purchased power: For resale to other utilities $280.9 $344.0 $332.7 From PURPA generation 105.2 94.0 68.9 Other 33.8 12.7 29.0 Total power purchased 419.9 450.7 430.6 Power exchanges, net (2.5) .7 (1.4) $417.4 $451.4 $429.2
The amount of power purchased from other utilities for use by subsidiaries and for resale to other utilities depends upon the availability of the subsidiaries' generating equipment, transmission capacity, and fuel, and their cost of generation and the cost of operations of other utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to other utilities is described under SALES AND REVENUES above. The cost of power purchased for use by the subsidiaries, including power from PURPA generation, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the subsidiaries' regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net income. The increases in purchases from PURPA generation reflect additional generation from new PURPA projects. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in employee benefit costs and salaries and wages. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $5 million. The subsidiaries are currently recovering approximately 85% of SFAS No. 106 expenses in rates and will be requesting recovery of substantially all of the remainder in 1994 rate cases. During 1992, the subsidiaries implemented significant changes to their benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 20% greater than 1993 amounts.
M-4
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other postemployment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The subsidiaries currently accrue for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993. The subsidiaries are also experiencing, and expect to continue to experience, increased expenditures due to the aging of their power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the Clean Air Act Amendments of 1990 (CAAA).
Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note I to the consolidated financial statements) and the replacement of aging equipment at the subsidiaries' power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $4 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($5 million) and increased property taxes ($2 million). These increases were offset by decreased West Virginia Business and Occupation taxes (B&O taxes) due to decreased generation in that state. The 1992 increase resulted from increased property taxes ($4 million), increases in gross receipts taxes ($3 million), and increased capital stock taxes ($2 million), offset by decreased B&O taxes ($2 million).
The net increase of $13 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($9 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($3 million). The net decrease in 1992 of $4 million resulted primarily from plant removal and certain bond refinancing cost tax deductions for which deferred taxes were not provided. Note B to the consolidated financial statements provides a further analysis of income tax expenses.
M-5
The combined increase of $4 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. Fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the levels of short-term debt maintained by the companies.
The decrease in dividends on preferred stock of subsidiaries reflects the 1992 redemption of three series totaling $25 million with dividend rates of 9.4% to 9.64% and the 1993 redemption of an additional $2 million of 4.7% to $7.16 series, offset by the 1992 sale of $40 million of market auction preferred stock with an average dividend rate of 2.6%.
LIQUIDITY AND CAPITAL RESOURCES
SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". System companies need cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stocks, and for their construction programs. To meet these needs, the companies have used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the companies' cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
CAPITAL REQUIREMENTS
Construction expenditures for 1993 were $574 million and for 1994 and 1995 are estimated at $500 million and $400 million, respectively. These estimates include $161 million and $53 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA discussed under ITEM 1. ENVIRONMENTAL MATTERS. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for
M-6
compliance with both Phase I and Phase II of the CAAA. The subsidiaries are estimating amounts of approximately $1.4 billion, which includes $482 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the subsidiaries have additional capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note G to the consolidated financial statements).
INTERNAL CASH FLOWS
Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $270 million in 1993. Regulatory commission orders received in Maryland, Pennsylvania, Virginia, and West Virginia provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with various amounts of lag. Based upon the authorizations received and requested and new rate cases planned in 1994, internal generation of cash can be expected to increase.
The increase in other investments reflects the 1993 cash surrender values for secured benefit plans and a related prepayment. Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($54 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the subsidiaries' regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
FINANCINGS
In October 1993, the Company issued 2,400,000 shares of its common stock for $64.1 million. Also during 1993, the Company issued 1,364,846 shares of common stock under its Dividend Reinvestment and Stock Purchase Plan (DRISP), and Employee Stock Ownership and Savings Plan (ESOP) for $36.1 million. During 1993 the subsidiaries issued $43 million of 6.25% to 6.3% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $634 million of debt securities having interest rates of 7% to 9.75% through the issuance of $652 million of securities having interest rates of 4.95% to 7.75%. The costs
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associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $44 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long-term securities. Short-term debt increased from $11.2 million in 1992 to $130.6 million in 1993. The subsidiaries canceled or postponed approximately $152 million of debt and equity financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its subsidiaries established an internal money pool whereby surplus funds of the Company and certain subsidiaries may be borrowed on a short-term basis by the Company's subsidiaries. This has contributed to the decrease in the 1993 temporary cash investment amounts. Allegheny Generating Company in 1992 replaced its $65.7 million of commercial paper with $50.9 million of money pool borrowings and $2.4 million of four-year, 6.05%-6.10% medium-term notes. Allegheny Generating Company has available an established program to replace money pool borrowings with medium-term notes or commercial paper.
At December 31, 1993, unused lines of credit with banks were $149 million. In addition, a multi-year credit program was established in January 1994, which provides that the subsidiaries may borrow on a standby revolving credit basis up to $300 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the subsidiaries plan to issue about $230 million of new securities, consisting of both debt and equity issues and, if economic and market conditions make it desirable, may refinance up to $728 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The subsidiaries may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available. The Company plans to fund the subsidiaries' sale of common stock through the issuance of short-term debt and DRISP/ESOP common stock sales.
The subsidiaries anticipate that they will be able to meet their future cash needs through internal cash generation and external financings as they have in the past and possibly through alternative financing procedures.
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ENVIRONMENTAL MATTERS AND OTHER CONTINGENCIES
In the normal course of business, the subsidiaries are subject to various contingencies and uncertainties relating to their operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note I to the consolidated financial statements.
All of the state jurisdictions in which the subsidiaries operate have enacted hazardous and solid waste management legislation. While the subsidiaries do not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The subsidiaries are incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the subsidiaries.
As of January 1994, Monongahela has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and Monongahela, Potomac Edison, and West Penn have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the subsidiaries. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against any or all of the subsidiaries. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at subsidiary-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of Monongahela. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the subsidiaries believe potential liability of the subsidiaries is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by Monongahela for an amount substantially less than the anticipated cost of defense. While the subsidiaries believe that all of these cases are without merit, they cannot predict the outcome of these cases or whether other cases will be filed.
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Monongahela
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Income Net income was $61.7 million, $58.3 million, and $54.1 million in 1993, 1992, and 1991, respectively. The increase in net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses.
Sales and Revenues KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-3 and D-4 Such kWh sales increased .3% in 1993 and decreased 1.0% in 1992. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase (Decrease) from Prior Year
1993 1992 (Millions of Dollars)
Increased (decreased) kWh sales $ 6.6 $(5.3) Fuel and energy cost adjustment clauses (a) 11.8 12.3 Rate increases (b): West Virginia 4.1 12.1 Ohio 2.1 1.6 6.2 13.7
Other .2 (1.3) $24.8 $19.4
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.
(b) Reflects a surcharge in West Virginia for recovery of carrying charges on expenditures to comply with the Clean Air Act Amendments of 1990 (CAAA), designed to produce $3.1 million on an annual basis effective on July 1, 1992, which was increased to $8.7 million on an annual basis effective on July 1, 1993, and a rate increase in Ohio, designed to produce $3.3 million on an annual basis, which became effective on July 21, 1992.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days showed only a slight increase over 1992, and were only 6% above normal, cooling degree days increased 54% over 1992, contributing to the 1993 kWh sales increases. The Company experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
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KWh sales to industrial customers decreased 4.4% in 1993 and .7% in 1992. The 1993 decrease was primarily due to continuing declines in sales to coal and primary metals customers. Coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993. Lower sales to primary metals customers was due in part to one iron and steel customer's increased use of its own generation.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .3 1.0 1.8 From purchased power 2.8 3.6 3.1 3.1 4.6 4.9
Revenues (in millions): From Company generation $ 8.4 $ 26.7 $ 48.5 From sales of purchased power 77.6 92.9 91.5 $86.0 $119.6 $140.0
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWH) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off.
The increase in other revenues in 1993 and 1992 resulted from continued increases in sales of capacity, energy, and spinning reserve to other affiliated companies because of additional capacity and energy available from new PURPA projects in both years. This increase was offset in part in 1993 by an agreement with the Federal Energy Regulatory Commission to record in 1993 about $3 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. About 90% of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on net income.
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Operating Expenses
Fuel expenses decreased 3% in 1993 and 9% in 1992. Both decreases were primarily due to decreases in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $ 68.6 $ 85.5 $ 83.0 From PURPA generation 55.7 37.4 13.2 Other 8.1 3.1 7.2 Power exchanges, net (.6) .3 (.5) Affiliated transactions: AGC capacity charges 23.3 24.2 25.1 Energy and spinning reserve charges .5 2.8 5.3 $155.6 $153.3 $133.3
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The increases in purchases from PURPA generation reflects additional generation from new PURPA projects. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute. Energy and spinning reserve charges decreased in 1993 and 1992 primarily because of additional generation available from new PURPA projects.
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The increase in other operation expense for 1993 and 1992 resulted primarily from increases in salaries and wages and employee benefit costs. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, will increase future employee benefit costs for postretirement benefit expenses. The Company is currently recovering approximately 50% of SFAS No. 106 expenses in rates and will be requesting recovery of the remainder in 1994 and early 1995 rate cases. This reflects for West Virginia and Ohio only the recovery of the previously authorized pay-as-you-go component. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 25% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
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Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $1 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($1 million) and increased property taxes ($1 million), offset by decreased West Virginia Business and Occupation taxes (B&O taxes) ($1 million) due to decreased generation in that state. The 1992 decrease resulted from decreased B&O taxes ($2 million) and prior period B&O tax adjustments ($2 million), offset somewhat by increases in gross receipts and property taxes ($2 million).
The net increase of $6 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($4 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). The net decrease in 1992 of $3 million resulted primarily from plant removal and certain bond refinancing cost tax deductions for which deferred taxes were not provided. Note B to the financial statements provides a further analysis of income tax expenses.
The combined increase of $2 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures primarily associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to decrease as the Company completes its Phase I compliance program. The decrease in other income, net, in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used
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internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
Capital Requirements Construction expenditures for 1993 were $141 million and for 1994 and 1995 are estimated at $103 million and $83 million, respectively. These estimates include $39 million and $10 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $400 million, which includes $122 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has additional capital requirements of debt maturities (see Note H to the financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, was about $69 million for 1993. A regulatory commission order has been received in West Virginia authorizing procedures to provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with a certain amount of lag. Based upon the authorization received and new rate cases planned in 1994 and early 1995, internal generation of cash can be expected to increase.
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Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($13 million). The five- year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $10.68 million of 6.25% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $67 million of debt securities having interest rates of 7.5% to 9.5% through the issuance of $72 million of securities having interest rates of 5.625% to 5.95%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $12 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. Short-term debt, including notes payable to affiliates under the money pool, increased from $8.0 million in 1992 to $63.1 million in 1993. The Company canceled or postponed approximately $69 million of debt and equity financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available.
At December 31, 1993, the Company had SEC authorization to issue up to $100 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $81 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $50 million of new equity securities and, if economic and market conditions make it desirable, may refinance up to $285 million of first
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mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the financial statements.
All of the state jurisdictions in which the Company operates have enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
As of January 1994, the Company has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the
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Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of the Company. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by the Company for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Income
Net income was $73.5 million, $67.5 million, and $58.2 million in 1993, 1992, and 1991, respectively. The increase in net income in 1993 resulted primarily from kWh sales and retail rate increases. The increase in 1992 resulted primarily from retail rate increases. These revenue increases, in both years, were offset in part by higher expenses.
Sales and Revenues
KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-5 and D-6. Such kWh sales increased 6.3% and 2.0% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase from Prior Year 1993 1992 (Millions of Dollars) Increased kWh sales $24.4 $ 7.7 Fuel and energy cost adjustment clauses (a) 19.1 10.4 Rate increases (b): Maryland 12.7 11.7 Virginia 2.5 1.8 West Virginia 1.1 .3 16.3 13.8 Other 2.9 .2 $62.7 $32.1
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on net income.
(b) Reflects a rate increase in Maryland, designed to produce $11.3 million on an annual basis, which became effective on February 25, 1993, and a rate increase in Virginia, designed to produce $10.0 million on an annual basis, which became effective on September 28, 1993, subject to refund. The Maryland surcharge for recovery of carrying charges on Clean Air Act Amendments of 1990 (CAAA) compliance investment of $1.7 million effective on June 4, 1992, which was increased to $3.9 million effective on December 3, 1992, was rolled into base rates effective with the February 1993 increase. Rate increases also include a CAAA surcharge in West Virginia designed to produce $.8 million on an annual basis effective July 1, 1992, which was increased to $2.2 million on an annual basis effective July 1, 1993.
The increased kWh sales to residential and commercial customers in 1993 reflect both higher use and growth in number of customers. While 1993 heating degree days showed only a slight increase over 1992, and were only 7%
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above normal, cooling degree days increased 82% over 1992 and were 12% over normal, contributing to the 1993 kWh sales increases. The Company experienced a normal winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
KWh sales to industrial customers increased 4.3% in 1993 and 2.0% in 1992. The increase in both years occurred in almost all industrial groups, the most significant of which in 1993 was from sales to cement customers.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .4 1.0 1.8 From purchased power 3.5 4.4 3.8 3.9 5.4 5.6 Revenues (in millions): From Company generation $8.6 $27.5 $47.4 From sales of purchased power 99.5 113.6 114.3 $108.1 $141.1 $161.7
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off. About 95% of the aggregate benefits from sales to nonaffiliated utilities is passed on to retail customers and has little effect on net income.
The decrease in other revenues in 1993 resulted from an agreement with the Federal Energy Regulatory Commission to record in 1993 about $4 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years.
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Operating Expenses Fuel expenses decreased 4% in 1993 and 6% in 1992. Both decreases were primarily due to decreases in kWh generated. The 1992 decrease also included a 1% decrease in average coal prices. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the financial statements, with the result that changes in fuel expenses have little effect on net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities, capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $87.9 $104.6 $103.7 Other 10.5 3.7 8.9 Power exchanges, net (.8) .2 (.4) Affiliated transactions: AGC capacity charges 28.0 29.6 31.3 Other affiliated capacity charges 28.4 21.9 23.4 Energy and spinning reserve charges 51.1 41.2 37.6 $205.1 $201.2 $204.5
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power purchased from nonaffiliates for use by the Company and affiliated energy and spinning reserve charges are mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on net income. The 1993 increase in other purchased power reflects efforts to conserve coal because of selective work stoppages by the United Mine Workers of America for most of the year.
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While the Company does not currently purchase generation from qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), several projects have been proposed, and an agreement has been reached with one facility to commence purchasing generation in 1999. This project and others may significantly increase the cost of power purchases passed on to customers. The increase in affiliated capacity and energy and spinning reserve charges in 1993 was due to growth of kWh sales to retail customers and an increase in affiliated energy available because of energy purchased by an affiliate from new PURPA projects in 1992 and 1993.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in employee benefit costs and salaries and wages. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $1.5 million. The Company is currently recovering approximately 90% of SFAS No. 106 expenses in rates and will be requesting recovery of the remainder in 1994 rate cases. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 25% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system.
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The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
Depreciation expense increases resulted primarily from additions to electric plant. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $1 million in 1993 due to increases in gross receipts taxes resulting from higher revenues from retail customers ($1 million) and increased property taxes ($1 million), offset by decreased West Virginia Business and Occupation taxes due to decreased generation in that state ($1 million). The 1992 increase was due to increased property ($1 million) and gross receipts ($1 million) taxes.
The net increase of $2 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($3 million) and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million), offset by plant removal tax deductions for which deferred taxes were not provided ($1 million). The net increase in 1992 was primarily due to an increase in income before taxes. Note B to the financial statements provides a further analysis of income tax expenses.
The combined increase of $2 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. The decrease in other income, net in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt and certain preferred stock,
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and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
During 1993, the Company continued its participation in the Collaborative Process for Demand-Side Management in Maryland with the Maryland PSC Staff, Office of People's Counsel, the Department of Natural Resources, Maryland Energy Administration, and the Company's largest industrial customer. The Company received the Maryland PSC's approval to implement a Commercial and Industrial Lighting Rebate Program as of July 1, 1993. Through December 31, 1993, the Company had received applications for $7.5 million in rebates related to the commercial lighting program. Program costs, including rebates and lost revenues, are deferred and are to be recovered through an energy conservation surcharge over a five-year period.
Capital Requirements Construction expenditures for 1993 were $179 million and for 1994 and 1995 are estimated at $136 million and $106 million, respectively. These estimates include $40 million and $10 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable rulings of state commissions allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $350 million, which includes $153 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has
M-24
additional annual capital requirements of an annual preferred stock sinking fund ($1.2 million) and debt maturities (see Note H to the financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $75 million in 1993. Regulatory commission orders received in all of the state jurisdictions and the FERC provide for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with various amounts of lag. Based upon the authorizations received and new rate cases planned in 1994, internal generation of cash can be expected to increase.
Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($14 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $13.99 million of 6.25% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $121 million of debt securities having interest rates of 7% to 9.5% through the issuance of $129 million of securities having interest rates of 5.875% to 7.75%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $9 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. The Company canceled or postponed approximately $36 million of debt financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short- term borrowing needs, to the extent that certain of the companies have funds available.
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At December 31, 1993, the Company had SEC authorization to issue up to $115 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $84 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $75 million of new debt securities and, if economic and market conditions make it desirable, may refinance up to $231 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction programs, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the financial statements.
All of the state jurisdictions in which the Company operates have enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
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As of January 1994, Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System-operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of MP. The Company is joint owner with MP in five generating plants, including four operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
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West Penn
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Net Income
Consolidated net income was $102.1 million, $98.2 million, and $101.2 million in 1993, 1992, and 1991, respectively. The increase in consolidated net income in 1993 resulted primarily from kWh sales and retail rate increases, offset in part by higher expenses. Higher retail revenues in 1992 from a surcharge to recover increases in various state taxes and greater kWh sales were more than offset by higher expenses.
Sales and Revenues
KWh sales to and revenues from residential, commercial, and industrial customers are shown on pages D-7 and D-8. Such kWh sales increased 3.1% and 2.7% in 1993 and 1992, respectively. The increases in revenues from sales to residential, commercial, and industrial customers resulted from the following:
Increase from Prior Year
1993 1992 (Millions of Dollars)
Increased kWh sales $15.5 $ 6.7 Fuel and energy cost adjustment clauses (a) 26.2 15.2 Rate increases (b) 25.2 5.8 Other 3.1 1.3
$70.0 $29.0
(a) Changes in revenues from fuel and energy cost adjustment clauses have little effect on consolidated net income.
(b) Reflects a base rate increase on an annual basis of about $61.6 million in Pennsylvania effective May 18, 1993, including $26.1 million for recovery of carrying charges on Clean Air Act Amendments of 1990 (CAAA) compliance costs, and in 1992 also reflects a surcharge effective August 24, 1991, to recover Pennsylvania tax increases.
The increased kWh sales to residential and commercial customers in 1993 reflect both growth in number of customers and higher use. While 1993 heating degree days remained about the same as 1992, and were only 6% below normal, cooling degree days increased 70% over 1992 and were 46% over normal, contributing to the 1993 kWh sales increases. The Company experienced a mild winter in the first quarter of 1992 followed by a much cooler than normal summer and early fall. As a result, weather had a negative impact on 1992 sales to retail customers.
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KWh sales to industrial customers increased .8% in 1993 and 6.3% in 1992. The relatively flat industrial sales growth in 1993 followed increases in industrial sales in 1992 which occurred in almost all industrial groups. One particular group, coal mines staffed by union personnel, recorded reduced usage because of selective work stoppages by the United Mine Workers of America (UMWA) for most of the year prior to the settling of the dispute in December 1993.
KWh sales to and revenues from nonaffiliated utilities are comprised of the following items:
1993 1992 1991 KWh sales (in billions): From Company generation .4 1.3 2.3 From purchased power 5.0 6.5 5.4
5.4 7.8 7.7
Revenues (in millions): From Company generation $11.5 $37.5 $62.5 From sales of purchased power 141.0 167.2 160.7
$152.5 $204.7 $223.2
Decreased sales to nonaffiliated utilities resulted primarily from decreased demand and continuing price competition. Sales supplied by the Company's generation in 1993 decreased to less than 15% of 1988 levels because of continuing growth of kWh sales to retail customers, which reduces the amount available for sale, and because other suppliers were willing or able to make the sales at lower prices. A significant factor affecting the Company's ability to compete in the market for sales to nonaffiliated utilities has been the approximate 290% increase (from about 67 cents per MWh to $2.60 per MWh) in taxes on generation in West Virginia since March 1989 - a significant cost not experienced by utilities not generating in West Virginia. Further decreases in these sales are anticipated in 1994 before leveling off.
The decrease in other revenues in 1993 and 1992 resulted from continued decreases in sales of energy and spinning reserve to an affiliated company because of additional energy available to it from new PURPA projects commencing in both years. The 1993 decrease was also due in part to an agreement with the Federal Energy Regulatory Commission to record in 1993 about $6 million of revenues as sales to nonaffiliated utilities. Similar transactions were recorded as other revenues in prior years. Most of the aggregate benefits from sales to affiliated and nonaffiliated utilities is passed on to retail customers and has little effect on consolidated net income.
M-29 Operating Expenses
Fuel expenses decreased 4% in each of the years of 1993 and 1992 primarily due to decreases in kWh generated. Fuel expenses are primarily subject to deferred power cost accounting procedures, as described in Note A to the consolidated financial statements, with the result that changes in fuel expenses have little effect on consolidated net income.
"Purchased power and exchanges, net" represents power purchases from and exchanges with nonaffiliated utilities and qualified facilities under the Public Utility Regulatory Policies Act of 1978 (PURPA), capacity charges paid to AGC, and other transactions with affiliates made pursuant to a power supply agreement whereby each company uses the most economical generation available in the System at any given time, and is comprised of the following items:
1993 1992 1991 (Millions of Dollars) Nonaffiliated transactions: Purchased power: For resale to other utilities $124.5 $153.9 $146.0 From PURPA generation 49.6 56.5 55.6 Other 15.2 5.9 12.9 Power exchanges, net (1.2) .3 (.5) Affiliated transactions: AGC capacity charges 42.3 43.5 44.1 Energy and spinning reserve charges 4.7 3.5 3.8 Other affiliated capacity charges .7 .6 .6
$235.8 $264.2 $262.5
The amount of power purchased from nonaffiliated utilities for use by the Company and for resale to nonaffiliated utilities depends upon the availability of the Company's generating equipment, transmission capacity, and fuel, and its cost of generation and the cost of operations of nonaffiliated utilities from which such purchases are made. The primary reason for the fluctuations in purchases for resale to nonaffiliated utilities is described under Sales and Revenues above. The cost of power and capacity purchased for use by the Company, including power from PURPA generation and affiliated transactions, is mostly recovered from customers currently through the regular fuel and energy cost recovery procedures followed by the Company's regulatory commissions and is primarily subject to deferred power cost procedures with the result that changes in such costs have little effect on consolidated net
M-30
income. The decrease in purchases from PURPA generation in 1993 was due to a planned generating outage at one PURPA project. The 1993 increase in other purchased power reflects efforts to conserve coal during the UMWA dispute.
The increase in other operation expense for 1993 and 1992 resulted primarily from increases in salaries and wages and in 1993 also from employee benefit costs. The Financial Accounting Standards Board's (FASB) standard, SFAS No. 106, increased 1993 postretirement benefit expense by approximately $3.1 million. The Company is currently recovering all of SFAS No. 106 expenses in rates. During 1992, the Company implemented significant changes to its benefits plans, including cost caps, in an effort to both control and reduce employee benefits costs. The cost caps provide for future postretirement medical benefit costs to be capped at two times 1993 levels. Because 1993 medical costs were more than actuarially projected, SFAS No. 106 costs for 1994 are expected to be approximately 5% greater than 1993 amounts.
Another FASB standard, SFAS No. 112, "Employers' Accounting for Postemployment Benefits", effective in 1994, requires companies to accrue for other post- employment benefits such as disability benefits, health care benefits for disabled employees, severance pay, and workers' compensation claims. The Company currently accrues for workers' compensation claims and the estimated liability for the other benefits is not expected to be material.
Maintenance expenses represent costs incurred to maintain the power stations, the transmission and distribution (T&D) system, and general plant, and reflect routine maintenance of equipment and rights-of-way as well as planned major repairs and unplanned expenditures, primarily from forced outages at the power stations and periodic storm damage on the T&D system. Maintenance expense in 1993 includes the effects of an ice storm and blizzard in March 1993. The Company is also experiencing, and expects to continue to experience, increased expenditures due to the aging of its power stations. Variations in maintenance expense result primarily from unplanned events and planned major projects, which vary in timing and magnitude depending upon the length of time equipment has been in service without a major overhaul, the amount of work found necessary when the equipment is dismantled, and outage requirements to comply with the CAAA.
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Depreciation expense increases resulted primarily from additions to electric plant and in 1993 also from a change in depreciation rates and net salvage amortization as a result of the May 1993 rate order. Because of the increased levels of capital expenditures as a result of the CAAA (see Note J to the consolidated financial statements) and the replacement of aging equipment at the Company's power stations, depreciation expense is expected to increase significantly over the next few years.
Taxes other than income increased $2 million in 1993 primarily due to increases in gross receipts taxes resulting from higher revenues from retail customers ($3 million) offset in part by decreased West Virginia Business and Occupation taxes (B&O taxes) ($2 million) due to decreased generation in that state. The 1992 increase resulted from increased property and capital stock taxes ($4 million), increased B&O taxes ($1 million), and increases in gross receipts taxes ($1 million).
The net increase of $7 million in federal and state income taxes in 1993 resulted primarily from an increase in income before taxes ($6 million), and an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($1 million). The net decrease in 1992 of $4 million resulted primarily from a decrease in income before taxes. Note B to the consolidated financial statements provides a further analysis of income tax expenses.
The combined increase of $.3 million in allowances for funds used during construction (AFUDC) in 1993 reflects increased construction expenditures including those associated with the CAAA, net of CAAA amounts included in rate base and earning a cash return. Future levels of AFUDC can be expected to increase slightly with increasing levels of CAAA expenditures until late 1994 upon substantial completion of Phase I of the CAAA compliance program. The decrease in other income, net, in 1993 resulted primarily from the Company's share of decreases in the earnings of AGC (see Note D to the consolidated financial statements). Other fluctuations in other income, net, were individually insignificant. Other interest expense reflects changes in the level of short-term debt maintained by the Company.
Liquidity and Capital Resources SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company needs cash for operating expenses, the payment of interest and dividends, retirement of debt, and for its construction program. To meet these needs, the Company has used internally generated funds and external financings, such
M-32
as the sale of common and preferred stock, debt instruments, instalment loans, and lease arrangements. The timing and amount of external financings depend primarily upon economic and financial market conditions, the Company's cash needs, and capitalization ratio objectives. The availability and cost of external financing depend upon the financial health of the companies seeking those funds.
Capital Requirements Construction expenditures for 1993 were $251 million and for 1994 and 1995 are estimated at $258 million and $208 million, respectively. These estimates include $82 million and $33 million, respectively, for substantial completion of the program of complying with Phase I of the CAAA. It is anticipated that the Harrison Scrubber Project will be completed on schedule (late 1994) and that the final cost will be approximately 24% below the original budget. Primary factors contributing to the reduced cost include: 1) the absence of any major construction problems to date; 2) financing and material and equipment costs lower than expected; and 3) favorable ruling of the Pennsylvania PUC allowing the inclusion of carrying costs of construction in rates in lieu of AFUDC. Construction expenditures through the year 2000 may include substantial amounts for compliance with both Phase I and Phase II of the CAAA. The Company is estimating amounts of approximately $700 million, which includes $207 million expended through 1993, depending upon the strategy eventually selected for complying with Phase II. The mere possibility of new legislation which restricts or discourages carbon dioxide emissions, either through taxation or caps, further complicates the CAAA Phase II planning process. The remaining amount of this CAAA construction estimate, together with normal construction activity assures that continuing external financings will be required. In addition, the Company has additional capital requirements of debt maturities (see Note H to the consolidated financial statements).
Internal Cash Flows Internal generation of cash, consisting of cash flows from operations reduced by dividends, increased to $119 million in 1993. A regulatory commission order has been received from the PUC which provides for current cash recovery of the carrying costs of CAAA expenditures in rates, albeit with a certain amount of lag. Based upon the authorization received and a new rate case planned in 1994, internal generation of cash can be expected to increase.
M-33
Materials and supplies, primarily fuel, constituted a significant source of cash in 1993 ($27 million). The five-year National Bituminous Coal Wage Agreement terminated on February 1, 1993. Coal inventories (fuel) as of December 31, 1992, were increased over 1991 amounts to provide an increased coal supply in the event of a strike. The union chose a strategy of selective shutdowns including mines that accounted for approximately 60% of the System's regular coal supply. The union signed a new five-year contract in December 1993. System coal inventory, which declined during the dispute, and which is somewhat lower than the seasonal norm, is considered adequate.
Financings During 1993 the Company issued $18.04 million of 6.30% tax-exempt solid waste disposal notes to Harrison County, West Virginia, and refunded an aggregate of $246 million of debt securities having interest rates of 7% to 9.75% through the issuance of $251 million of securities having interest rates of 4.95% to 6.375%. The costs associated with the debt redemptions are being amortized over the life of the new bonds. Due to the significant number of refinancings which have occurred over the past two years, this balance is now about $12 million. Reduced future interest expense will more than offset these expenses.
Short-term debt is used to meet temporary cash needs until the timing is considered appropriate to issue long- term securities. The Company canceled or postponed approximately $47 million of debt financings in 1993 due to favorable short-term alternatives. In 1992, the Company and its affiliates established an internal money pool as a facility to accommodate intercompany short-term borrowing needs, to the extent that certain of the companies have funds available.
At December 31, 1993, the Company had SEC authorization to issue up to $170 million of short-term debt. In addition, a multi-year credit program was established in January 1994, which provides that the Company may borrow on a standby revolving credit basis up to $135 million. After the initial three-year term, the program agreement provides that the maturity date may be extended in one-year increments. The borrowings have the support of a long-term credit facility. During 1994, the Company plans to issue about $105 million of new securities, consisting of both debt and equity issues and, if economic and market conditions make it desirable, may refinance up to $212 million of first mortgage bonds, preferred stock, and pollution control revenue notes. The Company may also engage in additional Harrison County tax-exempt solid waste disposal financings to the extent that funds are available.
The Company anticipates that it will be able to meet its future cash needs through internal cash generation and external financings as it has in the past and possibly through alternative financing procedures.
Environmental Matters and Other Contingencies In the normal course of business, the Company is subject to various contingencies and uncertainties relating to its operations and construction program, including cost recovery in the regulatory process, laws, regulations and uncertainties related to environmental matters, and legal actions. Contingencies and uncertainties related to the CAAA are discussed above and under Note J to the consolidated financial statements.
Pennsylvania has enacted hazardous and solid waste management legislation. While the Company does not have significant hazardous waste concerns, solid wastes, such as fly ash and other coal by-products generated from power stations, must be disposed in accordance with the state requirements. The Company is incurring various costs, which are recoverable in rates, to comply with these and other environmental matters. The level of future expenditures for environmental matters is impossible to determine with any degree of certainty. It is management's opinion that the ultimate costs will not have a material effect on the financial position of the Company.
M-35
As of January 1994, Monongahela Power Company (MP), an affiliated company, has been named as a defendant along with multiple other defendants in 1,429 pending asbestos cases involving multiple plaintiffs and the Company and its affiliates have been named as defendants along with multiple defendants in an additional 626 cases by multiple plaintiffs. Because these cases are filed by "shotgun" complaints naming many plaintiffs and many defendants, it is presently impossible to determine the actual number of claims against the Company and its affiliates. However, based on past experience and data available to date, it is estimated that less than 600 cases actually involve claims against the Company or its affiliates. All complaints allege that the plaintiffs sustained unspecified injuries resulting from claimed exposure to asbestos in various generating plants and other industrial facilities operated by the various defendants, although all plaintiffs do not claim exposure at facilities operated by all defendants. All plaintiffs claiming exposure at System- operated stations were employed by third-party contractors, with the exception of three who claim to have been employees of MP. The Company is joint owner with MP in four generating plants, including three operated by MP in West Virginia. Each plaintiff generally seeks compensatory and punitive damages against all defendants in amounts of up to $1 million and $3 million, respectively; in those cases that include a spousal claim for loss of consortium, damages are generally sought against all defendants in an amount of up to $1 million for the loss of consortium claim. Therefore, because of the multiple defendants, the Company believes its potential liability is a very small percentage of the total amount of the damages sought. A total of 94 cases have been previously settled by MP for an amount substantially less than the anticipated cost of defense. While the Company believes that all of these cases are without merit, it cannot predict the outcome of these cases or whether other cases will be filed.
M-36
AGC
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
As described under Liquidity and Capital Resources, revenues are determined under a cost of service formula rate schedule. Therefore, if all other factors remain equal, revenues are expected to decrease each year due to a normal continuing reduction in the Company's net investment in the Bath County station and its connecting transmission facilities upon which the return on investment is determined. Revenues for 1993 and 1992 decreased due to a reduction in interest charges and net investment, and reduced operating expenses which are described below. Additionally, revenues for 1993 and 1992 were reduced by the recording of estimated liabilities for possible refunds pending final Federal Energy Regulatory Commission (FERC) decisions in rate case proceedings (see Liquidity and Capital Resources).
The net investment (primarily net plant less deferred income taxes) decreases to the extent that provisions for depreciation and deferred income taxes exceed net plant additions. The decrease in operating expenses in 1993 resulted from a decrease in federal income taxes due to a decrease in income before taxes ($1.9 million) offset by an increase in the tax rate due to the Revenue Reconciliation Act of 1993 ($.5 million), partially offset by an increase in operation and maintenance expense. The decrease in operating expenses in 1992 resulted primarily from reduced federal income taxes because of a decrease in income before taxes, partially offset by increases in taxes other than income.
The increase in taxes other than income in 1992 was due to increased property taxes.
The decreases in interest on long-term debt in 1993 and 1992 were the combined result of decreases in the average amount of and interest rates on long-term debt outstanding.
Liquidity and Capital Resources
SEC regulations define "liquidity" as "the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's need for cash". The Company's only operating assets are an undivided 40% interest in the Bath County (Virginia) pumped-storage hydroelectric station and its connecting transmission facilities. The Company has no present plans for construction of any other major facilities.
M-37
Pursuant to an agreement, the Parents buy all of the Company's capacity in the station priced under a "cost of service formula" wholesale rate schedule approved by the FERC. Under this arrangement, the Company recovers in revenues all of its operation and maintenance expenses, depreciation, taxes, and a return on its investment.
Through February 29, 1992, the Company's return on equity (ROE) was adjusted annually pursuant to a settlement agreement approved by the FERC. On March 1, 1990, the ROE decreased from 12% to 11.25%, and on March 1, 1991, it was increased to 11.53%. In December 1991, the Company filed for a continuation of the existing ROE of 11.53% and other parties (the Consumer Advocate Division of the Public Service Commission of West Virginia, Maryland People's Counsel, and Pennsylvania Office of Consumer Advocate, collectively referred to as the joint consumer advocates or JCA) filed to reduce the ROE, with any resultant rate decreases subject to refund from March 1, 1992 through May 31, 1993. Hearings were completed in June 1992, and a recommendation was issued by an Administrative Law Judge (ALJ) on December 21, 1993, for an ROE of 10.83%, which the JCA argues should be further adjusted to reflect changes in capital market conditions since the hearings. Exceptions to this recommendation have been filed by all parties for consideration by the full Commission. On January 28, 1994, the JCA filed a joint complaint claiming that both the existing ROE of 11.53% and the ALJ's recommended ROE of 10.83% are unjust and unreasonable. This new complaint requests an ROE of 8.53%, with rates subject to refund beginning April 1, 1994.
In 1993, the Company issued $50 million of 5.75% medium-term notes due 1998, $50 million of 5.625% debentures due 2003, and $100 million of 6.875% debentures due 2023 to refund $50 million 8% debentures due 1997, $50 million 8.75% debentures due 2017, and $100 million 9.125% debentures due 2016. The Company and its affiliates in 1992 established an internal money pool as a facility to accommodate intercompany short- term borrowing needs, to the extent that certain of the companies have funds available.
- 42 -
ITEM 8. | 105839 | 1993 |
25445 | 1993 |
||
Item 6. Selected Financial Data - ------- -----------------------
The five-year selected financial data for the years 1989 through 1993, appearing on page 44 of the 1993 Annual Report to Shareholders, is incorporated herein by reference in this Form 10-K Annual Report.*
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition - ------- ----------------------------------------------------------- and Results of Operations -------------------------
Management's Discussion and Analysis of Financial Condition and Results of Operations, appearing on pages 18 through 24 of the 1993 Annual Report to Shareholders, is incorporated herein by reference in this Form 10-K Annual Report.*
Item 8. | 13239 | 1993 |
ITEM 7: MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation (the Company) that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 36 through 63, as well as with the other information presented throughout the report.
All financial information has been restated on an historical basis to reflect the April 15, 1993 merger with Napa Valley Bancorp (the Merger) on a pooling-of-interests basis.
The Company earned $9.5 million in 1993, representing a 38 percent decrease from 1992 record earnings of $15.2 million and a 21 percent reduction from 1991 earnings of $12.0 million. The 1993 results include a second quarter loss of $4.1 million, mostly due to $10.5 million after-tax merger-related charges that were taken in the form of asset write-downs, additions to the loan loss provision and other related charges. The asset write-downs and the additional loan loss provision reflect the Company's plan of asset resolution.
Components of Net Income (Percent of average earning assets) 1993 1992 1991 - ------------------------------------------------------------------ Net interest income* 5.48% 5.50% 5.21% Provision for loan losses (.53) (.39) (.59) Non-interest income 1.34 1.33 1.36 Non-interest expense (5.43) (5.00) (4.82) Taxes* (.33) (.59) (.48) - ------------------------------------------------------------------- Net income .53% .85% .68% =================================================================== Net income as a percentage of average total assets .48% .77% .62% * Fully taxable equivalent (FTE)
On a per share basis, 1993 net income was $1.17, compared to $1.92 and $1.52 in 1992 and 1991, respectively. During 1993, the Company continued to benefit from reductions in cost of funds, increases in service fees and other non-interest income, and expense controls. However, merger-related costs more than offset these benefits. Earnings in 1992 improved over 1991 principally due to higher net interest margin, lower provisions for loan losses and control of non-interest expense.
The Company's return on average total assets was .48 percent in 1993, compared to .77 percent and .62 percent in 1992 and 1991, respectively. Return on average equity in 1993 was 6.51 percent, compared to 11.16 percent and 9.52 percent, respectively, in the two previous years.
NET INTEREST INCOME
Although interest rates continued to decline during most of 1993, the continuing downward repricing of interest-bearing liabilities and a more favorable composition of deposits, represented by increasing volumes of lower costing demand and savings account balances and declining volumes of higher costing time deposits, prevented declining earning-asset yields from significantly eroding the Company's net interest margin.
Components of Net Interest Income
(In millions) 1993 1992 1991 - ------------------------------------------------------------------- Interest income $ 137.0 $ 154.8 $ 176.6 Interest expense (42.3) (58.9) (87.4) FTE adjustment 2.8 2.7 2.7 - ------------------------------------------------------------------- Net interest income (FTE) $ 97.5 $ 98.6 $ 91.9 - ------------------------------------------------------------------- Average interest earning assets $1,779.3 $1,793.8 $1,762.4 Net interest margin (FTE) 5.48% 5.50% 5.21%
Net interest income (FTE) in 1993 decreased $1.1 million from 1992 to $97.5 million. Interest income decreased $17.8 million from 1992, due to a $14.5 million reduction in the average balance of interest earning assets and a 93 basis point decline in yields. This was partially offset by a $16.6 million decrease in interest expense, the combination of a $41.3 million decrease in the average balance of interest-bearing liabilities and a 101 basis point decline in rates paid, in part due to a more favorable composition of deposits.
DISTRIBUTION OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
The following tables present, for the periods indicated, information regarding the consolidated average assets, liabilities and shareholders' equity, the amounts of interest income from average interest earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities, expressed in thousand of dollars and rates. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments have been received and applied as interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate. Amortized loan fees, which are included in interest and fee income on loans, were $1.5 million lower in 1993 than in 1992 and $2.6 million higher in 1992 than in 1991.
Distribution of average assets, liabilities and shareholders' equity Yields/Rates and interest margin Full Year 1993 (dollars in thousands) --------------------------- Interest Rates Average income/ earned/ balance expense paid - ----------------------------------------------------------------------- Assets Money market assets and funds sold $4,463 $170 3.80% Trading account securities 183 6 3.14 Investment securities 631,700 39,794 6.30 Loans: Commercial 615,981 53,990 8.76 Real estate construction 55,038 4,745 8.62 Real estate residential 168,379 13,322 7.91 Consumer 303,567 27,726 9.13 - --------------------------------------------------------------- Total interest earning assets 1,779,311 139,753 7.85
Other assets 200,561 - ------------------------------------------------------- Total assets $1,979,872 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $330,867 -- -- Savings and interest-bearing transaction 938,475 19,305 2.06% Time less $100,000 340,122 14,176 4.17 Time $100,000 or more 135,505 4,837 3.57 - --------------------------------------------------------------- Total interest-bearing deposits 1,414,102 38,318 2.71 Funds purchased 57,135 1,937 3.39 Notes and mortgages payable 17,959 2,016 11.22 - --------------------------------------------------------------- Total interest-bearing liabilities 1,489,196 42,271 2.84 Other liabilities 14,652 Shareholders' equity 145,157 - ------------------------------------------------------- Total liabilities and shareholders' equity $1,979,872 ======================================================= Net interest spread (1) 5.01% Net interest income and interest margin (2) $97,482 5.48% ===============================================================
(1) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (2) Net interest margin is computed by dividing net interest income by total average interest earning assets.
Full Year 1992 (dollars in thousands) --------------------------- Interest Rates Average income/ earned/ balance expense paid - ----------------------------------------------------------------------- Assets Money market assets and funds sold $42,964 $1,765 4.11% Trading account securities 103 4 3.67 Investment securities 534,793 40,332 7.54 Loans: Commercial 646,359 60,050 9.29 Real estate construction 76,173 7,058 9.27 Real estate residential 168,030 15,314 9.11 Consumer 325,393 33,003 10.14 - --------------------------------------------------------------- Total interest earning assets 1,793,815 157,526 8.78
Other assets 175,609 - ------------------------------------------------------- Total assets $1,969,424 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $284,366 -- -- Savings and interest-bearing transaction 903,211 26,518 2.94% Time less $100,000 406,161 20,948 5.16 Time $100,000 or more 184,799 8,365 4.53 - --------------------------------------------------------------- Total interest-bearing deposits 1,494,171 55,831 3.74 Funds purchased 15,729 698 4.44 Notes and mortgages payable 20,439 2,363 11.56 - --------------------------------------------------------------- Total interest-bearing liabilities 1,530,339 58,892 3.85 Other liabilities 18,263 Shareholders' equity 136,456 - ------------------------------------------------------- Total liabilities and shareholders' equity $1,969,424 ======================================================= Net interest spread (1) 4.93% Net interest income and interest margin (2) $98,634 5.50% ===============================================================
(1) Net interest spread represents the average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities. (2) Net interest margin is computed by dividing net interest income by total average interest earning assets.
Full Year 1991 (dollars in thousands) --------------------------- Interest Rates Average income/ earned/ balance expense paid - ----------------------------------------------------------------------- Assets Money market assets and funds sold $39,182 $2,227 5.68% Trading account securities 835 54 6.47 Investment securities 446,283 39,218 8.79 Loans: Commercial 672,999 71,512 10.63 Real estate construction 96,654 11,002 11.38 Real estate residential 150,943 15,436 10.23 Consumer 355,502 39,798 11.19 - --------------------------------------------------------------- Total interest earning assets 1,762,398 179,247 10.17
Other assets 169,089 - ------------------------------------------------------- Total assets $1,931,487 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $265,383 -- -- Savings and interest-bearing transaction 773,904 36,119 4.67% Time less $100,000 466,487 31,838 6.83 Time $100,000 or more 230,276 15,113 6.56 - --------------------------------------------------------------- Total interest-bearing deposits 1,470,667 83,070 5.65 Funds purchased 26,885 1,676 6.23 Notes and mortgages payable 22,464 2,611 11.62 - --------------------------------------------------------------- Total interest-bearing liabilities 1,520,016 87,357 5.75 Other liabilities 20,886 Shareholders' equity 125,202 - ------------------------------------------------------- Total liabilities and shareholders' equity $1,931,487 ======================================================= Net interest spread (1) 4.42% Net interest income and interest margin (2) $91,890 5.21% =============================================================== (1) Net interest spread represents the average yield earned on interest- earning assets less the average rate paid on interest-bearing liabilities. (2) Net interest margin is computed by dividing net interest income by total average interest earning assets.
RATE AND VOLUME VARIANCES.
The following table sets forth a summary of the changes in interest income and interest expense from changes in average assets and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $9.5 million in 1993, including a $3.1 million merger-related provision in the second quarter, reflecting a different workout strategy for loans and properties acquired in the Merger, compared to $7.0 million in 1992 and $10.4 million in 1991. The level of the provision reflects the Company's continuing efforts to improve loan quality by enforcing strict underwriting and administration procedures and aggressively pursuing collection efforts with troubled debtors. For further information regarding net credit losses and the reserve for loan losses, see the Non-Performing Assets section of this report.
INVESTMENT PORTFOLIO
The Company maintains a securities portfolio consisting of U.S.Treasury, U.S. Government Agencies and Corporations, State and political subdivisions, asset-backed and other securities. Investment securities are held in safekeeping by an independent custodian. In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No.115"). The statement addresses the accounting and reporting for investments in equity securities that have a readily determinable fair value and for all investments in debt securities. The statement requires that all securities be classified, at acquisition, into one of three categories: held-to-maturity, available-for-sale, and trading. SFAS No. 115 is effective for fiscal years beginning after December 15, 1993; however, early implementation is permitted. The Company elected to implement SFAS No. 115 effective as of December 31, 1993.
The classification of all securities is determined at the time of acquisition. In classifying securities as being held-to-maturity, available-for-sale or trading, the Banks consider their collateral needs, asset/liability management strategies, liquidity needs, interest rate sensitivity and other factors that will determine the intent and ability to hold the securities to maturity.
The objective of the investment securities held-to-maturity is to strengthen the portfolio yield, and to provide collateral to pledge for federal, state and local government deposits and other borrowing facilities. The investments held-to-maturity had an average term to maturity of 47 months at December 31, 1993 and, as of the same date, those investments included $547.2 million in fixed rate and $9.9 million in adjustable rate securities.
Investment securities available-for-sale are typically used to supplement the Banks' liquidity portfolio with the objective of increasing the portfolio yield. Unrealized net gains and losses on these securities are recorded as an adjustment to equity net of taxes, and are not reflected in the current earnings of the Company. If the security is sold, any gain or loss is recorded as a charge to earnings and the equity adjustment is reversed. At December 31, 1993, the Banks held $168.8 million classified as investments available-for-sale. At December 31, 1993, $2.5 million, net of taxes was recognized as the unrealized net gain related to these securities.
The amount of trading securitiess at December 31, 1993, was not material.
For more information on investment securities, see Notes 1 and 2 to the Consolidated Financial Statements on pages 43 to 47 of this report.
The following table shows the book value of the Company's investment securities (in thousands of dollars) as of the dates indicated:
December 31, 1993 1992 1991 - ----------------------------------------------------------- U.S. Treasury $249,613 $126,522 $24,411 U.S. government agencies and corporations 254,691 237,753 299,219 States and political subdivisions (domestic) 127,297 87,031 74,847 Asset backed securities 65,433 82,270 79,743 Other securities 28,842 36,660 37,404 - ----------------------------------------------------------- Total $725,876 $570,236 $515,624 ===========================================================
The following table is a summary of the relative maturities (in thousands of dollars) and yields of the Company's investment securities as of December 31, 1993. Weighted average yields have been computed by dividing annual interest income, adjusted for amortization of premium and accretion of discount, by book value of the related securities. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the federal tax rate of 34 percent.
LOAN PORTFOLIO
The following table shows the composition of loans of the Company (in thousands of dollars) by type of loan or type of borrower, on the dates indicated. Secured loans are classified by type of securities and unsecured by the purpose of the loan.
Maturities and Sensitivity of Selected Loans to Changes in Interest Rates
The following table shows the maturity distribution and interest rate sensitivity of Commercial and Real estate construction loans at December 31, 1993.*
*Excludes loans to individuals and residential mortgages totaling $461,450. These types of loans are typically paid in monthly installments over a number of years. **Includes demand loans
Commitments and Lines of Credit
It is not the policy of the Company to issue formal commitments on lines of credit except to a limited number of well established and financially responsible local commercial enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of Letters of Credit to facilitate the customer's particular business transaction. Commitment fees generally are not charged except where Letters of Credit are involved. Commitments and lines of credit typically mature within one year. See also Note 11 of the Consolidated Notes to the Financial Statements on page 55.
RISK ELEMENTS
The Company closely monitors the markets in which it conducts its lending Company's primary market areas, in Management's view such impact has not had a material, adverse effect on the Company's liquidity and capital resources. The Company continues its strategy to control its exposure to real estate development loans and increase diversification of credit risk. Asset reviews are performed using grading standards and criteria similar to those employed by bank regulatory agencies. Assets receiving lesser grades fall under the classified assets category which includes all non-performing assets. These occur when known information about possible credit problems causes Management to have doubts about the ability of such borrowers to comply with loan repayment terms. These loans have varying degrees of uncertainty and may become non-performing assets. Classified assets receive an elevated level of Management attention to ensure collection. Total classified assets peaked following the second quarter Merger but declined significantly by December 31, 1993 due to extensive asset write-downs, loan collections, real estate liquidations and restructurings of the Napa Valley Bank loan portfolio reflecting the Company's workout strategy.
Non-Performing Assets
Non-performing assets include non-accrual loans, loans 90 days past due and still accruing, other real estate owned and loans classified as substantively foreclosed. Loans are placed on non-accrual status upon reaching 90 days or more delinquent, unless the loan is well secured and in the process of collection. Interest previously accrued on loans placed on non-accrual status is charged against interest income. Loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on non-accrual status even though the borrowers continue to repay the loans as scheduled. Such loans are classied by Management as performing non-accrual and are included in total non-performing assets. Performing non-accrual loans are reinstated to accrual status when improvements in credit quality eliminate the doubt as to the full collectibility of both interest and principal. When the ability to fully collect non-accrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Any subsequent interest received is recorded as interest income on a cash basis.
Non-Performing Assets (In millions) 1993 1992 1991 1990 1989 - ---------------------------------------------------------------------------- Performing non-accrual loans $ 1.9 $ 1.1 $ 2.2 $16.0 $10.7 Non-performing non-accrual loans 7.2 14.9 37.7 9.3 -- - ---------------------------------------------------------------------------- Non-accrual loans 9.1 16.0 39.9 25.3 10.7 Loans 90 or more days past due and still accruing .3 .1 1.0 6.2 6.8 Loan collateral substantively foreclosed 5.4 16.6 7.1 6.0 6.0 Other real estate owned 12.5 17.9 4.9 2.7 4.2 - ---------------------------------------------------------------------------- Total non-performing assets $27.3 $50.6 $52.9 $40.2 $27.7 ============================================================================ Reserve for loan losses as a percentage of non-accrual loans and loans 90 or more days past due and still accruing 272% 153% 58% 60% 91%
Performing non-accrual loans increased $800,000 to $1.9 million at December 31, 1993. This increase was principally due to one condominium construction loan. Non-performing non-accrual loans decreased $7.7 million to $7.2 million at December 31, 1993 due to loan collections, write-downs, foreclosure of loan collateral and reclassifications to loan collateral substantively foreclosed. Both loan collateral substantively foreclosed and other real estate owned declined $16.6 million due to asset write-downs and liquidations. The amount of gross interest income that would have been recorded for non-accrual loans for the year ending December 31, 1993, if all such loans had been current in accordance with their original terms while outstanding during the period, was $980,000. The amount of interest income that was recognized on non-accrual loans from cash payments made during the year ended December 31, 1993 totaled $345,000, representing an annualized yield of 3.06 percent. Cash payments received which were applied against the book balance of performing and non-performing non-accrual loans outstanding at December 31, 1993, totaled $534,000 compared to $104,000 in 1992.
Restructured loans totaled $4,432,000 at December 31, 1993, $319,000 at December 31, 1992, $2,892,000 at December 31, 1991 $2,200,000, at December 31, 1990 and $5,927,000 at December 31, 1989.
CREDIT LOSS EXPERIENCE
The Company's reserve for loan losses is maintained at a level estimated by Management to be adequate to provide for losses that can be reasonably credit loss experience, the amount of past due, non-performing and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. Initially, the reserve is allocated to segments of the loan portfolio based in part on quantitative analyses of historical credit loss experience. Criticized and classied loan balances are analyzed using both a linear regression model and standard allocation percentages. The results of this analysis are applied to current criticized and classied loan balances to allocate the reserve to the respective segments of the loan portfolio. In addition, loans with similar characteristics not usually criticized using regulatory guidelines due to their small balances and numerous accounts, are analyzed based on the historical rate of net losses and delinquency trends and are grouped by the number of days the payment on those loans are delinquent. While these factors are essentially judgmental and may not be reduced to a mathematical formula, Management considers that the $25.6 million reserve for loan losses, which constituted 2.30 percent of total loans at December 31, 1993, to be adequate as a reserve against inherent losses. Management continues to evaluate the loan portfolio and assess current economic conditions that will dictate future reserve levels.
In May 1993, the Financial Accounting Standards Board (FASB) issued statement No. 114, Accounting by Creditors for Impairment of a Loan (SFAS 114) which addresses the accounting treatment of certain impaired loans and amends FASB Statements No. 5 and No. 15. SFAS 114 does not address the overall adequacy of the allowance for loan losses. SFAS 114 is effective January 1, 1995 but earlier implementation is encouraged.
A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Under SFAS 114, impairment is measured based on the present value of the expected future cash flows discounted at the loans effective interest rate. Alternatively, impairment may be measured by using the loans observable market price or the fair value of the collateral if repayment is expected to be provided solely by the underlying collateral.
The Company intends to implement SFAS 114 in January 1995. The impact of implementation on the financial statements has not been determined, since measurement will be contingent upon the inventory of impaired loans outstanding as of January 1, 1995.
ALLOCATION OF RESERVE FOR LOAN LOSSES
The reserve for loan losses has been established to absorb possible future losses throughout the loan portfolio and off balance sheet credit risk. The Company's reserve for loan losses is maintained at a level estimated by management to be adequate to provide for losses that are reasonably foreseeable based upon specific conditions and other factors. The reserve is allocated to segments of the loan portfolio based in part upon quantitative analyses of historical net losses relative to loan balances outstanding. Criticized and classified loan balances, as identified by management using criteria similar to those used by the Banks' regulators, and historical net losses on those balances are analyzed using both a linear regression and standard allocation percentages model. The results of this statistical analysis are applied to current criticized and classified loan balances to allocate the reserve for loan losses to the respective segments of the loan portfolio. In addition, homogeneous loans, which are not usually criticized using regulatory guidelines due to their small balances and numerous accounts, are analyzed based on historical rates of net loan losses experienced for loans grouped by the number of days payments are delinquent. Such rates of net loan losses are applied to the current aging of homogeneous loans to allocate the reserve for loan losses. Management may judgmentally adjust the allocation of the reserve for loan losses based on changes in underwriting standards, anticipated rates of net loan losses which may differ from historical experience, economic conditions, the experience of credit officers and any other factors considered pertinent. Management's continuing evaluation of the loan portfolio and assessment of current economic conditions will dictate future reserve levels.
The following tables present the allocation of the loan loss reserve balance on the dates indicated:
(in thousands) December 31 1993 1992 - ------------------------------------------------------------------------------- Loans as Loans as Allocation Percent of Allocation Percent of of reserve Total of reserve Total Type of loan balance Loans balance Loans - ------------------------------------------------------------------------------- Commercial $12,537 55.0% $13,551 53.4% Real estate construction 2,538 3.6 964 5.4 Real estate residential 85 15.5 545 14.8 Consumer 3,921 25.9 3,872 26.4 Unallocated portion of reserve 6,506 -- 5,810 -- - ------------------------------------------------------------------------------- Total $25,587 100.0% $24,742 100.0% ===============================================================================
(in thousands) December 31 1991 1990 - ------------------------------------------------------------------------------ Loans as Loans as Allocation Percent of Allocation Percent of of reserve Total of reserve Total Type of loan balance Loans balance Loans -------- -------- -------- -------- Commercial $8,325 52.7% $2,698 52.5% Real estate construction 2,336 7.1 4,360 9.5 Real estate residential 50 12.9 29 10.4 Consumer 2,363 27.3 1,782 27.6 Unallocated portion of reserve 10,779 -- 10,132 -- - ------------------------------------------------------------------------------- Total $23,853 100.0% $19,001 100.0% ===============================================================================
(in thousands) December 31 1989 - ------------------------------------------------------------ Loans as Allocation Percent of of reserve Total Type of loan balance Loans -------- -------- Commercial $5,216 52.4% Real estate construction 2,709 11.9 Real estate residential 0 10.3 Consumer 853 25.4 Unallocated portion of reserve 7,182 -- - ------------------------------------------------------------- Total $15,960 100.0% =============================================================
The reduced allocation to commercial loans from December 31, 1992 to December 31, 1993 is primarily due to a reduction in the balance of criticized loans. The increased allocation to construction loans over the same period is attributable to an increase in criticized loans due to the recessionary environment. The increase in the unallocated portion of the reserve is due to the establishment of an additional "recessionary reserve" to recognize the potential for increased chargeoffs. The changes in the allocation to loan portfolio segments from December 31, 1991 to December 31, 1992 reflect changes in criticized and classified loan balances. The decreased allocation to construction loans is attributable to a decrease in criticized loans due to full collection or principal reducing payments received from customers. The increased allocation to commercial and consumer loans is attributable to a reduced level of recoveries.
ASSET AND LIABILITY MANAGEMENT
The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest-rate risk. The principal sources of asset liquidity are investment securities available for sale. At December 31, 1993, investment securities available for sale totaled $168.8 million.
The Company generates significant liquidity from its operating activities. The Company's profitability in 1993, 1992 and 1991 generated substantial increases in the cash flow provided from operations for such years to $28.4 million, $33.4 million and $26.7 million, respectively.
Additional cash flow is provided by financing activities, primarily the acceptance of customer deposits and short-term borrowings from banks. After a considerable increase in deposits in 1991 of $66.2 million, growth was only $600,000 in 1992 and the Company experienced a decline of $58.7 million in 1993 mostly due to deposits sold in connection with the sale of Sonoma Valley Bank. In addition to a $57.0 million compensating increase in short-term borrowings in 1993, Westamerica Bank issued in December a ten-year, $20.0 million subordinated capital note that qualifies as Tier II Capital and will be used as a source of liquidity for working capital purposes.
The Company uses cash flows from operating and financing activities to make investments in loans, money market assets and investment securities. Continuing with the strategy to reduce its exposure to real estate development loans, net loan repayments were $68.1 million, $32.8 million and $15.5 million in 1993, 1992 and 1991, respectively. The net repayment of loans resulted in added liquidity for the Company, which was used to increase its investment securities portfolios by $153.4 million, $75.8 million and $130.0 million in 1993, 1992 and 1991, respectively.
Interest rate risk is influenced by market forces. However, that risk may be controlled by monitoring and managing the repricing characteristics of assets and liabilities. In evaluating exposure to interest rate risk, the Company considers the effects of various factors in implementing interest rate risk management activities, including the utilization of interest rate swaps. Interest rate swaps outstanding at December 31, 1993 had aggregate notional amounts of $110.0 million of which $50.0 million matures in 1994 and $60.0 million matures in 1995. These interest rate swaps were entered into to hedge the adverse impact interest rate fluctuations have on interest-bearing transaction and savings deposits in the current interest rate environment.
The primary analytical tool used by Management to gauge interest-rate sensitivity is a simulation model used by many major banks and bank regulators. This industry standard model is used to simulate the effects on net interest income of changes in market interest rates that are up to 2 percent higher or 2 percent lower than current levels. The results of the model indicate that the mix of interest rate sensitive assets and liabilities at December 31, 1993 would not, in the view of Management, expose the Company to an unacceptable level of interest rate risk.
CAPITAL RESOURCES
The Company's capital position represents the level of capital available to support continued operations and expansion. The Company's primary captial resource is shareholders' equity, which increased $8.8 million or 6.1 percent from the previous year end and increased $23.0 million or 17.8 percent from December 31, 1991.
As a result of the Company's profitability, the retention of earnings and slow asset growth, the ratio of equity to total assets increased to 7.6 percent at December 31, 1993, up from 7.3 percent at December 31, 1992 and 6.6 percent at December 31, 1991. Tier I risk-based capital to risk-adjusted assets increased to 11.11 percent at December 31, 1993, from 10.02 percent at year end 1992. The ratio of total risk-based capital to risk-adjusted assets increased to 14.40 percent at December 31, 1993, from 12.01 percent at December 31, 1992.
Capital to Risk-Adjusted Assets
Minimum Regulatory Capital Minimum Regulatory Capital At December 31, 1993 1992 Requirements - ----------------------------------------------------------- Tier I Capital 11.11% 10.02% 4.00% Total Capital 14.40 12.01 8.00 Leverage ratio 7.42 7.39 4.00
The risk-based capital ratios improved in 1993 due to two factors: equity capital grew at a faster rate than total assets, and the decline in loan volumes and increase in investment securities reduced the level of risk-adjusted assets.
FINANCIAL RATIOS
The following table shows key financial ratios for the periods indicated.
For the Years Ended 1993 1992 1991 - ------------------------------------------------------------------------- Return on average total assets 0.48% 0.77% 0.62% Return on average shareholders' equity 6.51% 11.16% 9.52% Average shareholders' equity as a percent of: Average total assets 7.33% 6.93% 6.48% Average total loans 12.70% 11.22% 9.81% Average total deposits 8.32% 7.67% 7.21%
DEPOSITS
The following table sets forth, by time remaining to maturity the Company's domestic time deposits in amounts of $100,000 or more (in thousands of dollars).
Time Remaining to Maturity December 31, 1993 1992 1991 - ------------------------------------------------------------ Three months or less $73,988 $92,581 $139,487 Three to six months 23,817 46,378 58,564 Six months to 12 months 10,503 12,895 10,695 Over 12 months 4,685 6,630 6,699 - ------------------------------------------------------------ Total $112,993 $158,484 $215,445 ============================================================
See additional disclosures in Note 6 to Consolidated Financial statements on page 52 of this report.
SHORT-TERM BORROWINGS
The following table sets forth the short-term borrowings of the Company. (In thousands)
December 31 1993 1992 1991 - ----------------------------------------------------------------------- Federal funds purchased $25,000 $ -- $ --
Other borrowed funds: Retail repurchase agreements 28,038 4,099 3,204 Other 16,026 7,939 6,366 - ----------------------------------------------------------------------- Total other borrowed funds $44,064 $12,038 $9,570 - ----------------------------------------------------------------------- Total funds purchased $12,038 $12,038 $9,570 =======================================================================
Further details of the other borrowed funds are: (In thousands)
December 31 1993 1992 1991 - ------------------------------------------------------------------------ Outstanding Average during the year $37,284 $11,509 $18,865 Maximum during the year 68,608 19,055 44,558 Interest rates Average during the period 3.13% 4.73% 6.51% Average at period end 3.04 3.23 6.80
NON-INTEREST INCOME
Components of Non-Interest Income (In millions) 1993 1992 1991 - ----------------------------------------------------------------------- Service charges on deposit accounts $ 12.8 $ 12.4 $ 12.1 Merchant credit card 2.2 2.9 2.9 Mortgage banking income 1.5 1.8 1.5 Brokerage commissions .8 .6 .4 Net investment securities gains -- 1.1 1.7 Sale of Sonoma Valley Bank .7 -- -- Automobile receivable servicing 1.3 -- .5 Other 4.6 5.0 4.9 - ----------------------------------------------------------------------- Total $ 23.9 $ 23.8 $ 24.0 =======================================================================
Non-interest income increased to $23.9 million in 1993. Higher income from servicing automobile receivables, the sale of the Company's 50 percent interest in Sonoma Valley Bank, higher brokerage commissions, increased fees from deposit services, gains recognized on the sale of Napa Valley Bancorp cardholder portfolio and lower write-offs of mortgage service receivables, were partially offset by lower credit card merchant fees and lower mortgage servicing fees. 1992 non-interest income also reflects $1.1 million gains on the sale of investment securities held for sale. In 1992, non-interest income decreased $200,000 from the previous year, resulting principally from lower gains of investment securities held-for-sale and lower income from servicing automobile receivables partially offset by higher deposit account fees, mortgage banking income and brokerage commissions.
NON-INTEREST EXPENSE
Components of Non-Interest Expense (In millions) 1993 1992 1991 - ------------------------------------------------------------------- Salaries $ 31.6 $ 33.7 $ 34.7 Other personnel benefits 7.4 7.2 7.1 Other real estate owned 13.2 6.2 2.9 Occupancy 8.6 8.5 8.4 Equipment 6.2 5.3 5.5 FDIC insurance assessment 4.1 4.0 3.5 Data processing 3.7 3.1 3.0 Professional fees 3.1 3.3 3.3 Operational losses 2.0 .7 .5 Stationery and supplies 1.9 1.7 1.8 Advertising and public relations 1.8 1.8 2.0 Loan expense 1.6 1.4 1.3 Merchant credit card 1.1 1.7 1.9 Insurance .9 1.0 .7 Other 9.4 10.0 8.3 - ------------------------------------------------------------------- Total $ 96.6 $ 89.6 $ 84.9 =================================================================== Average full-time equivalent staff 905 1,092 1,148
Non-interest expense increased $7.0 million or 8 percent in 1993 compared with an increase of $4.7 million or 6 percent in 1992. The increase in 1993 is the direct result of merger-related foreclosed real estate owned expenses, reflecting a $10.0 million write-down of assets acquired in the Merger to fair value net of estimated selling costs reflecting the implementation of the Company's workout strategy, and other costs associated with the Merger, including $1.2 million in relocation costs, chargeoffs of $921,000 for obsolete furniture and equipment, $745,000 in investment banker fees, and other merger-related costs totaling approximately $1.2 million. Partially offsetting these increases in 1993 non-interest expense, salaries decreased $2.1 million, or 6 percent, reflecting the benefits realized from consolidation of operations after the Merger. Merchant credit card, professional fees and insurance expenses also decreased from 1992.
The ratio of average assets per full-time equivalent staff was $2.2 million in 1993 compared to $1.8 million in 1992; the Company strategy to improve efficiency can be clearly seen in the reduction of the average number of full-time equivalent staff from 1,092 in 1992 to 905 in 1993.
PROVISION FOR INCOME TAX
The provision for income tax decreased $4.9 million in 1993 as a direct result of lower pretax income and a $394,000 revaluation adjustment of deferred tax assets due to an increase in statutory tax rates. The provision was $3.0 million in 1993 compared to $7.9 million in 1992 and $5.8 million in 1991. The higher provision in 1992 is a direct result of higher pretax income.
ITEM 8. | 311094 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA.
On July 19, 1993, Park Ridge was merged with and into the registrant. The merger has been recorded as a "pooling of interests". Under this method of accounting, when the entities before and after a merger are under common control with the same management, the operations are combined at historical cost. Consequently, the selected consolidated financial information of the registrant set forth in the following table prior to 1993 has been restated for all periods prior to the effective date of the merger, and is identical to and has been extracted from the audited consolidated financial statements of Park Ridge for such periods. The selected financial data for 1993 has been extracted from the audited consolidated financial information of the registrant for the year ended December 31, 1993. The information in the tables and the notes thereto should be read in conjunction with the "Management's Discussion and Analysis" and the registrant's consolidated financial statements and the notes thereto, which are included elsewhere in this Report.
- ---------- (a) thru (g) see pages 13 and 14.
ITEM 6. SELECTED FINANCIAL DATA (continued).
(a) Depreciation of revenue earning equipment for the year 1993 includes net credits of $28.1 million as compared to net credits of $16.9 million in 1992, primarily attributable to higher proceeds received in 1993 on disposal of the equipment. The tax provision for the year 1993 includes a $1.1 million charge relating to the increase in net deferred tax liabilities as of January 1, 1993 due to changes in the tax laws enacted in August 1993, and a $2.0 million credit resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between its former parent companies, UAL and RCA.
Effective January 1, 1993, the registrant adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes ("FAS No. 109"), which requires the recognition of deferred tax assets, net of applicable reserves, related to net operating loss carryforwards and certain temporary differences. The changes made in FAS No. 109, as they relate to the registrant, did not have a material effect on the registrant's consolidated financial position, results of operations or cash flows.
(b) Depreciation of revenue earning equipment for the year 1992 includes net credits of $16.9 million as compared to net charges of $5.4 million in 1991, primarily attributable to higher proceeds received in 1992 on disposal of the equipment and the elimination of losses incurred in 1991 due to the increase in 1992 of "nonrisk" vehicles acquired which are returned to the vehicle manufacturers at pre-established prices.
The tax provision includes credits of $9.8 million, $16.7 million, and $38.8 million for the years 1992, 1991 and 1990, respectively, resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between the registrant and its former parent companies, UAL and RCA, and the reversal of tax accruals no longer required and benefits realized relating to certain foreign operations. The tax provision for the year 1991 also includes benefits of $5.5 million related to the close down and sale of certain unprofitable foreign operations.
The decrease in income before income taxes for the year ended December 31, 1991, as compared to the prior year, was due to provisions made in 1991 of approximately $20 million primarily incurred to close down certain unprofitable foreign operations and depreciation adjustments made to residual values of certain vehicles, $15 million of lower interest income in 1991 primarily relating to refunds of prior years' income taxes, and the adverse effects of the decrease in travel due to the war in the Persian Gulf and a slowdown in the economy. The decrease was partly offset by net credits of $8.9 million relating to the sale and disposition of certain properties.
(c) The tax provision for the year 1990 was favorable as compared to the tax provision for the prior year due to credit adjustments of $38.8 million recorded in 1990, resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between the registrant and its former parent companies, UAL and RCA.
ITEM 6. SELECTED FINANCIAL DATA (continued).
(d) Effective January 1, 1992, the registrant adopted the provisions of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions ("FAS No. 106"), which requires that postretirement health care and other non-pension benefits be accrued during the years the employee renders the necessary service. Prior to 1992, the registrant accrued for such benefits on a pay-as-you-go basis. As of January 1, 1992, the registrant recorded a cumulative decrease in net income of $4.3 million (net of $2.7 million tax benefit) as a result of implementing FAS No. 106.
(e) Effective January 1, 1991, the registrant adopted the provisions of FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts ("FAS No. 90-1"), which requires that proceeds received from warranty contracts should be deferred and recognized in income on a straight line basis over the contract period, and costs of services performed under the contract should be charged to expense as incurred. Prior to 1991, when vehicles were sold under an extended warranty contract, the proceeds received by the registrant under such contract, net of estimated costs to be incurred in fulfilling obligations under those contracts, were recorded in income when the sale occurred. As of January 1, 1991, the registrant recorded a cumulative decrease in net income of $3.5 million (net of $2.2 million tax benefit) as a result of implementing FAS No. 90-1.
(f) Effective January 1, 1989, the registrant adopted the provisions of Statement of Financial Accounting Standards No. 96, Accounting for Income Taxes ("FAS No. 96"), which requires the use of the liability method in accounting for income taxes. Deferred tax assets and liabilities are recorded based on the differences between the financial statement and tax bases of assets and liabilities and the tax rates in effect when these differences are expected to reverse. In addition, deferred tax amounts are recorded with respect to assets and liabilities acquired in business combinations prior to adoption, when prior years' financial statements are not restated to reflect adoption of FAS No. 96. The cumulative decrease in net income as a result of implementing FAS No. 96 was $2 million.
(g) Earnings have been calculated by adding interest expense and the portion of rentals estimated to represent the interest factor to income before income taxes. Fixed charges include interest charges (including capitalized interest) and the portion of rentals estimated to represent the interest factor.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
1993 vs. 1992
Revenues in 1993 of $2,855 million increased by $39 million as compared to 1992. This improvement was primarily attributable to gains in the car rental operations resulting from a greater number of transactions and domestic rate increases, and higher revenues in telecommunication services and construction equipment rental and sales due to increased volume. These increases were principally offset by decreases in car leasing and car rental revenues resulting from changes in foreign exchange rates.
Total expenses decreased $31 million to $2,753 million in 1993 as compared to $2,784 million in 1992. Direct operating expense increased principally due to higher costs in the car rental operations and in telecommunication services; these increases were partly offset by decreases resulting from changes in foreign exchange rates. Depreciation of revenue earning equipment increased primarily due to an increase in vehicles and equipment operated and the discontinuance by the domestic automobile manufacturers of fleet purchase cash incentives; partly offset by higher net proceeds received on disposal of revenue earning equipment in excess of book value, principally relating to the foreign and the construction equipment rental operations. In 1993, approximately 91% of the vehicles in the fleet were "nonrisk", which at the time of disposition will not result in any gain or loss. Selling, general and administrative expense decreased primarily due to lower administrative and advertising costs and changes in foreign exchange rates. The decrease in interest expense was primarily due to lower interest rates and higher interest income in 1993.
The tax provision of $49 million in 1993 was $27 million higher than the tax provision in 1992, primarily due to higher income before income taxes in 1993 and changes in effective tax rates. The 1993 tax provision includes a $1.1 million charge relating to the increase in net deferred tax liabilities as of January 1, 1993 due to changes in the tax laws enacted in August 1993. The 1993 and 1992 tax provisions include credits of $2.0 million and $9.8 million, respectively, resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between the registrant and its former parent companies, UAL and RCA. See Item 6 - Selected Financial Data and the notes thereto, and Notes 1 and 8 of the Notes to Consolidated Financial Statements included in this Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (continued).
1992 vs. 1991
Revenues in 1992 of $2.8 billion increased by $.2 billion as compared to 1991. This improvement was primarily attributed to higher revenues in the car rental operations resulting from an increase in travel and changes in exchange rates; increased revenues in claim administration and telecommunication services due to increased volume in the businesses partly due to acquisitions; and, in Europe, higher revenues in car leasing and car dealership operations due to the higher volume of business, changes in the mix of vehicles being leased, and changes in exchange rates. These increases were partly offset by lower revenues in the foreign operations of construction equipment rental and sales.
Total expenses increased $.2 billion to $2.8 billion in 1992 as compared to $2.6 billion in 1991. Direct operating expense increased principally due to higher volume in the car rental operations, increased costs in the claim administration and telecommunications service operations, higher costs in the domestic car rental operations for public liability and property damage claims, and net credits of $8.9 million included in 1991 relating to the sale and disposition of certain properties. Depreciation of revenue earning equipment increased primarily due to an increase in 1992 in the size of the car rental fleet and higher prices for the automobiles, substantially offset by higher net proceeds received on disposal of revenue earning equipment in excess of book value, and the additional depreciation recorded in 1991 to adjust residual values of certain vehicles partly related to the close down of certain unprofitable foreign operations. The adjustments included in depreciation of revenue earning equipment upon disposal of the equipment were $16.9 million credit in 1992 and $5.4 million charge in 1991; the improvement in 1992 was primarily attributable to the elimination of losses incurred in 1991 due to the increase in "nonrisk" vehicles in 1992, and higher proceeds received in 1992 on the sale of other equipment. In 1992, approximately 93% of the vehicles in the fleet were "nonrisk", which at the time of disposition will not result in any gain or loss. Selling, general and administrative expense increased primarily due to higher administrative expenses partly due to changes in exchange rates. The increase in interest expense was due to higher debt levels partly offset by lower interest rates in 1992.
The tax provision of $22 million in 1992 was higher than the tax benefit of $1 million in 1991, primarily due to higher income before income taxes in 1992 and larger tax credits included in 1991. Tax credits of $9.8 million were included in 1992 and $22 million were included in 1991 resulting from adjustments made to tax accruals in connection with tax audit evaluations and the effects of prior years' tax sharing arrangements between the registrant and its former parent companies, UAL and RCA, and in 1991 the reversal of tax accruals no longer required and benefits realized relating to certain foreign operations. See Item 6 - Selected Financial Data and the notes thereto, and Notes 1 and 8 of the Notes to Consolidated Financial Statements included in this Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (continued).
Liquidity and Capital Resources
Hertz' principal assets are highly liquid, consisting mainly of passenger automobiles and fairly standard classes of construction equipment. Disposal channels for these assets, including availability of vehicle manufacturers' guaranteed buyback programs, are large, well defined, and capable of absorbing Hertz' short fleet rotation requirements. Customer accounts receivable also turn rapidly and generate significant liquidity with approximately 30 days of sales outstanding. Cash requirements are highly seasonal, peaking when fleet acquisitions are the heaviest. In the annual business cycle, a typical low point for cash needs occurs during the fourth quarter. Hertz funds its domestic short-term borrowing requirements in the commercial paper market and through credit facilities with various banks. Hertz also has access to all global capital markets for its long-term debt requirements. Funding requirements of Hertz' foreign operations are generally provided through local currency short-term and revolving loans with local banks.
During 1993 net cash flows used for operating activities of $558 million were primarily used for the net expenditures of revenue earning equipment. These expenditures were funded by net borrowings of $442 million, which included proceeds from the issuance of long-term debt of $846 million.
The registrant has on file with the Securities and Exchange Commission, under Rule 415, a Registration Statement on Form S-3 which, as of December 31, 1993, allows the registrant to offer from time to time up to $300 million aggregate principal amount of its unsecured senior and senior subordinated debt securities on terms to be determined at the time the securities are offered for sale. In connection with this filing, the registrant issued in April 1993, $100 million, 6-1/2% Senior Notes, which mature April 1, 2000; issued in October 1993, $100 million, 6-3/8% Senior Notes, which mature October 15, 2005; and subsequently issued in February 1994, $150 million, 6% Senior Notes, which mature February 1, 2001. The funds were used for general corporate purposes and to reduce short-term borrowings.
In July 1993, the registrant filed with the Securities and Exchange Commission, under Rules 415 and 430A, an additional Registration Statement on Form S-3, which allowed the registrant to offer from time to time up to $500 million aggregate principal amount of its unsecured debt securities, which may be senior, senior subordinated or junior subordinated in priority of payment, on terms to be determined at the time the securities are offered for sale. In connection with this filing, the registrant issued on July 19, 1993, $150 million, 6-5/8% Junior Subordinated Notes, which mature July 15, 2000; and $250 million, 7% Junior Subordinated Notes, which mature July 15, 2003. The proceeds from these borrowings were used to repay $334.3 million promissory notes of Park Ridge and to reduce short-term borrowings.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION (continued).
Liquidity and Capital Resources (continued)
As of December 31, 1993, under a lease agreement with a third party lessor, the registrant may, at its option, lease from the third party lessor up to $500 million net cost of vehicles at any one time. At December 31, 1993, the net cost of the vehicles leased under this agreement was approximately $407 million (see Note 7 of the Notes to Consolidated Financial Statements included in this Report).
At December 31, 1993, Hertz had approximately $1.6 billion of consolidated unused lines of credit subject to customary terms and conditions, which includes unused amounts under domestic bank facilities totalling $500 million to support commercial paper and other short-term borrowings.
At December 31, 1993, approximately $52 million of the registrant's consolidated shareholders' equity was free of dividend limitations pursuant to its existing debt agreements.
In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", which requires a more detailed disclosure of debt and equity securities held for investment, the methods to be used in determining fair value, and when to record unrealized holding gains and losses in earnings or in a separate component of shareholders' equity for fiscal years beginning after December 15, 1993. Implementation of the standard is not expected to have a material effect on Hertz' consolidated financial position, results of operations or cash flows.
Financial reporting in the United States has traditionally been expressed by virtually all companies in terms of historical or actual costs only. Financial data comparing historical dollars expended or received in different years do not reflect the impact of inflation for Hertz, except, as of December 30, 1987, in accordance with the purchase method of accounting, assets and liabilities of Hertz were recorded at their estimated fair value. As a result of this change, the value of Hertz' net assets included the effects of inflation as of December 30, 1987. Since a significant portion of the assets of Hertz, namely "revenue earning equipment" is held for a short period of time, the effects of inflation on Hertz' financial data after December 30, 1987 are not significant.
ITEM 8. | 47129 | 1993 |
Item 6. Selected Financial Data ------- -----------------------
The selected financial data for the Company as of
December 31, 1993 and for the five years then ended, which is
required to be included pursuant to this Item 6, is included under
the caption "Selected Consolidated Financial Data" on page 11 of
the 1993 Annual Report and is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of ------- Financial Condition and Results of Operations ---------------------------------------------
Management's discussion and analysis required to be
included pursuant to this Item 7 is included under the caption
"Management's Discussion and Analysis of Financial Condition and
Results of Operations" on pages 12 and 13 of the 1993 Annual
Report and is incorporated herein by reference.
Item 8. | 205402 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
FIRST FINANCIAL MANAGEMENT CORPORATION
The following data should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Company's merger with International Banking Technologies, Inc. ("IBT") in August 1993 has been accounted for as a pooling of interests and, accordingly, the following information (including share information) has been restated to include both FFMC and IBT. During each of the periods presented below, FFMC has made various acquisitions, accounted for as purchases, which affect the comparability of information presented. For additional information concerning the Company's acquisitions, see Note B to the consolidated financial statements. In addition, in 1992 the Company disposed of one of its two business segments and recorded a loss in another business unit that was sold. These dispositions are outlined in Note C to the consolidated financial statements.
* Includes loss in business unit sold of $79,567 ($1.10 after-tax loss per share).
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CONTINUING AND DISCONTINUED OPERATIONS
The continuing operations of First Financial Management Corporation (the "Company" or "FFMC") consist of its information services businesses together with the corporate entity. These businesses provide a vertically integrated set of data processing, storage and management products for the capture, manipulation and distribution of information. Similarities exist among these businesses in the methods of providing services, in the customers served, and in the marketing activities utilized to obtain new customers. In addition, the Company continues to pursue further integration of its product and service offerings to gain competitive advantages. Services include merchant credit card authorization, processing and settlement; check guarantee and verification; debt collection and accounts receivable management; data imaging, micrographics and electronic data base management; health care claims processing and integrated management services; and the development and marketing of data communication and information processing systems, including in-store marketing programs and systems for supermarkets.
Discontinued operations consist of the Company's previous financial services businesses, comprised of Georgia Federal Bank, FSB ("Georgia Federal"), formerly the largest thrift institution in Georgia, together with First Family Financial Services ("First Family"), which previously was Georgia Federal's regional consumer finance subsidiary.
FFMC consummated several significant business transactions in 1993 that resulted from the Company's strategic reevaluation of its businesses completed during 1992. During the fourth quarter of 1992, the Company entered into agreements to sell First Family and Georgia Federal. These sales were consummated on November 10, 1992 and June 12, 1993, respectively. FFMC also agreed to sell Basis Information Technologies, Inc. ("Basis") during 1992's fourth quarter. Basis was the unit within the Company's information service businesses that provided data processing services to financial institutions. The sale of Basis was consummated on February 10, 1993.
The terms of both the Georgia Federal and Basis sale agreements provided that the results of operations of these businesses after December 31, 1992 accrued to the respective purchasers. Accordingly, the Company's financial results do not include results for these businesses for the year ended December 31, 1993.
Prior to entering into the agreement for the sale of Basis, the Company discontinued software development and wrote off related costs for a major product line in connection with the settlement of litigation with a vendor, the combination of which resulted in income of $13.8 million included in other revenues. Concurrently, the Company decided to explore the sale of Basis. In reviewing the potential market value of Basis, FFMC's management determined that a write-down of the carrying value of Basis' net assets was appropriate. Accordingly, the Company recognized a pretax loss of $79.6 million, an after-tax loss of $1.10 per share in 1992. Revenues attributable to Basis were $113.8 million in 1992 and its contribution to income before income taxes, aside from the items mentioned above, was approximately $4.5 million.
In August 1993, FFMC completed its merger with International Banking Technologies, Inc.
("IBT"). This business combination has been accounted for as a pooling of interests and, accordingly, the following discussions include IBT as a part of FFMC's continuing operations for all periods presented.
RESULTS OF OPERATIONS
The following discussions pertain to the Company's continuing operations.
1993 Compared with 1992
FFMC's revenues increased 17% to $1.7 billion in 1993 from $1.4 billion in the prior year. Excluding Basis' 1992 revenues, the revenue growth rate for the year was 27%. Income from continuing operations increased to $127.6 million in 1993 from $18.8 million in 1992. Excluding the Basis asset write-down from the prior year's results, income from continuing operations increased 53% in 1993 compared with the prior year. Income per share from continuing operations increased to $2.10 per share in 1993, compared with $.32 in 1992. Per share earnings increased 48% over 1992 excluding the Basis write-down.
The effect on the year-to-year revenue comparison of excluding Basis' 1992 revenues is largely offset by the incremental 1993 revenue contributions from the 1992 acquisitions of ALTA Health Strategies, Inc., renamed as FIRST HEALTH Strategies ("Strategies"), in April 1992 and TeleCheck Services, Inc. and its principal franchisee, Payment Services Company - U.S. (collectively referred to as "TeleCheck"), in July 1992. As a result, the 17% increase in revenues in 1993 is all attributable to internal growth.
The internal growth in 1993 was due primarily to significant volume growth within FFMC's existing businesses which more than offset continued pricing pressures in several of FFMC's product areas. The Company's merchant services areas experienced strong volume growth in its credit card services and check verification and guarantee businesses. Record new customer volume was added from marketing efforts, including national, regional and local merchants. In addition, FFMC continued to cross-sell the multiple product offerings within its merchant services area, which resulted in the signing of additional national merchants to processing contracts. FFMC also experienced volume growth in its health care services area, with increases in claims processing for both public and private sectors. Health care businesses received contract awards or began claims processing under previously awarded contracts during 1993. The Company's imaging business experienced volume growth in 1993, which competitive pricing pressure partially offset to produce a small increase in revenues for the year.
FFMC demonstrated the leveragibility of its businesses by translating the revenue increases, despite the pricing pressures noted above, into higher percentage rate increases in pretax income, thereby producing higher pretax margins. The Company's pretax margin was 12.9% in 1993 compared with a 10.2% pretax margin in 1992 (excluding the Basis write-down). Margins were also favorably influenced by the Company's continued emphasis on expense controls and the successful integration of acquisitions completed in 1992. Depreciation and amortization expenses declined 8% in 1993 primarily due to the inclusion of Basis in 1992. General and administrative expenses increased only 2% for the year (and decreased as a percent of revenues) as the Company enjoyed the benefit of the restructuring of its corporate infrastructure which occurred as a result of the 1992 strategic evaluation of the Company.
The impact of the revenue increases and the expansion of margins in 1993 was enhanced by
lower net interest expense during 1993. FFMC experienced lower borrowing levels in 1993, as a substantial portion of its debt obligations were repaid during the second quarter from cash received from the sale of businesses. Proceeds from these sales, along with increased cash generated from operations, resulted in higher levels of cash investments during the second half of 1993 which favorably impacted the Company's net interest expense for the year.
FFMC adopted Statement of Financial Accounting Standards No. 109 ("FAS 109"), "Accounting for Income Taxes," effective January 1, 1993. The Company elected the prospective method of adoption allowable under FAS 109 instead of restating prior period results. The cumulative effect on the Company's results of operations of adopting FAS 109 was not material, and no adjustment was recorded. In addition, the Omnibus Budget Reconciliation Act of 1993 (the "1993 Act") was signed into law during 1993 which contained several provisions which affected the Company's 1993 income tax expense.
The Company's effective tax rate decreased 1.5% in 1993 to 40.8%. The comparable prior year rate of 42.3% excludes the impact of the Basis write-down. The decrease, which occurred despite the 1% increase in the federal corporate tax rate, is attributable to lower levels of nondeductible goodwill, lower effective state tax rates and other favorable impacts of the 1993 Act and the Company's tax strategies.
1992 Compared with 1991
FFMC's revenues increased 35% to $1.4 billion in 1992 from $1.1 billion in 1991, primarily from new business acquisitions and revenue growth within existing businesses. Both income from continuing operations and related per share amounts decreased in 1992 compared with 1991's results. However, excluding the Basis asset write-down of $79.6 million, the Company's 1992 income from continuing operations increased 33% to $83.5 million from the $62.7 million reported in 1991. Fully diluted income per share from continuing operations, excluding the Basis write-down, increased 15% to $1.42 from $1.23 in 1991.
Revenue growth from business acquisitions in 1992 resulted primarily from the Company's acquisition of Strategies (April 1992) and TeleCheck (July 1992). Existing businesses expanded revenues in 1992 from volume increases as a result of new customers and expanded business with existing customers. The merchant credit card processing area benefited from an increase in retail activity during the 1992 holiday season in the fourth quarter. Health care services experienced increased claims processing volume and received several new long-term contracts with government agencies and became fully operational on several other processing contracts.
Higher personnel costs within the newly acquired Strategies and TeleCheck businesses in 1992 caused operating expenses, as a percentage of service revenues, to increase in 1992 over the prior year. In addition, 1992's business acquisitions increased goodwill amortization from prior year levels. Interest expense (net of interest income) declined in 1992 due to lower interest rates and reduced borrowing levels due to the conversion of all of the Company's convertible subordinated debentures into common stock in October 1991, and repayment of borrowings under FFMC's revolving credit facility from the cash proceeds received from the First Family sale.
FFMC's continuing operations, excluding the Basis asset write-down, generated 1992 earnings before taxes of $144.7 million, a pretax margin of 10.2%. This margin is consistent with the 9.9% pre-tax margin on earnings before income taxes of $104.6 million in 1991. The Company's 1992 effective
tax rate of 71.1% was substantially above the federal statutory rate due to the nondeductibility of the majority of the Basis asset write-down. Excluding the effect of the write-down, FFMC's provision for income taxes from continuing operations increased to 42.3% in 1992 from 40.1% in 1991. This increase was due primarily to increased state income taxes, lower IBT Subchapter S income taxed at the shareholder level, and lower tax credits.
ECONOMIC FLUCTUATIONS
The Company's business is somewhat insulated from economic fluctuations due to recurring revenues from long-term service contracts, and the fact that the Company's services often result in cost savings for its customers. The slow growth, but steadily improving economic environment during 1993 benefited FFMC's results, as the Company experienced higher year-to-year processing volumes, particularly in its merchant services area. The results of FFMC's health care services area have not been significantly affected by recent reform oriented developments in that industry.
The Company's business is not seasonal, except that its revenues, earnings and margins are favorably affected in the fourth quarter, primarily by increased merchant credit card and check volume during the holiday season.
Although FFMC cannot precisely determine the impact of inflation on its operations, inflation affects the Company through increased costs of employee compensation and other operating expenses. In addition, competition for employees with data processing skills, programming expertise, and other technical knowledge contributes to increased costs in some parts of the country. To the extent permitted by the Company's service contracts, these increases in costs are passed along to customers in the form of periodic price increases. FFMC's revenues from merchant credit card processing and check verification and guarantee services are generally a percentage of the dollar volume of transactions processed. The Company's operating margins on these services are therefore relatively insulated from the effects of inflation on merchant prices for goods and services. As a result, the Company has not been significantly affected by inflation.
CAPITAL RESOURCES AND LIQUIDITY
The following discussions pertain to the Company's continuing operations, and the effects on cash flows of FFMC's business dispositions.
Cash generated from operating activities increased 42% in 1993 to $207 million, as compared with the $146 million generated in 1992 and $121 million in 1991. This increase was due primarily to increased income from continuing operations. FFMC reinvests cash in its businesses, principally for property and equipment additions, software development and customer conversions. Amounts reinvested totalled $80 million in 1993 compared with $78 million in 1992 and $67 million in 1991. The Company anticipates that the level of these capital investments in its existing businesses for 1994 will be similar to 1993 amounts. Cash from operating activities exceeded non-acquisition investing activities by $128 million in 1993, $68 million in 1992, and $53 million in 1991.
FFMC activated its credit card bank, First Financial Bank ("FFB"), during the second quarter of 1993 with a required initial capitalization of $70 million. The capitalization of FFB is based upon requirements of bank card associations given the size of FFMC's credit card processing operations. The primary purpose of FFB is to support the Company's merchant services activities, a function previously
provided by Georgia Federal Bank. Except for the support FFB provides for FFMC's merchant services activities, FFB does not conduct any significant banking activities, accept deposits from unaffiliated parties, or engage in lending activities. FFB's capitalization and activities comply with applicable regulatory requirements and restrictions.
The Company received $345 million in cash in 1993 through dividends from its discontinued operation and from the sale of businesses, after expenses, that were completed during 1993. The Company also had received $150 million in cash from Georgia Federal during 1992, comprised of a $100 million dividend and a $50 million payment toward the settlement of income tax liabilities from the sale of First Family which were paid by FFMC during 1993. The Company utilized these proceeds to repay $154 million of long-term debt obligations in 1993 and $146 million in 1992, including all outstanding borrowings under FFMC's revolving credit facility. The Company's long-term debt to equity ratio dropped to 1.2% at December 31, 1993 from 13.9% at December 31, 1992.
Cash consideration paid for business acquisitions (net of cash acquired), including amounts paid related to acquisitions completed in prior years, utilized $92 million in 1993, $267 million in 1992 and $72 million in 1991. The Company funded the 1993 acquisitions from cash resulting from operations and from cash balances generated from the sale of businesses. FFMC utilized capital markets and borrowings under debt arrangements to supplement excess cash generated from operations to fund its acquisition program in 1992.
FFMC has potential obligations under certain acquisition agreements to pay future consideration to the former shareholders of specified acquired businesses. Any such payments will be due only if the acquired entity's results of operations exceed specified targeted levels which are generally set substantially above the historical experience of the acquired entity. Thus, any such payments will not negatively impact the Company's financial position.
The Company currently has available lines of credit of $460 million; no borrowings were outstanding under these arrangements at December 31, 1993. These arrangements consist primarily of a $450 million unsecured revolving credit facility. This facility has a term ending in June 1995, with two possible one year extensions, and allows FFMC flexibility to reduce borrowing levels with excess cash funds which are not immediately utilized for business investments. Remaining excess cash funds are invested in short-term interest-bearing securities.
The Company continued its practice established in 1989 of paying semi-annual $.05 per share cash dividends to shareholders, maintaining a constant dividend rate per share despite a three-for-two stock split effective March 31, 1992.
FFMC's cash and cash equivalents of $186 million at December 31, 1993, except for cash and cash equivalents in its credit card bank (currently $80 million), are available for acquisitions and general corporate purposes. If suitable opportunities arise for additional acquisitions the Company may use cash, draw on its credit facilities, or use common stock or other securities as payment of all or part of the consideration for such acquisitions, or FFMC may seek additional funds in the equity or debt markets. The Company believes that its current level of cash and future cash flows from operations are sufficient to meet the needs of its existing businesses.
ITEM 8. | 36326 | 1993 |
859257 | 1993 |
||
79879 | 1993 |
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial and other data for Golden West for the years indicated. Such information is qualified in its entirety by the more detailed financial information set forth in the financial statements and notes thereto appearing in the documents incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA (Continued)
ITEM 6. SELECTED FINANCIAL DATA (Continued)
ITEM 6. SELECTED FINANCIAL DATA (Continued)
(a) Earnings represent income from continuing operations before income taxes and fixed charges. Fixed charges include interest expense and amortization of debt expense. (b) The definition of nonperforming assets includes non-accrual loans (loans that are 90 days or more past due) and real estate owned acquired through foreclosure. (c) The requirements were 1.5%, 3.0%, and 8.0% (7.2% prior to December 31, 1992) for tangible, core, and risk-based capital, respectively, at December 31, 1992, and 1993. World Savings and Loan Association currently meets its fully phased-in capital requirement.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following narrative focuses on the significant financial statement changes that have taken place at Golden West over the past three years and includes a discussion of the Company's financial condition and results of operations during that period. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION
The accompanying table summarizes the Company's major asset, liability, and equity components in percentage terms at yearends 1993, 1992, 1991, and 1990. As the table shows, customer deposits represent the majority of the Company's liabilities. On the other side of the balance sheet, the loan portfolio, which consists primarily of long-term mortgages, is the largest asset component.
The disparity between the repricing (maturity or interest rate change) of deposits and other liabilities and the repricing of mortgage loans can affect the Company's liquidity and can have a material impact on the Company's results of operations. The difference between the repricing of assets and liabilities is commonly referred to as the gap. The gap table on the following page shows that, as of December 31, 1993, the Company's assets reprice sooner than its liabilities. Consequently, one would expect falling interest rates to lower Golden West's earnings and rising rates to increase the Company's earnings. However, Golden West's earnings are also affected by the built-in lag inherent in the Eleventh District Cost of Funds Index (COFI), which is the benchmark the Company uses to determine the rate on the great majority of its adjustable rate mortgages. Specifically, there is a two-month delay in reporting the COFI because of the time required to gather the data needed to compute the index. As a result, the current COFI actually reflects the Eleventh District's cost of ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
funds at the level it was two months prior. Consequently, when the interest rate environment changes, the COFI reporting lag causes assets to initially reprice more slowly than liabilities, enhancing earnings when rates are falling and holding down income when rates rise.
(a) Based on scheduled maturity or scheduled repricing, loans reflect scheduled repayments and projected prepayments of principal. (b) Includes cash in banks, FHLB stock, and loans collateralized by customer deposits. (c) Liabilities with no maturity date, such as passbook and money market deposit accounts, are assigned zero months.
CASH AND INVESTMENTS
Golden West's investment portfolio is composed primarily of federal funds, short-term repurchase agreements collateralized by mortgage-backed securities, and short-term money market securities. In determining the amounts of assets to invest in each class of investments, the Company considers relative rates, liquidity, and credit quality. When opportunities arise, the Company enters into arbitrage transactions with ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
secured borrowings and short-term investments to profit from the rate differential. The level of the Company's investments position in excess of its liquidity requirements at any time depends on liquidity needs and available arbitrage opportunities.
The Office of Thrift Supervision requires insured institutions, such as World Savings, to maintain a minimum amount of cash and certain qualifying investments for liquidity purposes. The current minimum requirement is equal to a monthly average of 5% of customer deposits and short-term borrowings. For the months ended December 31, 1993, 1992, and 1991, World's regulatory average liquidity ratio was 8%, 7%, and 8%, respectively, consistently exceeding the requirement.
Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." FAS 115 establishes three investment classifications: held to maturity, trading, and available for sale. In accordance with FAS 115, the Company modified its accounting policies as of December 31, 1993, to identify investment securities as either held to maturity or available for sale. The Company has no trading securities. Held to maturity securities are recorded at cost with any discount or premium amortized using a method that is not materially different from the interest method. Securities held to maturity are recorded at cost because the Company has the ability to hold these securities to maturity and because it is Management's intention to hold them to maturity. At December 31, 1993, the Company had no securities held to maturity. Securities available for sale increase the Company's portfolio management flexibility for investments and are reported at fair value. Net unrealized gains and losses are excluded from earnings and reported net of applicable income taxes as a separate component of stockholders' equity until realized. At December 31, 1993, the Company had no securities held to maturity or for trading. At December 31, 1993, the Company had securities available for sale in the amount of $1.6 billion and unrealized gains on securities available for sale recorded to stockholders' equity of $41 million. Gains or losses on sales of securities are realized and recorded in earnings at the time of sale and are determined by the difference between the net sales proceeds and the cost of the security, using specific identification, adjusted for any unamortized premium or discount. The Company has other investments which are recorded at cost with any discount or premium amortized using a method that is not materially different from the interest method. The adoption of FAS 115 resulted in the reclassification of certain securities from the investment securities portfolio to the securities available for sale portfolio. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
Prior to December 31, 1993, securities were classified as either securities held for sale or investment securities. Securities held for sale were recorded at the aggregate portfolio's lower of amortized cost or market, with the unrealized gains and losses included in earnings. Investment securities were recorded at amortized cost.
MORTGAGE-BACKED SECURITIES
FAS 115 also requires the same three classifications for mortgage-backed securities: held to maturity, trading, and available for sale. In accordance with FAS 115, the Company modified its accounting policies as of December 31, 1993, to identify MBS as either held to maturity or available for sale. The Company has no trading MBS. Mortgage-backed securities held to maturity are recorded at cost because the Company has the ability to hold these MBS to maturity and because management intends to hold these securities to maturity. Premiums and discounts on MBS are amortized or accreted using the interest method, also known as the level yield method, over the life of the security. At December 31, 1993, the Company had mortgage-backed securities held to maturity in the amount of $408 million. MBS available for sale are reported at fair value, with unrealized gains and losses excluded from earnings and reported net of applicable income taxes as a separate component of stockholders' equity until realized. At December 31, 1993, the Company had mortgage-backed securities available for sale in the amount of $1.1 billion and unrealized gains on mortgage-backed securities recorded to stockholders' equity of $44 million. Gains or losses on sales of MBS are realized and recorded in earnings at the time of sale and are determined by the difference between the net sales proceeds and the cost of the MBS, using specific identification, adjusted for any unamortized premium or discount. Prior to December 31, 1993, all MBS were recorded at amortized cost.
Repayments of MBS during the years 1993, 1992, and 1991 amounted to $646 million, $552 million, and $200 million, respectively. The increase in repayments in 1993 over 1992 and in 1992 over 1991 was primarily due to an increase in refinance activity as many borrowers took advantage of lower interest rates. The portion of the Company's loans receivable represented by MBS was 6%, 8%, and 9% at yearends 1993, 1992, and 1991, respectively.
LOAN PORTFOLIO
New loan originations in 1993, 1992, and 1991 amounted to $6.4 billion, $6.5 billion, and $4.9 billion, respectively. Refinanced loans constituted 59% of new loan originations in 1993 compared to 56% in 1992 and 46% in 1991. The 1993 origination volume remained high due to the continued demand in the marketplace for refinancing of existing loans, plus expansion of the Company's loan origination capacity. Although the Company ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
has lending operations in 21 states, the primary mortgage origination focus continues to be on residential property in California. In 1993, 73% of total loan originations were on residential properties in California, compared to 83% and 88% in 1992 and 1991, respectively. Although California originations continue to be a large portion of total originations, the decrease in 1993 as compared to 1992 and 1991 was due to increased penetration by the Company in markets outside California and the slight decrease of originations in California. The percentage of the total loan portfolio (excluding mortgage-backed securities) that is comprised of residential loans in California was 81% at December 31, 1993, and 83% at December 31, 1992, and 1991. The total growth in the portfolio for each of the years ended December 31, 1993, and 1992, was $1.9 billion or 9%.
Golden West continues to emphasize adjustable rate mortgages (ARMs)--loans with interest rates that change periodically in accordance with movements in specified indexes. The portion of the mortgage portfolio (excluding MBS) composed of rate-sensitive loans was 87% at yearends 1993, 1992, and 1991. Despite stiff competition from mortgage bankers who aggressively marketed fixed-rate mortgages at the lowest rates seen in the past 20 years, Golden West's ARM originations constituted approximately 75% of new mortgage loans made by the Company in 1993, compared with 80% in 1992 and 89% in 1991.
Repayments of loans during the years 1993, 1992, and 1991 amounted to $3.8 billion, $4.1 billion, and $2.8 billion, respectively. The decrease in repayments in 1993 over 1992 was due to lower mortgage payoffs within our loan portfolio. The increase in repayments in 1992 over 1991 was primarily due to an increase in refinance activity as many borrowers took advantage of lower interest rates by replacing older, high-cost debt with new, more attractively priced instruments.
The Company adopted Statement of Financial Accounting Standards No. 114 (FAS 114), "Accounting by Creditors for Impairment of a Loan," in the fourth quarter of 1993, retroactive to January 1, 1993. FAS 114 requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. The valuation allowance and provision for loan losses are adjusted for changes in the present value of impaired loans for which impairment is measured based on the present value of expected future cash flows. The Company had previously measured loan impairment in accordance with the methods prescribed in FAS 114. As a result, no additional loss provisions were required by early adoption of the pronouncement. FAS 114 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
requires that impaired loans for which foreclosure is probable should be accounted for as loans. As a result, $16 million of in-substance foreclosed loans, with a valuation allowance of $7 million, were reclassified from real estate held for sale to loans receivable. Prior year amounts have not been restated.
One measure of the soundness of the Company's portfolio is its ratio of nonperforming assets to total assets. Nonperforming assets include non-accrual loans (loans that are 90 days or more past due) and real estate acquired through foreclosure. In prior years, loans considered in-substance foreclosed were included in real estate held for sale, but upon adoption of FAS 114, impaired loans are now classified with loans receivable. NPAs amounted to $394 million, $330 million, and $282 million at yearends 1993, 1992, and 1991, respectively.
The increase in NPAs in 1993 and 1992 was primarily in single-family loans and foreclosed real estate in California. The continued weak California economy and high unemployment rate resulted in an increase in loan delinquencies and, in certain areas, decreases in real estate prices. The growth in NPAs has also been impacted by high levels of bankruptcy filings, which often delay the collection process and extend the length of time a loan remains delinquent. The Company continues to closely monitor all delinquencies and takes appropriate steps to protect its interests.
The Company's troubled debt restructured, which are loans that have been modified due to a weakness in the collateral and/or borrower, were $37 million, or 0.13% of assets, at December 31, 1993, compared to $13 million, or 0.06% of assets, at December 31, 1992, and $18 million, or 0.08% of assets, at December 31, 1991. The increase is due in part to the FAS 114 reclassification which included loans that had been modified. A majority of the Company's TDRs have temporary interest rate reductions and have been made primarily to customers negatively impacted by adverse economic conditions.
The Company's ratio of NPAs and TDRs to total assets increased to 1.50% at December 31, 1993, from 1.33% and 1.24% at yearends 1992 and 1991, respectively.
REAL ESTATE HELD FOR SALE
Real estate acquired through foreclosure increased to $63 million at December 31, 1993, from $57 million a year earlier. The increase occurred primarily in one- to four-family properties in California. The Company's total Real Estate Held for Sale portfolio decreased to $64 million at December 31, 1993, from $67 million a year earlier due to the reclassification of loans in-substance foreclosed upon adoption of FAS 114 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
during December 1993. The components of the real estate held for sale portfolio at December 31, 1993, 1992, and 1991, are shown below:
(a) All amounts are net of general valuation allowances.
ALLOWANCE FOR LOAN LOSSES
The Company's allowance for loan losses was $107 million at December 31, 1993, compared to $71 million and $48 million at yearends 1992 and 1991, respectively. The provision for loan losses was $66 million, $43 million, and $35 million in 1993, 1992, and 1991, respectively. The 1993 increase in the allowance and the provision over 1992 was considered prudent given the continued difficulties in the California economy, which led to an increase in nonperforming assets and chargeoffs.
CUSTOMER DEPOSITS
Customer deposits increased by $880 million, excluding those arising from acquisition and sales activity, compared to a decrease of $255 million in 1992, excluding branch sales, and an increase of $640 million in 1991. Rates paid on deposit accounts dropped steadily in 1993 and 1992, reaching the lowest level in 20 years for most products. Although rates paid on new accounts were lower than they had been in previous years, consumer funds were attracted during 1993 as a result of special promotions in the Company's savings markets. The Company experienced a net outflow of deposits during 1992 because the Company emphasized other, more cost-effective sources of funds, primarily Federal Home Loan Bank advances. In 1993, the Company acquired seven branches in Arizona containing $320 million in deposits and sold all seven of the Ohio branches with $264 million in deposits. The Company has no brokered deposits. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
ADVANCES FROM FEDERAL HOME LOAN BANKS
The Company uses Federal Home Loan Bank borrowings, also known as "advances," to supplement cash flow and to provide funds for loan origination activities. Advances offer strategic advantages for asset-liability management including long-term maturities and, in certain cases, prepayment at the Company's option. FHLB advances increased by $782 million in 1993 compared to increases of $1.3 billion and $325 million in 1992 and 1991, respectively.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
The Company borrows funds through transactions in which securities are sold under agreements to repurchase. These funds are used to take advantage of arbitrage investment opportunities and to supplement cash flow. Reverse Repos are entered into with selected major government securities dealers, as well as large banks, typically using MBS from the Company's portfolio. Reverse Repos with dealers and banks amounted to $377 million, $486 million, and $579 million at yearends 1993, 1992, and 1991, respectively.
OTHER BORROWINGS
At December 31, 1993, Golden West had on file registration statements with the Securities and Exchange Commission for the sale of up to $100 million of subordinated notes.
Golden West issued subordinated debt securities of $100 million in January 1993, and $200 million in October 1993, bringing the balance to $1.0 billion at December 31, 1993. As of December 31, 1993, the Company's subordinated debt was rated A3 and A- by Moody's Investors Service (Moody's) and Standard & Poor's Corporation (S&P), respectively.
World Savings currently has on file a shelf registration with the OTS for the issuance of $2.0 billion of unsecured medium-term notes. As of December 31, 1993, $1.2 billion was available for issuance. The Association had medium-term notes outstanding under the current and prior registrations with principal amounts of $677 million at December 31, 1993, compared to $81 million at December 31, 1992, and $167 million at December 31, 1991. As of December 31, 1993, the Association's medium-term notes were rated A1 and A+ by Moody's and S&P, respectively.
World Savings also has on file a registration statement with the OTS for the sale of up to $250 million of subordinated notes. Under a prior filing with the OTS, $50 million of subordinated notes remain unissued. As of December 31, 1993, World Savings had issued $200 million of subordinated securities. As of December 31, 1993, World Savings' subordinated notes were rated A2 and A by Moody's and S&P, respectively. The subordinated ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
notes are included in World Savings' risk-based regulatory capital as Supplementary Capital.
STOCKHOLDERS' EQUITY
The Company has increased its total stockholders' equity in each of the years 1993, 1992, and 1991 through the retention of a high percentage of net earnings. In addition, stockholders' equity increased in 1993 by $85 million due to the adoption of FAS 115 as of December 31, 1993.
The Company has on file a shelf registration statement with the Securities and Exchange Commission to issue up to two million shares of its Preferred Stock. The Preferred Stock may be sold from time to time in one or more transactions for total proceeds of up to $200 million. The Preferred Stock may be issued in one or more series, may have varying provisions and designations, and may be represented by depository shares. The Preferred Stock is not convertible into Common Stock. No Preferred Stock has yet been issued under the registration.
On October 28, 1993, the Company's Board of Directors' authorized the purchase by the Company of up to 3.2 million shares of Golden West's common stock. As of December 31, 1993, 204,000 shares had been repurchased and retired.
The OTS requires federally insured institutions, such as World, to meet minimum capital requirements. Under these regulations, a savings institution is required to meet three separate capital requirements. The first requirement is to have tangible capital of 1.5% of adjusted total assets. At December 31, 1993, World Savings had tangible capital of $2.0 billion, or 7.27% of adjusted total assets, $1.6 billion in excess of the regulatory requirement.
The second requirement is to have core capital of 3% of adjusted total assets. Core capital is defined as tangible capital plus certain allowable amounts of supervisory goodwill and direct investments. However, the amount of supervisory goodwill and direct investments that can be counted as core capital will be phased-down to zero by January 1, 1995. At December 31, 1993, World Savings had core capital of $2.2 billion, or 8.02% of adjusted total assets, $1.4 billion in excess of the regulatory requirement.
The third capital requirement is to have risk-based capital equal to 8.0% of risk-weighted assets. At December 31, 1993, World Savings had risk-based capital in the amount of $2.5 billion, or 17.42% of risk-weighted assets, exceeding the current requirement by $1.4 billion.
It should be noted that World Savings also continues to exceed all three capital requirements on a fully phased-in basis. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
The Federal Deposit Insurance Corporation Improvement Act of 1991 required each federal banking agency to implement prompt corrective actions for capital deficient institutions that it regulates. In response to this requirement, the OTS adopted final rules, effective December 19, 1992, based upon FDICIA's five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The determination of whether an association falls into a certain classification depends primarily on its capital ratios. The following table summarizes the capital ratios for each of the five classifications and shows that World Savings met the "well capitalized" standard as of December 31, 1993.
(a) Core capital divided by adjusted total assets. (b) Core capital divided by risk-weighted assets. (c) Total capital is the same as risk-based capital and consists of such items as qualifying subordinated debt, cumulative perpetual and intermediate-term preferred stock, certain convertible debt securities, and general allowances for loan losses.
The OTS limits capital distributions by savings and loan associations. For purposes of capital distributions, the OTS has classified World Savings as a Tier 1 association; thus, the Association may pay dividends during a calendar year of up to 100% of net income to date during the calendar year plus up to one-half of capital in excess of the fully phased-in requirement ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION (continued)
at the end of the prior year subject to thirty days' advance notice to the OTS.
RESULTS OF OPERATIONS
PROFIT MARGINS/SPREADS
An important determinant of Golden West's earnings is its primary spread--the difference between its yield on earning assets and its cost of funds. The Company's primary spread is somewhat dependent on changes in interest rates because Golden West's liabilities tend to respond more rapidly to rate movements than do its assets. Because of the relatively stable interest rate environment during 1993, the benefit from the COFI timing lag was significantly smaller, resulting in a lower spread than a year ago. The primary spread was unusually high during 1992 because, during that year's falling interest rate environment, the cost of deposits and borrowings declined much faster than the yield on the Company's major earning asset, the loan portfolio, in large part due to the two month reporting lag of the Eleventh District Cost of Funds Index to which $19.5 billion of Golden West's assets are tied.
YIELD ON EARNING ASSETS
Golden West originates ARMs to manage the rate sensitivity of the asset side of the balance sheet. Most of the Company's ARMs have interest rates that change monthly in accordance with an index based on the cost of deposits and borrowings of savings institutions that are members of the FHLB of San Francisco (the COFI). Consequently, when interest rates de- creased in 1991 and 1992, the yield on the Company's loan portfolio also decreased. During 1993, although interest rates were more stable, the index continued to decline somewhat. In addition, during 1992 and 1993, the Company experienced large payoffs of high-rate fixed loans and MBS, which also contributed to the decrease in the yield on loans. The yield on earning assets showed a decline throughout 1991, 1992, and 1993 from a high of 10.22% in January 1991 to 6.61% at December 31, 1993, due in large part to decreases in the COFI during the period.
COST OF FUNDS
Approximately 81% of Golden West's liabilities are subject to repricing in less than one year. Because the cost of these liabilities is affected by short-term interest rates, a fall in the general level of interest rates led to a decrease in the Company's cost of funds during 1993, 1992, and 1991.
The effect of these changes on asset yields and liability costs may be seen in the following table, which shows the components of the Company's primary spread at the end of the years 1991 through 1993. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS (continued)
INTEREST ON LOANS
In 1993 and 1992, interest on loans decreased due to a decline in the average portfolio yield partially offset by an increase in the average portfolio balance.
INTEREST ON MBS
In 1993 and 1992, interest on MBS decreased due to a decline in the average portfolio yield and a decrease in the average portfolio balance.
INTEREST AND DIVIDENDS ON INVESTMENTS
The income earned on the investment portfolio fluctuates, depending upon the volume outstanding and the yields available on short-term investments. Income from the Company's investments was higher in 1993 than in 1992 due to a higher average portfolio balance and increased FHLB dividends. Interest and dividends on investments was lower in 1992 than in 1991 due to a lower portfolio yield.
INTEREST ON CUSTOMER DEPOSITS
The major portion of the Company's customer deposit base consists of savings accounts with remaining maturities of less than one year. Thus, the amount of interest paid on these funds depends upon the level of short-term interest rates and the savings balances outstanding. The decrease in interest on customer deposits in 1993 and 1992 was due to a decrease in the average cost of deposits.
INTEREST ON ADVANCES
Interest paid on FHLB advances was higher in 1993 than in 1992 due to an increase in the average balance of these liabilities partially offset by a decrease in the average cost. Interest paid on FHLB advances was lower in 1992 than in 1991 due to a decrease in the average cost of these liabilities partially offset by an increase in the average balance of these liabilities. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS (continued)
OTHER BORROWINGS
Interest expense on other borrowings amounted to $158 million, $154 million, and $165 million for the years ended 1993, 1992, and 1991, respectively. The increase in the expense from 1993 over 1992 was due to an increase in the average balance of these liabilities partially offset by a decrease in the average cost. The decrease in the expense from 1992 over 1991 was due to a decrease in the average cost of other borrowings and a decrease in the average balance.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $66 million, $43 million, and $35 million for the years ended 1993, 1992, and 1991, respectively. The increase in the provision from 1993 over 1992 and 1992 over 1991 reflected increased chargeoffs, increased nonperforming assets, and the continued weak California economy.
GAIN (LOSS) ON THE SALE OF SECURITIES AND MORTGAGE-BACKED SECURITIES
The gain (loss) on the sale of securities and mortgage-backed securities was a gain of $23 million and $4 million for the years ended 1993 and 1992, respectively, compared to a loss of $1 million for the year ended 1991. The 1993 gain included a $24 million reduction of a valuation allowance on investments charged to income in a previous year compared to a $4 million reduction in 1992.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased during the three years under discussion. The primary reasons for the increases for all three years were general inflation, growth of mortgage and deposit balances, the expansion of loan origination capacity, the installation of enhancements to data processing systems, and the expansion at Atlas Mutual Funds. The increase in 1993 was also due to the expansion of savings and loan activity outside of California and the relocation of some of our administrative operations to San Antonio, Texas. General and administrative expense as a percentage of average assets was 0.97%, 0.99%, and 0.99% at December 31, 1993, 1992, and 1991, respectively.
TAXES ON INCOME
Golden West utilizes the accrual method of accounting for income tax purposes and for preparing its published financial statements. For financial reporting purposes only, the Company uses "purchase accounting" in connection with certain assets acquired through mergers. The purchase accounting portion of income is not subject to tax.
In the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS (continued)
FAS 109 requires a change from the deferred method to the liability method of computing deferred income taxes. The Company has applied FAS 109 prospectively. The cumulative effect of this change in accounting for income taxes for the periods ending prior to January 1, 1993, is not material. FAS 109 required the Company to adjust its purchase accounting for prior business combinations by increasing deferred tax assets and reducing goodwill by $23 million to reflect the non-taxability of purchase accounting income. This deferred tax asset is being amortized over the remaining lives of the related purchased assets.
The consolidated financial statements presented for the years prior to 1993 reflect income taxes under the deferred method required by previous accounting standards.
Taxes as a percentage of earnings increased in 1993 over 1992 due to the effect of the amortization of the deferred tax asset related to the $23 million adjustment arising from the adoption of FAS 109, as well as the effect of the federal legislation enacted during 1993 that increased the federal corporate income tax rate from 34% to 35%.
ACQUISITIONS
During 1993, the Company acquired $320 million in deposits and seven branches in Arizona from PriMerit Bank.
On July 15, 1991, the Company took title to the common stock of Beach Federal Savings and Loan Association of Boynton Beach, Florida, and its $1.5 billion in assets. The transaction has been accounted for as a purchase, and the results of operations have been included with the Company's results of operations since July 15, 1991. As a result of the Beach acquisition, Golden West recognized, for tax purposes, certain Beach net operating losses that resulted in a $25 million benefit in 1992 and a $103 million benefit in 1991. For financial statement reporting, this benefit has been recorded as negative goodwill and is being amortized into income over ten years. In 1993, 1992, and 1991, $13 million, $12 million, and $5 million, respectively, of the negative goodwill was amortized.
On March 31, 1991, World Savings and Loan Association of Ohio, a wholly owned subsidiary of Golden West, was merged into World Savings. In conjunction with Golden West's acquisition of World of Ohio in 1988, the benefits of net operating loss carryforwards resulted in recording $18 million of negative goodwill in 1991. This benefit has been amortized into income over the period 1989 to 1993. In 1993, 1992, and 1991, $3 million, $4 million, and $11 million, respectively, of the negative goodwill was amortized. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS (continued)
During 1991, World Savings acquired from the Resolution Trust Corporation (RTC) $355 million of deposits and 11 branches from four separate acquisitions.
The acquisitions are not material to the financial position or net earnings of Golden West and pro forma information is not deemed necessary.
DIVESTITURES
During 1993, the Company sold $133 million of savings in two Ohio branches to Trumbull Savings and Loan and its remaining five Ohio branches with $131 million deposits to Fifth Third Bancorp. During 1992, the Company sold one branch in California containing $40 million in deposits and two branches in the state of Washington containing $37 million in deposits.
LIQUIDITY AND CAPITAL RESOURCES
The Association's principal sources of funds are cash flows generated from earnings; customer deposits; loan repayments; borrowings from the FHLB; issuance of medium-term notes; and debt collateralized by mortgages, MBS, or securities. In addition, the Association has a number of other alternatives available to provide liquidity or finance operations. These include borrowings from public offerings of debt or equity, sales of loans, negotiable certificates of deposit, issuance of commercial paper, and borrowings from commercial banks. Furthermore, under certain conditions, World Savings may borrow from the Federal Reserve Bank of San Francisco to meet short-term cash needs. The availability of these funds will vary depending upon policies of the FHLB, the Federal Reserve Bank of San Francisco, and the Federal Reserve Board.
The principal sources of funds for the Association's parent, Golden West, are dividends from World Savings and the proceeds from the issuance of debt and equity securities. ITEM 8. | 42293 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
SOUTHERN. Reference is made to information under the heading "Selected Consolidated Financial and Operating Data," contained herein at pages II-38 through II-49.
ALABAMA. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-78 through II-91.
GEORGIA. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-123 through II-137.
GULF. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II- 166 through II-179.
MISSISSIPPI. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-207 through II-220.
SAVANNAH. Reference is made to information under the heading "Selected Financial and Operating Data," contained herein at pages II-245 through II-258.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
SOUTHERN. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-8 through II-15.
ALABAMA. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-53 through II-58.
GEORGIA. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-95 through II-101.
GULF. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-141 through II-147.
MISSISSIPPI. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-183 through II-189.
SAVANNAH. Reference is made to information under the heading "Management's Discussion and Analysis of Results of Operations and Financial Condition," contained herein at pages II-224 through II-230.
II-2
ITEM 8. | 3153 | 1993 |
9548 | 1993 |
||
ITEM 6. SELECTED FINANCIAL DATA
Information required by Item 6 of Part II is presented in the table entitled "Five Year Summary of Selected Financial Data" on page 14 of the Company's 1993 Annual Report to Shareholders. Such information is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
An exceptionally strong lumber market and record earnings in diapers more than offset losses in tissue and pulp to return Pope & Talbot to profitability in 1993, after two years of losses. Pope & Talbot's earnings for 1993 were $21.0 million, or $1.80 per share ($1.67 on a fully diluted basis), up from 1992's loss of $2.3 million, or $.19 per share. Operations contributed $21.6 million, or $1.85 per share in 1993; however, also included was a net charge of $562,000, or $.05 per share, reflecting the cumulative effect of accounting changes adopted in 1993. See Note 1 of Notes to Consolidated Financial Statements for an explanation of the accounting changes.
Widely divergent business environments affected Pope & Talbot's businesses during 1993. An improving housing industry, combined with sharply curtailed timber harvests in the Pacific Northwest as a result of environmental pressures, produced lumber prices that were 34 percent higher on average in 1993 than 1992, resulting in the best wood products earnings in the Company's history. Demand for the Company's disposable diapers remained strong in 1993 and, combined with only minor price reductions as a result of competitors' price reduction efforts, resulted in record profits for the diaper business. Conversely, tissue produced a loss for the second year in a row, as extremely competitive conditions in the tissue industry continued, and world pulp markets remained poor, resulting in losses from our pulp business for the third consecutive year.
Revenues reached a record $628.9 million in 1993, a 16 percent increase from $544.3 million in 1992. Higher lumber sales prices in wood products was the most significant factor impacting the revenue increase. In pulp and paper, revenue gains from higher diaper sales volumes were largely offset by poor pricing and demand for tissue and pulp.
Liquidity and Capital Resources
Capital spending, largely to expand drying capabilities, improve pulp quality and to meet environmental requirements at the Company's Halsey, Oregon pulp mill, increased the debt-to-total-capitalization ratio to 42 percent at year-end 1993, from 34 percent at the end of 1992. The Company continues to have available $95 million under existing credit agreements, of which $11 million was borrowed at December 31, 1993.
The Company's primary sources of internally generated cash are operating income plus depreciation; the principal external source of cash is debt financing. Cash generated from operations was $36.9 million in 1993. Additionally, during 1993 the Company completed an offering of $75 million of 8 3/8 percent, 20-year debentures, and received $16 million at 6.55 percent from the State of Oregon under the State's Small Scale Energy Loan Program.
See Note 4 of Notes to Consolidated Financial Statements for further long-term debt information and subsequent years' debt repayment schedules. These cash resources were used to finance $82.6 million of capital expenditures, $8.9 million for the payment of dividends, and to reduce borrowings on the Company's lines of credit including repayment of $45.0 million on the Company's unsecured revolving-credit agreement. Scheduled long-term debt repayments were $500,000 in 1993 and are anticipated to be $901,000 in 1994. The most significant capital improvement projects included $47 million to improve pulp quality, expand drying capabilities and reduce both the use of chlorine in the bleaching process and the discharge of dioxins from the Halsey pulp mill. The project to reduce chlorine usage and dioxin discharges is necessary to comply with an agreement entered into with the Oregon Department of Environmental Quality on meeting target dioxin emission levels. Other significant projects during 1993 included completion of the first phase of a project to improve raw material utilization at the Castlegar, B.C. sawmill, installation of equipment to produce diaper training pants and other cost reduction and product improvement projects for the Company's diaper business.
At December 31, 1993, the Company had numerous capital projects in process at its facilities. It is expected that $25 million will be required to complete approved projects, including those in progress at year-end. The principal projects included in this amount are for completion of the pulp drying improvements at Halsey and the completion of diaper cost reduction projects. In addition, the Company anticipates that additional capital projects will be undertaken during 1994, primarily to sustain existing operations. Projected 1994 capital spending is expected to be funded with internally generated cash, supplemented with borrowings on the Company's lines of credit.
The December 31, 1993 current ratio remained essentially unchanged from year-end 1992 at 1.7 to 1. Significant changes in the components of working capital included increases in accounts receivable, inventories, and income taxes payable. Accounts receivable increased primarily due to a $6.1 million United States income tax refund receivable. Inventories increased approximately $21.6 million. Significant changes in inventory balances include a change in accounting for supplies inventories and higher log volumes from taking advantage of buying opportunities. Income taxes payable increased approximately $9.2 million reflecting higher current income taxes payable on higher earnings in Canada.
The impact of fluctuations in foreign currency exchange rates have not had, and are not expected to have, a significant effect on the Company's liquidity or results of operations.
Results of Operations
Wood Products
The Company's wood products business, which in 1993 comprised 48 percent of consolidated revenues, generated operating profit of $62.1 million in 1993, a sharp increase over earnings of $15.3 million in 1992, and a loss of $1.1 million in 1991. The 1993 earnings were more than double the previous best wood products earnings of $29.9 million reported in 1979. Housing starts, which historically have been a significant factor in the profitability of the wood products business, have improved in conjunction with the general economy and lower interest rates. Housing starts have increased from 1.0
million in 1991 to 1.2 million in 1992 and 1.28 million in 1993. Although these improvements in the housing market were a factor in the improved lumber sales prices, this alone was not adequate to generate the sales price increases and earnings improvements realized in 1993. A more significant factor continues to be the significantly curtailed harvest levels for timber from federal lands in the Pacific Northwest as a result of continuing environmental pressures to reduce timber harvests. During 1991, log costs increased as a result of constricting supply from federal lands. During 1992, lumber sales prices increased to offset these log cost increases and returned the relationship of log costs to sales prices to more historic levels. As log supplies, and consequently lumber supplies, tightened further in 1993, sales prices rose substantially. During 1993, log costs for the Company's United States sawmills increased generally with the increase in lumber sales prices. The Company has shifted much of its timber dependency out of Western Washington and Western Oregon where the environmental concerns over timber harvests have sharply restricted the volume of public timber available, and increased the cost of remaining timber, into regions of more stable timber supplies such as the Black Hills region of South Dakota and Wyoming and British Columbia. Currently, 80 percent of the Company's lumber capacity is in the Black Hills and British Columbia, with the remaining 20 percent representing the Company's Port Gamble, Washington sawmill. In the second quarter of this year, a Presidential Commission issued a proposal for resolving the timber supply situation in the Pacific Northwest. The proposal has been criticized by various environmental and industry groups. At this point, it is uncertain whether the proposal will be adopted. Until a solution is adopted, it is likely that timber supplies will remain restricted in the Pacific Northwest. When an agreement ultimately is reached, it is likely that the ultimately agreed upon harvest levels will be less than historic levels, but more than is currently available.
During 1992, the United States government imposed a 6.51 percent tariff on Canadian lumber sold in the United States. During 1993, the Company paid approximately $9.2 million under this tariff resulting in higher costs for the approximately 425 million board feet of Canadian lumber sold in the United States. In December 1993, a bi-national commission ruled that there is no basis for this duty. However, this decision may be appealed by the United States Government. At this time, it is unknown if the United States Government will make such an appeal, or if any adjustment to the tariff would be made, either upward or downward, and if any such adjustment would be made retroactive to March 1992, when the tariff was first imposed.
Lumber sales volume increased to 726 million board feet in 1993, up 9 percent from 669 million board feet in 1992 and 496 million board feet in 1991. The increased lumber volume over the three-year period was due primarily to the mid 1992 acquisition of the 225 million board-feet-per-year Castlegar, B.C. sawmill. With the acquisition of this sawmill, lumber capacity for the Company is now approximately 785 million board feet. The Company's sawmills operated essentially at capacity for 1993, except for the Port Gamble sawmill, which reduced production during the year as a result of lack of acceptably priced timber in relation to end-product prices. Port Gamble is the only Company sawmill in the high-priced timber regions of the Pacific Northwest and the Company, recognizing the limitation on acquiring adequate, acceptably priced timber supplies for the mill, has previously reduced its carrying value to its estimated recoverable value.
Wood Products revenues climbed to a record $300 million in 1993 from $214.2 million in 1992 and $153 million in 1991. Both 1992 and 1993 revenue increases were a combination of volume increases and higher sales prices. Sales volumes were up 35 percent in 1992 and 9 percent in 1993 primarily from having the Castlegar sawmill for part of 1992, and for a full year in 1993. Lumber sales prices were up an average of 40 percent for the Company's Canadian sawmills and Port Gamble. These mills, which comprised approximately 80 percent of the Company's total lumber production, compete primarily in the home construction markets which have seen the greatest lumber supply reductions from the Pacific Northwest timber harvest restrictions. The remaining 20 percent of the Company's lumber production comes from two mills located in the Black Hills region of South Dakota and Wyoming. Lumber from these mills goes principally into remodeling markets and competes less directly with Pacific Northwest lumber. Prices for these products rose an average of 17 percent during 1993. Overall, sales prices were up an average of 34 percent in 1993 and 13 percent in 1992.
Pulp and Paper Products
The pulp and paper segment, which produces private label tissue and disposable diapers as well as market pulp, generated 52 percent of 1993 revenues. Operating profits from pulp and paper have declined from $6.2 million in 1991 to losses of $4.6 million in 1992 and $9.8 million in 1993. Disposable diapers have been increasingly profitable from 1991 through 1993; however, losses in tissue products and market pulp in 1992 and 1993 more than offset diaper profits. Pulp and paper revenues have remained essentially flat over the last three years, with 1993 sales of $328.9 million, 1992 sales of $330.2 million and 1991 sales of $349.3 million. Tissue products and market pulp revenues declined in 1992 and again in 1993 on lower pricing and volumes. Diaper sales volume and selling prices improved in 1992 and in 1993 volume again improved while prices declined slightly.
Losses in the Company's market pulp business were the most significant factor in the pulp and paper segment's 1993 loss. A combination of an extremely depressed pulp market and the high cost of wood chips, the primary raw material for pulp, resulted in the increasing losses for 1991 through 1993. As a result of the weak markets, many pulp mills in the industry experienced significantly curtailed production rates during 1993. The Company's pulp mill at Halsey operated at 60 percent of capacity in 1993 and 83 percent of capacity in 1992. Historically, the Company had sold pulp to an adjacent tissue facility owned by James River Corporation. Beginning in 1992, James River began producing recycled pulp at Halsey and began phasing out of purchases of the Company's pulp. By mid 1993, James River no longer was purchasing any of the Company's pulp. As a result of depressed world pulp prices, selective downtime was taken in lieu of selling pulp in the open market to replace this lost tonnage. Consistent with world pulp pricing, the Company's sales prices in 1993 were approximately 12 percent below 1992's already depressed prices. Overall, pulp revenues decreased 36 percent to $40.3 million in 1993. Of this decline, approximately $17 million was due to volume reductions, and approximately $6 million was due to price declines. Based on a long-term pulp supply arrangement entered into in 1993, the Company began supplying, in December 1993, pulp to a printing and writing grade paper mill which opened at the beginning of 1994. The mill was purchased recently from its former owners by a group of private investors. The total output of this paper mill will be sold to one customer who will re-market the paper to outside customers. It has been anticipated that ultimately the paper mill
would purchase pulp from the Company in significant quantities, depending on sales by the paper mill to its customer. However, to date pulp purchases have not been at this level. In the event that the paper mill's sales to its customer are adversely impacted for any reason, sales of the Company's pulp may be adversely impacted. Pricing for this pulp will be computed using a formula based on prices for white paper. Based on the prices in effect for white paper at the end of 1993, the price that pulp would be sold under this agreement would be 8 percent higher than the average pulp price the Company obtained for its pulp at the end of 1993.
Environmental concerns over timber harvests, which have caused high log costs for the Company's Port Gamble sawmill, have also caused higher chip costs and reduced chip availability from historic sources at the Halsey pulp mill over the last three years. In order to maintain an adequate supply of wood fiber to the mill, the Company has expanded its geographic base from which it obtains softwood chips and has developed the capability of using sawdust and hardwood chips as raw materials for a portion of the production, which historically have been less expensive than the softwood chips normally used as the primary raw material for the pulp mill. It is anticipated that a portion of the pulp sold to the paper mill will be produced from sawdust and hardwood chips. In order to maintain an adequate supply of chips for the anticipated 60 percent of the pulp mill's production which will remain based on these softwood chips, the Company will continue to use an expanded geographic base to obtain chips, adding to their cost. Unless environmental restrictions on timber harvests are relaxed, chip prices likely will remain high, and sawdust and hardwood chip prices may also increase.
In the tissue business, continued low industry operating rates resulting from industry capacity increases in recent years which have exceeded demand growth, coupled with aggressive pricing by tissue producers, resulted in a second consecutive loss year for the Company's tissue business. Overall, tissue operated at approximately 97 percent of capacity in 1993. Prices for the Company's tissue products declined in 1992 an average of 6 percent from the already depressed 1991 levels and declined by another 1 percent in 1993. Overall, prices for the Company's tissue have declined an average 13 percent from 1989, when tissue prices first began to decline. During 1992, the Company permanently closed one high-cost tissue facility and instituted cost reduction measures which reduced tissue operating costs in 1993; however, these savings were partially offset by increases in prices paid for wastepaper, the primary raw material for the Company's tissue products.
Diaper earnings improved substantially in 1993 over already strong earnings in 1992 and 1991. Diaper sales volumes in 1992 were 10 percent greater than 1991. This sales growth continued in 1993, with sales volumes 21 percent ahead of 1992 at a record 1.1 billion diapers. Based on the existing mix of diaper sales, the Company's diaper business operated essentially at capacity in 1993. During 1992, Procter & Gamble, a significant producer of branded disposable diapers, instituted an everyday low price program intended to reduce the shelf package prices to the consumer. Private label disposable diapers, including the Company's, are priced under the pricing umbrella of branded products; however, the Company was generally able to maintain its diaper sales prices in 1993 at 1992 levels, which were on average 6 percent above 1991 levels. In November 1992, the Company closed one of its five diaper facilities and transferred the diaper machines to the remaining facilities. This eliminated the overhead of operating one additional facility while leaving diaper capacity essentially unchanged.
Other Matters
In 1993, the Company adopted Financial Accounting Standards Board Statement No. 109 on accounting for income taxes. The charge to earnings for adopting this new standard was $2.3 million ($.20 per share) and is reflected as part of the cumulative effect of accounting changes in the Consolidated Statements of Income.
In 1993, expendable supplies on hand, which previously were charged to expense as purchased, were included in supplies inventories as of January 1, 1993. The cumulative effect of this change in accounting method amounted to $1.8 million ($.15 per share), net of tax, and is reflected as part of the cumulative effect of accounting changes in the Consolidated Statements of Income.
In November 1992, the Financial Accounting Standards Board issued a pronouncement on Employers' Accounting for Postemployment Benefits. This statement must be adopted by the Company no later than 1994. The Company will adopt the new standard in the first quarter of 1994. The Company has reviewed the pronouncement and does not expect its implementation to have a material effect on the Company's financial position or results of operations.
ITEM 8. | 311871 | 1993 |
Item 6. Selected Financial Data Selected financial data of the Corporation on pages 56 and 57 of the Annual Report to Shareholders for 1993 is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis on pages 34 through 55 of the Annual Report to Shareholders for 1993 is incorporated herein by reference.
Item 8. | 354396 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
See pages 28 through 31 of the Company's 1993 Annual Report to Shareholders, which pages are incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
See the text under the heading "Financial Review" on pages 32 through 37 of the Company's 1993 Annual Report to Shareholders, which information is incorporated herein by reference.
ITEM 8. | 96943 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Pursuant to General Instruction J of Form 10-K, the information required by Item 6 is omitted.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pursuant to General Instruction J of Form 10-K, the information required by Item 7 is omitted.
Set forth on the following pages is Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 1993.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS ENVIRONMENT
The Company's principal business activities, investment banking and securities trading and sales are, by their nature, subject to volatility, primarily due to changes in interest and foreign exchange rates, global economic and political trends and industry competition. As a result, revenues and earnings may vary significantly from quarter to quarter and from year to year. In 1993, the Company's operating results were achieved in an environment of declining interest rates in the United States, mixed economic trends around the world and continued globalization of the capital markets.
The general decline in interest rates in the United States, which began in 1990, continued in 1993 with interest rates declining to their lowest levels in more than 10 years. Investors, seeking higher returns, reduced their holdings of short-term fixed income securities in favor of longer term debt and equity securities in U.S. and non-U.S. markets. Corporate issuers took advantage of this environment and the pools of capital available for investment to restructure their balance sheets through the issuance of equity, repayment of debt and refinancing of debt at lower interest rates. These factors resulted in record levels of debt and equity issuances in 1993.
RESULTS OF OPERATIONS
During 1993, the Company completed the sales of three businesses: The Boston Company on May 21; Shearson on July 31; and SLHMC on August 31. In the Company's audited historical consolidated financial statements, the operating results of The Boston Company are accounted for as a discontinued operation while the operating results of Shearson and SLHMC are included in the Company's results from continuing operations through their respective sale dates.
Because of the significant sale transactions completed during 1993, the Company's historical financial statements are not fully comparable for all years presented. To facilitate an understanding of the Company's results, the following discussion is segregated into three sections and provides financial tables that serve as the basis for the review of results. These sections are as follows:
- Historical Results: the results of the Company's ongoing businesses; the results of Shearson and SLHMC through their respective sale dates; the loss on the sale of Shearson; the reserves for non-core businesses; the results of The Boston Company (accounted for as a discontinued operation); and the cumulative effect of changes in accounting principles.
- The Lehman Businesses: the results of the ongoing businesses of the Company.
- The Businesses Sold: the results of Shearson and SLHMC; the loss on the sale of Shearson; and the reserves for non-core businesses related to the sale of SLHMC.
HISTORICAL RESULTS (CONTINUING, SOLD AND DISCONTINUED BUSINESSES)
HISTORICAL RESULTS (CONTINUING, SOLD AND DISCONTINUED BUSINESSES) FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
Net revenues decreased 12% to $4,346 million in 1993 from $4,947 million in 1992 due to the sale of Shearson and SLHMC, offset in part by a 13% increase in net revenues of the Lehman Businesses. Net revenues of $4,947 million in 1992 increased 11% over 1991 net revenues of $4,457 million with net revenues of the Lehman Businesses and the Businesses Sold increasing by 12% and 10%, respectively.
Non-interest expenses decreased 3% to $4,492 million in 1993 from $4,628 million in 1992 due to the sale of Shearson and SLHMC. Non-interest expenses of $4,628 million in 1992 increased 11% over 1991 non-interest expenses of $4,174 million due primarily to a 13% increase in compensation and benefits expense, (including a 15% increase in compensation and benefits expenses related to the Businesses Sold) and higher levels of provisions for legal settlements and bad debts.
The Company reported a net loss of $259 million for the year ended December 31, 1993, compared to net income of $173 million in 1992 and net income of $160 million in 1991. Included in the 1993 net loss of $259 million was an after-tax loss on the sale of Shearson of $630 million ($535 million pre-tax) and an after-tax charge of $92 million ($141 million pre-tax) related to certain non-core businesses, including a $79 million ($120 million pre-tax) charge related to the sale of SLHMC and a $13 million ($21 million pre-tax) charge related to certain partnership syndication activities in which the Company is no longer actively engaged. The 1993 net loss also included income from discontinued operations of The Boston Company of $189 million, which included an after-tax gain of $165 million on the sale and after-tax operating earnings of $24 million. The 1992 net income of $173 million included a $22 million ($33 million pre-tax) write-down in the carrying value of certain real estate investments, income from discontinued operations of $77 million and a charge of $8 million related to the cumulative effect of the changes in accounting for non-pension postretirement benefits and income taxes. Net income of $160 million in 1991 included income from discontinued operations of $10 million and a $71 million tax benefit on previously reported losses for which no financial statement benefit had been permitted.
Included in the table below are the specific revenue and expense categories comprising the historical results as segregated between the Lehman Businesses and the Businesses Sold. The historical amounts for the Lehman Businesses do not include pro forma adjustments for the effects of the Distribution.
THE LEHMAN BUSINESSES FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992
Summary. For the Lehman Businesses, income from continuing operations increased 122% to $266 million in 1993 from $120 million in 1992. The 1993 results consisted of $279 million of income from the continuing businesses decreased by a $14 million reserve ($21 million pre-tax) for certain non-core partnership syndication activities in which the Company is no longer actively engaged. The 1992 results include a $22 million after-tax ($33 million pre-tax) write-down in the carrying value of certain real estate investments.
Net Revenues. Net revenues increased 13% to $2,595 million in 1993 from $2,304 million in 1992. Revenues related to market making and principal transactions and investment banking were the primary sources of the increase.
Market Making and Principal Transactions. Market making and principal transactions include the results of the Company's market making and trading related to customer activities, as well as proprietary trading for the Company's own account. Revenues from these activities encompass net realized and mark-to- market gains and (losses) on securities and other financial instruments owned as well as securities and other financial instruments sold but not yet purchased. The Company utilizes various hedging strategies as it deems appropriate to minimize its exposure to significant movements in interest and foreign exchange rates and the equity markets. Market making and principal transactions revenues increased 13% to $1,053 million in 1993 from $934 million in 1992, reflecting greater activity and strong customer order flow across all business lines. The following discussion provides an analysis of the Company's market making and principal transactions revenues based upon the various product groups which generated these revenues.
Market Making & Principal Transactions Revenues (in millions):
Fixed income revenues decreased 20% to $462 million in 1993 from $580 million in 1992. This decrease was due principally to decreased revenues from mortgage-related securities and money market instruments.
Equity revenues include net gains on market making and trading in listed and over-the-counter equity securities. Equity revenues increased 28% to $288 million from $225 million in 1992, primarily as a result of higher revenues from the Company's proprietary trading activities.
Derivative products revenues include net revenues primarily from the trading and market making activities of the Company's fixed income derivative products group. These products include interest rate and currency swaps, caps, collars, floors and similar instruments. Derivative products revenues increased 213% to $222 million in 1993 from $71 million in 1992. The increased revenues were primarily a result of increased Company activity in these markets and increased usage of these products by the Company's clients and customers. At December 31, 1993, the notional value of the Company's fixed income derivatives contracts increased to over $270 billion from approximately $110 billion at December 31, 1992. Notional amounts do not represent a quantification of the market or credit risk of the positions; rather, notional amounts represent the amounts used to calculate contractual cash flows to be exchanged and are generally not actually paid or received. During 1994, the Company will commence derivative trading and market making activities through Lehman Brothers Financial Products Inc., a separately capitalized triple-A rated derivatives subsidiary. This subsidiary is expected to increase the Company's customer base and the volume of activity in its fixed income derivatives business and capture additional underwriting business.
Foreign exchange and commodities revenues include revenues derived from market making and trading in spot and forward foreign currency contracts, foreign currency futures contracts and other commodity futures contracts. Revenues from these sources increased 40% to $81 million in 1993 from $58 million in 1992. Included in these results were foreign exchange revenues of $70 million and $56 million for 1993 and 1992, respectively, reflecting an increase of 25%. This increase was due primarily to increased customer-related and proprietary trading activities throughout 1993. Revenues from commodity trading activities increased to $11 million in 1993 from approximately $2 million in 1992, due primarily to increased customer-related trading activities throughout 1993. Foreign exchange contracts outstanding, including forward commitments to purchase and forward commitments to sell, at December 31, 1993 and 1992 were $234 billion and $97 billion, respectively.
Investment Banking. Investment banking revenues increased 24% to $624 million in 1993 from $502 million in 1992. The 1993 results were driven primarily by a 39% increase in underwriting revenues to $477 million in 1993 from $343 million in 1992. Underwriting revenues increased as a result of significantly higher underwriting volumes in both equity and fixed income products, with the increase in equity underwriting the primary component.
Commissions. Commission revenues increased 7% to $437 million in 1993 from $410 million in 1992, primarily as a result of higher volumes of customer trading of securities and commodities on exchanges. Commission revenues are generated from the Company's agency activities on behalf of corporations, institutions and high net worth individuals.
Interest and Dividends. Interest and dividend revenues increased 3% to $4,868 million in 1993 from $4,717 million in 1992. Net interest and dividend income increased 6% to $426 million in 1993 from $401 million in 1992. Net interest and dividend revenue amounts are closely related to the Company's trading activities. A significant portion of net interest revenue is due to trading decisions and strategies, the results of which are reflected in market making and principal transactions. The Company evaluates these strategies on a total return basis. Therefore, changes in net interest revenue from period to period should not be viewed in isolation but should be viewed in conjunction with revenues from market making and principal transactions.
Other Revenues. Other revenues decreased 4% to $55 million in 1993 from $57 million in 1992. Asset management and related advisory fees increased 15% to $23 million in 1993 from $20 million in 1992, offset by a decrease in certain other revenue sources.
Non-interest Expense. Compensation and benefits expense increased 14% to $1,400 million in 1993 from $1,223 million in 1992, reflecting higher compensation due to increases in revenues and profitability. However, compensation and benefits expense as a percentage of net revenues increased only moderately to 54.0% in 1993 from 53.1% in 1992.
Excluding compensation and benefits expense, non-interest expenses decreased 8% to $803 million in 1993 from $869 million in 1992. Included in the 1993 amount was a charge of $21 million ($14 million after-tax) related to certain non-core partnership syndication activities in which the Company is no longer actively engaged. The 1992 results included a $33 million write down ($22 million after-tax) in the carrying value of certain real estate investments. Excluding these charges, as well as compensation and benefits, non-interest expenses declined 6% to $782 million in 1993 from $836 million in 1992. This decrease was due primarily to lower levels of provisions for legal settlements and bad debts and reduced operating expenses.
Cost Reduction Effort. In August 1993, the Company announced an expense reduction program with the objective of reducing costs by $170 million on an annualized basis by the end of the first quarter of 1994. The Company's expense structure for the first half of 1993, adjusted for changes in the volume and mix of revenues as well as for additional costs due to external factors such as inflation or new legislation, is the basis against which these goals are being measured. As of March 31, 1994, the Company had taken the following actions which it believes will result in $170 million of cost reductions on an annualized basis: (i) reduced certain purchased costs by lowering the volume of goods and services purchased, renegotiating rates with vendors and strengthening internal compliance with established policies and procedures; (ii) consolidated certain administrative and support functions; (iii) strengthened compliance and control functions; and (iv) completed its annual review of personnel, the objective of which is to upgrade personnel and eliminate positions to improve the Company's overall productivity.
During the first quarter of 1994, the Company completed a review of personnel needs, which will result in the termination of certain personnel. The Company anticipates that it will record a severance charge of approximately $25 million pre-tax in the first quarter of 1994 as a result of these terminations.
In addition to these actions, the Company has identified a variety of actions that are expected to reduce expenses further, such as (i) additional reductions in certain purchased expenses and (ii) the relocation in the summer of 1994 of certain administrative, operations and other support personnel to newly leased facilities in New Jersey. See "Properties."
Distribution of Holdings Common Stock
On January 24, 1994, American Express announced the Distribution. Prior to the Distribution, which is subject to certain conditions, an additional equity investment of approximately $1.25 billion will be made in Holdings, most significantly by American Express. Holdings currently expects to file the Registration Statement with the Commission with respect to the Distribution during the second quarter of 1994.
THE LEHMAN BUSINESSES FOR THE YEARS ENDED DECEMBER 31, 1992 AND 1991
Summary. For the Lehman Businesses, income from continuing operations decreased 37% to $120 million in 1992 from $190 million in 1991, primarily as a result of a higher effective tax rate in 1992 as compared to 1991, due to the recognition in 1991 of $71 million of tax benefits under Statement of Financial Accounting Standards ("SFAS") No. 96. The 1992 results reflect higher revenues in virtually all of the Company's major revenue categories and improved net interest margins resulting in a 12% increase in net revenues. Also contributing to the 1992 results was a 14% increase in non-interest expense primarily due to a 10% increase in compensation and benefits expense in line with the improved net revenues and a $22 million after-tax ($33 million pre-tax) write-down in the carrying value of certain real estate investments.
Net Revenues. Net revenues increased 12% to $2,304 million in 1992 from $2,051 million in 1991. Investment banking revenues were the primary source of the improvement, increasing 42% to $502 million in 1992 from $354 million in 1991.
Market Making and Principal Transactions. Market making and principal transactions include the results of the Company's market making and trading related to customer activities and proprietary trading for the Company's own account. Revenues from these activities encompass net realized and mark-to-market gains and (losses) on securities and other financial instruments owned as well as securities and other financial instruments sold but not yet purchased. The Company uses various hedging strategies to minimize its exposure to significant movements in interest and foreign exchange rates and the equity markets as it deems appropriate. Market making and principal transactions revenues increased 10% in 1992 to $934 million from $846 million in 1991. The following discussion provides an analysis of the Company's market making and principal transactions revenues based upon the various product groups which generated these revenues.
Revenues from fixed income products increased 36% to $580 million in 1992 from $427 million in 1991, with mortgage-related securities and money market instruments contributing most of the increase.
Equity revenues include net gains on market making and trading in listed and over-the-counter equity securities. Equity revenues decreased 29% to $225 million in 1992 from $318 million in 1991, primarily as a result of lower revenues from the Company's proprietary trading activities.
Derivative products revenues include net revenues primarily from the trading and market making activities of the Company's fixed income derivatives group. These products include interest rate and currency swaps, caps, collars, floors and similar instruments. Derivative products revenues increased 78% to $71 million in 1992 from $40 million in 1991, primarily as a result of increased Company activity in these markets and increased usage of these products by the Company's clients and customers. At December 31, 1992, the notional value of the Company's fixed income derivatives contracts increased to approximately $110 billion from approximately $45 billion at December 31, 1991.
Foreign exchange and commodities revenues include revenues derived from market making and trading in spot and forward foreign currency contracts, foreign currency futures contracts and other commodity futures contracts. Revenues from these sources decreased 5% to $58 million in 1992 from $61 million in 1991. Foreign exchange revenues increased 19% to $56 million in 1992 from $47 million in 1991, primarily due to an expansion of the Company's proprietary trading activities during 1992. Commodity trading revenues decreased to approximately $2 million in 1992 from approximately $14 million in 1991. Foreign exchange contracts outstanding, including forward commitments to purchase and forward commitments to sell, at December 31, 1992 and 1991 were $97 billion and $53 billion, respectively.
Investment Banking. Investment banking revenues increased 42% to $502 million in 1992 from $354 million in 1991. This increase was due to a 61% increase in underwriting revenues to $343 million in 1992 from $213 million in 1991.
Commissions. Commission revenues decreased 10% to $410 million in 1992 from $458 million in 1991. This decrease was due primarily to the strategic deemphasis of the Company's institutional futures sales
activities in 1992. Commission revenues are generated from the Company's agency activities on behalf of corporations, institutions and high net worth individuals.
Interest and Dividends. Interest and dividend revenues increased 10% to $4,717 million in 1992 from $4,283 million in 1991. Net interest and dividend income increased 18% to $401 million in 1992 from $340 million in 1991. Net interest and dividend revenue amounts are closely related to the Company's trading activities. A significant portion of net interest revenue results from trading decisions and strategies, the results of which are reflected in market making and principal transactions. The Company evaluates these strategies on a total return basis. Therefore, changes in net interest revenue from period to period should not be viewed in isolation but should be viewed in conjunction with revenues from market making and principal transactions.
Other Revenues. Other revenues increased 8% to $57 million in 1992 from $53 million in 1991. The growth in asset management fees was the primary source of this increase. Asset management and related advisory fees increased 33% to $20 million in 1992 from $15 million in 1991.
Non-interest Expense. Compensation and benefits expense increased 10% to $1,223 million in 1992 from $1,114 million in 1991. Compensation and benefits expense as a percent of net revenues decreased to 53.1% in 1992 from 54.3% in 1991, due to improvements in productivity.
Excluding compensation and benefits, non-interest expenses increased 21% to $869 million in 1992 from $719 million in 1991. As previously discussed, 1992 results included a $33 million write-down in the carrying value of certain real estate investments. Excluding this charge, as well as compensation and benefits expense, other non-interest expenses increased 16% to $836 million in 1992 from $719 million in 1991. The increase in expenses was due primarily to higher provisions for legal settlements and bad debts as well as increased operating expenses related to the Company's investments in the expansion of its foreign exchange and derivatives businesses.
THE LEHMAN BUSINESSES INCOME TAXES -- FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
In 1993, the Lehman Businesses had an income tax provision of $126 million which consisted of a provision of $133 million for continuing businesses and a tax benefit of $7 million related to non-core business reserves. The effective tax rate for the continuing businesses was 32%, which is less than the statutory U.S. federal income tax rate principally due to benefits attributable to income subject to preferential tax treatment partially offset by state and local income taxes. During the third quarter of 1993, the statutory U.S. federal income tax rate was increased to 35% from 34%, effective January 1, 1993. The Company's 1993 tax provision includes a one-time benefit of approximately $8 million from the impact of the federal rate change on the Company's net deferred tax assets. The Company's effective tax rate for continuing businesses is expected to increase slightly in 1994, subject to changes in the level and geographic mix of the Company's profits.
The Company had a net deferred tax liability of $36 million in 1992 as compared to a net deferred tax asset of $148 million in 1991. The elimination of the net deferred tax asset was primarily related to the utilization of net operating loss carryforwards ("NOLs") which resulted in cash savings to the Company.
In addition, the Company had, as of December 31, 1993, approximately $145 million of tax NOLs available to offset future taxable income, the benefits of which have not yet been reflected in the financial statements. Although the benefit related to these NOLs does not currently meet the recognition criteria of SFAS No. 109, strategies are being implemented to increase the likelihood of realization. It is anticipated that approximately $15 million of these NOLs will be transferred to American Express in connection with the Distribution.
In 1992, the Lehman Businesses had an income tax provision of $92 million which consisted of a provision of $103 million from continuing businesses and a tax benefit of $11 million related to the $33 million write-down in certain real estate investments previously discussed. Excluding this tax benefit, the effective tax rate for the continuing businesses was 42%, which was higher than the statutory U.S. federal income tax rate primarily due to state and local taxes.
Effective January 1, 1992, the Company adopted SFAS No. 109, "Accounting for Income Taxes." Previously, the Company accounted for income taxes in accordance with SFAS No. 96. As a result of the adoption, the Company recorded a $68 million increase in consolidated net income from the cumulative effect of this change in accounting principles, $64 million of which related to discontinued operations. In addition, the Company reduced goodwill by $258 million related to the recognition of deferred tax benefits attributable to the Company's 1988 acquisition of The E. F. Hutton Group Inc. The Company established a deferred tax asset of $326 million in the first quarter of 1992 related to tax benefits previously unrecorded under SFAS No. 96.
The 1991 tax provision of $28 million includes $71 million for the recognition of benefits on previously reported losses for which no financial statement benefit had been permitted. Excluding the recognition of these benefits, the 1991 effective tax rate was 46%, which was higher than the statutory U.S. federal income tax rate due primarily to state and local income taxes and the non-deductibility of goodwill amortization.
THE BUSINESSES SOLD FOR THE YEARS ENDED DECEMBER 31, 1993 AND 1992
This discussion is provided to analyze the operating results of the Businesses Sold. For purposes of this discussion, the amounts described as the Businesses Sold include the results of operations of Shearson and SLHMC, the loss on sale of Shearson and the reserve for non-core businesses related to the sale of SLHMC. All 1993 amounts for the Businesses Sold include results through their dates of sale and therefore reported results for 1993 are not fully comparable with prior years' results.
Net revenues related to the Businesses Sold were $1,751 million in 1993 and $2,643 in 1992. Excluding the loss on the sale of Shearson and the reserve for non-core businesses related to SLHMC, non-interest expenses of the Businesses Sold were $1,634 million in 1993 and $2,536 million in 1992. Compensation and benefits expense were $1,164 million in 1993 and $1,759 million in 1992.
The Businesses Sold recorded a net loss of $646 million in 1993 compared to net income of $52 million in 1992. The 1993 results include a loss on sale of Shearson of $630 million and a $79 million charge recorded in the first quarter as a reserve for non-core businesses in anticipation of the sale of SLHMC. The loss on the sale of Shearson included a reduction in goodwill of $750 million and transaction-related costs such as relocation, systems and operations modifications and severance. Excluding the $630 million after-tax loss on sale, Shearson's net income was $63 million in 1993 compared to $55 million in 1992. Excluding the $79 million after-tax charge discussed above, SLHMC operations were break-even in 1993 compared to a net loss of $3 million in 1992.
THE BUSINESSES SOLD FOR THE YEARS ENDED DECEMBER 31, 1992 AND 1991
Net revenues related to the Businesses Sold increased 10% to $2,643 million in 1992 from $2,406 million in 1991, due primarily to increases in other revenues and commissions. The growth in other revenues was due to increases in investment advisory and custodial fees, reflecting growth in the Company's managed asset products. An increase in the volume of customer directed trading activity was the primary source of the increased level of commission revenues. Non-interest expenses of the Businesses Sold increased 8% to $2,536 million in 1992 from $2,341 million in 1991. Compensation and benefits increased 15% to $1,759 million in 1992 from $1,529 million in 1991, reflecting higher compensation due to increased revenues.
Net income for the Businesses Sold increased 86% to $52 million in 1992 from $28 million in 1991. Shearson net income was $55 million in 1992 and $29 million in 1991.
THE BUSINESSES SOLD INCOME TAXES -- FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991
The 1993 tax provision of $108 million for Businesses Sold included (i) expenses of $54 million related to the operating results of Shearson; (ii) an expense of $95 million from the sale of Shearson and (iii) a tax
benefit of $41 million related to the $120 million reserve for non-core businesses recorded in anticipation of the sale of SLHMC. The provision related to the sale of Shearson primarily resulted from the write-off of $750 million of goodwill which was not deductible for tax purposes. For 1992 and 1991 the tax expense related principally to the Shearson operations. The effective tax rate for the Businesses Sold was 51% in 1992 and 57% in 1991, with the excess over the statutory U.S. federal income tax rate primarily resulting from state and local taxes and the non-deductibility of goodwill amortization.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1993, total assets were $57.8 billion, compared to $74.0 billion at December 31, 1992. The composition of the Company's assets changed significantly during 1993 due to the sales of The Boston Company, Shearson and SLHMC. The Company's asset base now consists primarily of cash and cash equivalents, and assets which can be sold within one year, including securities and other financial instruments owned, collateralized short-term agreements and receivables. At December 31, 1993, these assets comprised approximately 97% of the Company's balance sheet. Long-term assets consist primarily of other receivables, property, equipment and leasehold improvements, deferred expenses and other assets, and excess of cost over fair value of net assets acquired.
Daily Funding Activities. The Company finances its short-term assets primarily on a secured basis through the use of securities sold under agreements to repurchase, securities and other financial instruments sold but not yet purchased, advances from Holdings and other affiliates, securities loaned and other collateralized liability structures. Repurchase agreements and other types of collateralized borrowings historically have been a more stable financing source under all market conditions. Because of their secured nature, these collateralized financing sources are less credit sensitive and also provide the Company access to lower cost funding.
The Company uses short-term unsecured borrowing sources to fund short-term assets not financed on a secured basis. The Company's primary sources of short-term, unsecured general purpose funding include commercial paper and short-term debt, including master notes and bank borrowings under uncommitted lines of credit. Commercial paper and short-term debt outstanding totalled $2.6 billion at December 31, 1993, compared to $6.6 billion at December 31, 1992. Of these amounts, commercial paper outstanding totalled $0.4 billion at December 31, 1993, with an average maturity of 14 days, compared to $3.2 billion at December 31, 1992, with an average maturity of 11 days. The 1993 year-end balances reflected the repayment of commercial paper and short-term debt obligations with the proceeds from the sales of The Boston Company, Shearson and SLHMC.
To reduce liquidity risk, the Company carefully manages its commercial paper and master note maturities to avoid large refinancings on any given day. In addition, the Company limits its exposure to any single commercial paper investor to avoid concentration risk. LBI's access to short-term and long-term debt financing is highly dependent on its debt ratings. LBI's current long-term senior subordinated/short-term debt ratings are as follows: S&P A/A-1; Moody's A3/P-1 and IBCA -- /A1. As of the Distribution Date, LBI expects to receive a long-term senior debt rating of A and a short-term debt rating of from Fitch Investor Services.
The Company's uncommitted lines of credit provide an additional source of short-term financing. As of December 31, 1993, the Company had $5.7 billion in uncommitted lines of credit, provided by 51 banks, consisting of facilities that the Company has been advised are available but for which no contractual lending obligation exists.
Long-term assets are financed with a combination of long-term debt and equity. The Company issues subordinated indebtedness as an integral component of its regulatory capital base. The Company maintains long-term debt in excess of its long-term assets to provide additional liquidity, which the Company uses to meet its short-term funding requirements and reduce its reliance on commercial paper and short-term debt.
During 1993, the Company issued $722 million in long-term debt, compared to $239 million in 1992. In addition to refinancing long-term debt, these issuances strengthened the Company's capital base, which consists of long-term debt plus equity. The Company staggers the maturities of its long-term debt to minimize refunding risk. At December 31, 1993, the Company had long-term debt outstanding of $3.7 billion with an
average life of 2.6 years, compared to $4.4 billion outstanding at December 31, 1992, with an average life of 3.1 years. For long-term debt with a maturity of greater than one year, the Company had $2.4 billion outstanding with an average life of 3.7 years at December 31, 1993, compared to $3.5 billion outstanding with an average life of 3.7 years at December 31, 1992. The Company anticipates that 1994 long-term debt issuances will exceed those of 1993. The proceeds of these issuances primarily will be used to refinance long-term debt maturing in 1994 and to meet regulatory capital objectives.
The Company enters into a variety of financial and derivative products agreements as an end user to hedge and/or modify its exposure to foreign exchange and interest rate risk of certain assets and liabilities. These agreements are not part of the Company's trading portfolio of derivative products. The Company primarily enters into interest rate swaps and caps to modify the interest characteristics of its long-term debt obligations. The Company recognizes the net interest expense or income related to these agreements on an accrual basis, including the amortization of premiums, over the life of the contracts.
At December 31, 1993 and 1992, the Company had outstanding interest rate swap and cap agreements for the above purposes of approximately $2.7 billion and $2.9 billion, respectively. Included in these amounts were approximately $2.3 billion of interest rate swaps and caps, maturing in 1995 and 1997, which serve to reduce the Company's overall fixed rate debt to a lower fixed rate. Of the remaining interest rate swaps, the most significant serve to convert a portion of the Company's fixed rate debt to a floating rate. The Company has matched substantially all of the maturities of its remaining interest rate swaps to the terms of its underlying borrowings.
The $2.7 billion of notional amount of interest rate swap and cap agreements mature as follows:
The effect of interest rate swap and cap agreements was to decrease interest expense by approximately $54 million, $53 million and $15 million in 1993, 1992 and 1991, respectively. At December 31, 1993 and 1992, the unrecorded net gain on these agreements was approximately $55 million and $84 million, respectively. The Company has no deferred gains or losses related to terminated agreements.
The Company expects to continue using interest rate swap and cap agreements to modify the effective interest cost associated with its long-term indebtedness. The $2.3 billion of interest rate swaps and caps described above, which reduce the Company's rate on its fixed rate debt to a lower fixed rate, will lower 1994 and 1995 interest expense by approximately $25 million and $15 million, respectively. The effect of the remaining interest rate swaps is dependent on the level of interest rates in the future.
Liquidity Management. The maintenance of the liability structure and balance sheet liquidity as discussed above is achieved through the daily execution of the following financing policies: (i) match funding the Company's assets and liabilities; (ii) maximizing the use of collateralized borrowing sources; and (iii) diversifying and expanding borrowing sources.
(i) The Company's first financing policy focuses on funding the Company's assets with liabilities which have maturities similar to the anticipated holding period of the assets to minimize refunding risk. The anticipated holding period of assets financed on an unsecured basis is determined by the expected time it would take to obtain financing for these assets on a collateralized basis.
(ii) The Company's second financing policy is to maximize that portion of its balance sheet that is funded through collateralized borrowing sources, which include repurchase agreements, securities loaned,
securities sold but not yet purchased and other collateralized liability structures. The Company currently funds over 68% of its assets on a collateralized basis. As discussed above, repurchase agreements and other types of collateralized borrowings historically have been a more reliable financing source under all market conditions.
(iii) The Company's third financing policy is to diversify and expand its borrowing sources in an effort to maximize liquidity and reduce concentration risk. Through its institutional sales force, the Company seeks financing from a global investor base with the goal of broadening the availability of its funding sources.
The Company incorporates these policies in its liquidity contingency planning process, which is designed to enhance the availability of alternative sources of funding in a period of financial stress. Financial stress is defined as any event which severely constrains the Company's access to unsecured funding sources. The Company's liquidity contingency plan is based on an estimate of its ability to meet its funding requirements with collateralized financing. To help achieve this objective, the Company would rely on the additional liquidity created by its policy of issuing long-term debt in excess of long-term assets and its ability to pledge its unencumbered marketable securities as collateral to obtain financing rather than on a sale of these securities.
The Company's liquidity contingency plan is continually reviewed and updated as the Company's asset/liability mix and liquidity requirements change. The Company believes that these policies, combined with the maintenance of sufficient capital levels, position the Company to meet its liquidity requirements in periods of financial stress.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
In addition to financial instruments recorded on the consolidated balance sheet, the Company enters into off-balance sheet financial instruments primarily consisting of derivative contracts and credit-related arrangements. Derivative products include futures, forwards, swaps, options, caps, collars, floors, swaptions, forward rate agreements, foreign exchange contracts and similar instruments.
Derivative products are generally based on notional amounts, while credit-related arrangements are based upon contractual amounts. The notional values of these instruments are generally not recorded on the balance sheet. Off-balance-sheet treatment is generally considered appropriate when the exchange of the underlying asset or liability has not occurred or is not assured, or where the notional amounts are utilized solely as a basis for determining cash flows to be exchanged. Therefore, the notional amounts of these instruments do not reflect the Company's market or credit risk amount.
The Company conducts its derivative activities through wholly owned subsidiaries. In late 1993, the Company established a new subsidiary, Lehman Brothers Financial Products Inc., a separately capitalized triple-A rated derivatives subsidiary. This subsidiary, which is expected to commence activities during the third quarter of 1994, was established to increase the volume of the Company's derivatives business related to customer-driven derivative activities.
The Company records derivatives from dealer-related and proprietary trading activities at market or fair value, with unrealized gains and losses, recognized in the consolidated statement of operations as market making and principal transactions revenue. While the notional value of these instruments is not reflected in the consolidated balance sheet, the mark to market value of trading-related derivatives is reflected on a net basis in the December 31, 1993 and 1992 balance sheets as securities and other financial instruments owned or securities and other financial instruments sold not yet purchased, as applicable.
Derivative products, like all financial instruments, include various elements of risk which must be actively managed. General types of risk from derivative products include market risk, liquidity risk and credit risk.
Market risk from derivatives results from the potential for changes in interest and foreign exchange rates and fluctuations in commodity or equity prices. The market risk for derivatives is similar to that of cash instruments. The Company may employ hedging strategies to reduce its exposure to fluctuations in market prices of securities and volatility in interest or foreign exchange rates.
Liquidity risk from derivatives represents the cost to the Company of adjusting its positions in times of high volatility and financial stress. The liquidity of derivative products is highly related to the liquidity of the underlying cash instruments. As with on-balance sheet financial instruments, the Company's valuation policies for derivatives include consideration of liquidity factors.
The Company incorporates these policies in its liquidity contingency planning process, which is designed to enhance the availability of alternative sources of funding in a period of financial stress. Financial stress is defined as any event which severely constrains the Company's access to unsecured funding sources. The Company's liquidity contingency plan is based on an estimate of its ability to meet its funding requirements with collateralized financing. To help achieve this objective, the Company would rely on the additional liquidity created by its policy of issuing long-term debt in excess of long-term assets and its ability to pledge its unencumbered marketable securities as collateral to obtain financing rather than on a sale of these securities.
The Company's liquidity contingency plan is continually reviewed and updated as the Company's asset/liability mix and liquidity requirements change. The Company believes that these policies, combined with the maintenance of sufficient capital levels, position the Company to meet its liquidity requirements in periods of financial stress.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS AND DERIVATIVES
In addition to financial instruments recorded on the consolidated balance sheet, the Company enters into off-balance sheet financial instruments primarily consisting of derivative contracts and credit-related arrangements. Derivative products include futures, forwards, swaps, options, caps, collars, floors, swaptions, forward rate agreements, foreign exchange contracts and similar instruments.
Derivative products are generally based on notional amounts, while credit-related arrangements are based upon contractual amounts. The notional values of these instruments are generally not recorded on the balance sheet. Off-balance-sheet treatment is generally considered appropriate when the exchange of the underlying asset or liability has not occurred or is not assured, or where the notional amounts are utilized solely as a basis for determining cash flows to be exchanged. Therefore, the notional amounts of these instruments do not reflect the Company's market or credit risk amount.
The Company conducts its derivative activities through wholly owned subsidiaries. In late 1993, the Company established a new subsidiary, Lehman Brothers Financial Products Inc., a separately capitalized triple-A rated derivatives subsidiary. This subsidiary, which is expected to commence activities during the third quarter of 1994, was established to increase the volume of the Company's derivatives business related to customer-driven derivative activities.
The Company records derivatives from dealer-related and proprietary trading activities at market or fair value, with unrealized gains and losses, recognized in the consolidated statement of operations as market making and principal transactions revenue. While the notional value of these instruments is not reflected in the consolidated balance sheet, the mark to market value of trading-related derivatives is reflected on a net basis in the December 31, 1993 and 1992 balance sheets as securities and other financial instruments owned or securities and other financial instruments sold not yet purchased, as applicable.
Derivative products, like all financial instruments, include various elements of risk which must be actively managed. General types of risk from derivative products include market risk, liquidity risk and credit risk.
Market risk from derivatives results from the potential for changes in interest and foreign exchange rates and fluctuations in commodity or equity prices. The market risk for derivatives is similar to that of cash instruments. The Company may employ hedging strategies to reduce its exposure to fluctuations in market prices of securities and volatility in interest or foreign exchange rates.
Liquidity risk from derivatives represents the cost to the Company of adjusting its positions in times of high volatility and financial stress. The liquidity of derivative products is highly related to the liquidity of the underlying cash instruments. As with on-balance sheet financial instruments, the Company's valuation policies for derivatives include consideration of liquidity factors.
Credit risk from derivatives relates to the potential for a counterparty defaulting on its contractual agreement. The Company manages its counterparty credit risk through a process similar to its other trading-related activities. This process includes an evaluation of the counterparty's credit worthiness at the inception of the transaction, periodic review of credit standing and various credit enhancements in certain circumstances. In addition, the Company attempts to execute master netting agreements which provide for net settlement of contracts with the same counterparty in the event of cancellation or default when appropriate or when allowable under relevant law.
For a discussion of the Company's policies and procedures regarding risk, see "Business -- Risk Management."
Cash Flows. Cash and cash equivalents increased $21 million in 1993 to $316 million, as the net cash provided by operating and investing activities exceeded the net cash used in financing activities. In addition, cash and cash equivalents for discontinued operations increased $42 million in 1993. Net cash provided by operating activities of $1,312 million included the loss from continuing operations adjusted for non-cash items of approximately $464 million for the year ended December 31, 1993. Net cash used in financing activities was $3,784 million in 1993. Net cash provided by investing activities of $2,535 million in 1993 included cash proceeds from the sales of The Boston Company, Shearson and SLHMC of $2,570 million.
Cash and cash equivalents decreased $120 million in 1992 to $295 million, as the net cash used in operating and investing activities exceeded the net cash provided by financing activities. In addition, cash and cash equivalents for discontinued operations decreased $1,082 million. Net cash used in operating activities of $5,194 million included income from continuing operations adjusted for non-cash items of approximately $564 million for the year ended December 31, 1992. Net cash used in investing activities was $25 million in 1993. Net cash provided by financing activities was $4,017 million.
Cash and cash equivalents decreased $388 million in 1991 to $415 million as the net cash provided by financing and investing activities was exceeded by net cash used and operating activities. In addition, cash and cash equivalents for discontinued operations increased $706 million. Net cash used in operating activities of $3,365 million included income from continuing operations adjusted for non-cash items of approximately $538 million for the year ended December 31, 1991. Net cash provided by financing and investing activities was $879 million and $2,804 million, respectively.
SPECIFIC BUSINESS ACTIVITIES AND TRANSACTIONS
The following sections include information on specific business activities of the Company which affect overall liquidity and capital resources:
Westinghouse. In May 1993, the Company and Westinghouse Electric Corporation ("Westinghouse") entered into a partnership to facilitate the disposition of Westinghouse's commercial real estate portfolio valued at approximately $1.1 billion, which will be accomplished substantially by securitizations and asset sales. The Company invested approximately $154 million in the partnership, and also made collateralized loans to the partnership of $752 million. During the third quarter of 1993, Lennar Inc. was appointed portfolio servicer and purchased a 10% limited partnership interest from the Company and Westinghouse.
At December 31, 1993, the carrying value of the Company's investment in the partnership was $154 million and the outstanding balance of the collateralized loan, including accrued interest, was $539 million. The remaining loan balance is expected to be repaid in 1994 through a combination of mortgage remittances, securitizations, asset sales and refinancings by third parties.
High Yield Securities. The Company underwrites, trades, invests and makes markets in high yield corporate debt securities. The Company also syndicates, trades and invests in loans to below investment grade companies. For purposes of this discussion, high yield debt securities are defined as securities of or loans to companies rated below BBB- by S&P and below Baa3 by Moody's, as well as non-rated securities or loans which, in the opinion of management, are non-investment grade. High yield debt securities are carried at market value and unrealized gains or losses for these securities are reflected in the Company's Consolidated Statement of Operations. The Company's portfolio of such securities at December 31, 1993 and 1992 included
long positions with an aggregate market value of approximately $661 million and $895 million, respectively, and short positions with an aggregate market value of approximately $75 million and $47 million, respectively. The portfolio may from time to time contain concentrated holdings of selected issues. The Company's two largest high yield positions were $61 million and $56 million at December 31, 1993 and $128 million and $123 million at December 31, 1992.
Change in Facilities. In 1993, Holdings agreed to lease approximately 392,000 square feet of office space located at 101 Hudson Street in Jersey City, New Jersey (the "Operations Center"). The lease term will commence in August 1994 and provides for minimum rental payments of approximately $87 million over its 16-year term. Concurrently, Holdings announced it would relocate certain administrative employees to five additional floors at 3 World Financial Center in New York, New York. These floors will be purchased by Holdings from American Express for approximately $44 million by Holdings. In connection with the relocation to the Operations Center and the additional space at the World Financial Center, Holdings anticipates incremental fixed asset additions of approximately $112 million. Upon commencement of the relocation, a substantial portion of the lease and depreciation charges will be allocated to the Company based upon the Parent's method of allocating certain intercompany charges.
Non-Core Activities and Investments. In March 1990, the Company discontinued the origination of partnerships (whose assets are primarily real estate) and investments in real estate. Currently, the Company acts as a general partner for approximately $4.2 billion of partnership investment capital and manages a real estate investment portfolio with an aggregate investment basis of approximately $108 million. The Company provided additional reserves for these activities of $21 million and $33 million in 1993 and 1992, respectively. At December 31, 1993 and 1992, the Company had remaining net exposure to these investments (defined as the remaining unreserved investment balance plus outstanding commitments and contingent liabilities under guarantees and credit enhancements) of $71 million and $201 million, respectively. In certain circumstances, the Company provides financial and other support and assistance to such investments to maintain investment values. Except as described above, there is no contractual requirement that the Company continue to provide this support. Although a decline in the real estate market or the economy in general or a change in the Company's disposition strategy could result in additional real estate reserves, the Company believes that it is adequately reserved.
CHANGE OF FISCAL YEAR
On March 28, 1994, the Board of Directors of Holdings approved, subject to the Distribution, a change in the Company's fiscal year-end from December 31 to November 30. Such a change to a non-calendar cycle will shift certain year-end administrative activities to a time period that conflicts less with the business needs of the Company's institutional customers.
EFFECTS OF INFLATION
Because the Company's assets are, to a large extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation affects the Company's expenses, such as employee compensation, office space leasing costs and communications charges, which may not be readily recoverable in the price of services offered by the Company. To the extent inflation results in rising interest rates and has other adverse effects upon the securities markets, it may adversely affect the Company's financial position and results of operations in certain businesses.
NEW ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standards Board Interpretation No. 39, "Offsetting of Amounts related to Certain Contracts" ("FIN No. 39"), was issued in March 1992. Effective for balance sheets after January 1, 1994, FIN No. 39 restricts the current industry practice of offsetting certain receivables and payables. Although the implementation of this standard is expected to substantially increase gross assets and liabilities, the Company believes that its results of operations and overall financial condition will not be affected. The FASB has instructed its staff to explore modifying FIN No. 39 to create certain exceptions, which, if enacted, would substantially mitigate the increase in the Company's gross assets and liabilities expected to initially result from the implementation of FIN No. 39.
In November 1992, the FASB issued Statement of Financial Standards ("SFAS") No. 112, "Employers Accounting for Postemployment Benefits." This statement requires the accrual of obligations associated with services rendered to date for employee benefits accumulated or vested for which payment is probable and can be reasonably estimated. The Company will record a charge to reflect a cumulative effect of a change in accounting principle of approximately $13 million after-tax in the first quarter of 1994.
In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company records substantially all its securities at market value. No adjustment is anticipated to be recorded as a result of this accounting pronouncement.
RISK MANAGEMENT
Risk management is an integral part of the Company's business. The Company has established extensive policies and procedures to identify, monitor, assess and manage risk effectively. For a discussion of these policies and procedures, see "Business -- Risk Management."
ITEM 8. | 728586 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
Information required by this item is set forth in the Section entitled "Financial Highlights Last Ten Years" appearing on pages 42 and 43 of the 1993 Annual Report to Stockholders, and is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
Information required by this item is set forth in the Section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing on pages 17 through 22 of the 1993 Annual Report to Stockholders, and is incorporated herein by reference.
ITEM 8. | 93542 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
FINANCIAL HIGHLIGHTS
ADVANTA CORP. AND SUBSIDIARIES
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
Net income for 1993 rose to $76.6 million or $1.92 per share. This reflects increases of 60% and 39%, respectively, from the $48.0 million or $1.38 per share reported in 1992. Net income before extraordinary item was $77.9 million or $1.95 per share, increases of 62% and 41%, respectively, from 1992. Earnings per share for 1993 incorporated a 15% increase in the number of common shares outstanding versus 1992, reflecting an equity offering by the Company in March 1993. Earnings per share for 1992 have been adjusted to reflect an effective three-for-two stock split as a result of the October 15, 1993 stock dividend.
Earnings for 1993 increased primarily as a result of a $1.1 billion or 34% increase in average managed receivables, continued improvement in credit quality with the total managed charge-off rate decreasing from 3.4% in 1992 to 2.9% in 1993, and controlled growth in operating expenses. The Company continues to securitize a majority of the growth in its receivables and to report the performance of the securitized receivables as noninterest revenues. Consequently, the 34% increase in average managed receivables resulted in a $62.5 million or 32% increase in noninterest revenues to $255.6 million in 1993, from $193.1 million in 1992. As a result of improved credit quality, the provision for credit losses in 1993 fell to $29.8 million from $47.1 million in 1992. Despite a lower provision, reserve coverage of impaired owned assets was higher at December 31, 1993 compared to a year ago. Disciplined cost management resulted in operating expenses increasing only 27%, while average managed receivables grew 34% and the operating expense ratio fell to 4.1% for 1993 compared to 4.4% in 1992.
Net interest income of $72.1 million for 1993 increased $3.4 million or 5% from 1992 as a result of a $170 million increase in average earning asset balances, offset by a 22 basis point drop in the owned net interest margin. The Company is executing a strategy to market a "risk-adjusted" credit card product in which credit cards are issued with lower rates to customers whose credit quality is expected to result in a lower rate of credit losses (the "risk-adjusted" strategy). This strategy resulted in a drop in credit card yields thereby lowering the owned net interest margin.
Over the last three years, average managed receivables have grown at a compound annual rate of 34%. This receivable growth has generated higher financial returns, net income and earnings per share. The Company intends to continue pursuing a strategy of receivable growth with a goal of increasing average managed receivables by 30% or more in 1994.
Net income for 1992 of $48.0 million or $1.38 per share increased 91% and 72%, respectively, from $25.2 million or $.81 per share in 1991.
Earnings increased in 1992 primarily as a result of an $807 million or 34% increase in average managed receivables and a 51 basis point increase in the managed net interest margin. Average securitized assets rose 67% in 1992 increasing noninterest revenues $59.8 million or 45%. The largest single component of noninterest revenues, credit card securitization income, rose $38.3 million or 90% as average securitized credit card receivables increased 85%.
The provision for credit losses was down 15% in 1992 compared to 1991 as a result of lower charge-offs and delinquency levels on owned receivables. Operating expenses increased 28% with a 34% increase in average managed receivables, while operating expenses as a percentage of average managed receivables fell to 4.4% in 1992 from 4.6% in 1991.
(1)See Note 1 to Consolidated Financial Statements.
ADVANTA CORP. AND SUBSIDIARIES
The owned net interest margin fell to 4.85% in 1993 from 5.07% in 1992, due to a 173 basis point decrease in the yield on interest earning assets partially offset by a 151 basis point improvement in the cost of funding those assets. In 1993, the owned net interest margin of 4.85% reflects the benefit of the March 1993 equity offering and increased retained earnings.
Credit card, mortgage and lease receivable securitization activity shifts revenues from interest income to noninterest revenues. This ongoing securitization activity reduces the level of higher-yielding receivables on the balance sheet while increasing the quantity of lower-yielding money market assets. While the money market assets are subsequently replaced with new receivables, the active securitization program reduces the average yield of the on-balance sheet portfolio. Net interest income on securitized credit card balances is reflected in credit card securitization income. Net interest income on securitized mortgage loans is reflected in income from mortgage banking activities, and net interest income on securitized lease receivables is reflected in leasing revenues, net. All securitization income is included in noninterest revenues. See Note 1 to Consolidated Financial Statements.
Average managed credit card receivables of $3.0 billion for 1993 increased $755 million or 34% from 1992. This increase can be attributed to several successful credit card campaigns which generated approximately 853,000 new accounts and a large volume of balance transfers by card- holders. Owned receivable balances would have been higher in both years had it not been for the securitization of $1.0 billion of credit card receivables in 1993 and $950 million in 1992. The 241 basis point decline in the yield on owned credit card receivables was the result of the Company's "risk-adjusted" strategy and the influence of a predominance of newer, lower-yielding accounts in the owned portfolio. It is anticipated that these accounts will start repricing upwards in 1994.
Average managed mortgage loans increased to $1.0 billion in 1993, a 34% increase from $786.3 million in 1992. The average balance of owned mortgage loans de-creased to $154.2 million in 1993 from $185.6 million in 1992 primarily due to the securitization of $608 million of receivables in 1993. Mortgage loan originations of $510 million in 1993 were up $84 million or 20% from 1992. Yields on owned mortgage loans decreased to 9.91% from 11.40% in 1992 reflecting the lower rate environment and a significant increase in the proportion of first lien mortgage loans in the portfolio.
Average managed lease receivables of $154.8 million increased $45 million or 42% from 1992. Average owned balances on leases increased $12.7 million during 1993 due to increased originations and portfolio purchases. Yields on owned leases increased from 17.46% in 1992 to 18.70% in 1993 due to a higher amount of late fees.
A significant decline in the owned average cost of funds was experienced in 1993 as the cost of funds fell to 5.18% from 6.39% in 1992. The rollover of deposits in a lower rate environment, lower money market rates, and the Company's entrance into funding markets not previously available to them with a newly acquired investment-grade rating were the primary reasons for this decline.
Net interest income of $68.7 million in 1992 dropped slightly from $69.3 million in 1991 primarily as a result of a 61 basis point decline in the owned net interest margin. This decline in the owned net interest margin was a result of a 218 basis point decline in yields on interest earning assets partially offset by a 157 basis point improvement in the cost of funding those assets. Offsetting this decline in the owned net interest margin was a $96 million increase in average interest earning asset balances.
The following table provides an analysis of both owned and managed interest income and expense data, average balance sheet data, net interest spread (the difference between the yield on interest earning assets and the average rate paid on interest-bearing liabilities), and net interest margin (the difference between the yield on interest earning assets and the average rate paid to fund interest earning assets) for 1991 through 1993. Average owned loan and lease receivables and the related interest revenues exclude deferred origination costs and the amortization thereof (see Note 1 to Consolidated Financial Statements) and include certain loan fees.
ADVANTA CORP. AND SUBSIDIARIES
INTEREST RATE ANALYSIS
ADVANTA CORP. AND SUBSIDIARIES
INTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET - - - --------------------------------------------- The following table presents the effects of changes in average volume and interest rates on individual financial statement line items on a tax equivalent basis, excluding the amortization of deferred origination costs and including certain loan fees. Changes not solely due to volume or rate have been allocated on a pro rata basis between volume and rate. The effects on individual financial statement line items are not necessarily indicative of the overall effect on net interest income.
(1) Includes income from assets held and available for sale.
PROVISION FOR CREDIT LOSSES - - - --------------------------- The provision for credit losses of $29.8 million in 1993 decreased $17.3 million or 37% from $47.1 million in 1992. This decrease can be attributed to lower charge-offs on owned receivables, which on a consolidated basis were 2.4% of average receivables compared to 3.9% in 1992, and to lower levels of impaired assets. The owned impaired asset level fell to $22.5 million at December 31, 1993, from $31.6 million a year ago. Lower delinquency levels helped to strengthen the Company's reserve coverage of impaired assets to 138.6% at December 31, 1993, from 127.4% a year ago.
During 1993, the Company transferred $11 million of on-balance sheet unallocated loan loss reserves to increase off-balance sheet mortgage loan recourse reserves, which reserves are netted against excess mortgage servicing rights.
The provision for credit losses of $47.1 million in 1992 decreased $8.4 million or 15% from $55.5 million in 1991. This decrease was primarily due to lower charge-offs on owned receivables and lower impaired asset levels.
A description of the credit performance of the loan portfolio is set forth under the section entitled "Credit Risk Management."
ADVANTA CORP. AND SUBSIDIARIES
Noninterest revenues of $255.6 million in 1993 increased $62.5 million or 32% from $193.1 million in 1992.
Due to the securitization of credit card receivables, activity from securitized account balances normally reported as net interest income and charge-offs is reported in securitization income and servicing income, both of which are included in noninterest revenues. Credit card securitization income increased 68% to $135.8 million from $80.8 million in 1992 while average securitized credit card receivables increased 46% to $2.1 billion in 1993 from $1.5 billion in the prior year. Securitization income as a percentage of average securitized receivables was 6.4% in 1993 compared with 5.6% for 1992. See Note 1 to Con-solidated Financial Statements for further description of securitization income.
Credit card securitization income is the revenue collected on the securitized receivables, including interest, interchange income and certain fees, less the related ex-penses, including interest payments to investors in the trusts, charge-offs, servicing costs and transaction expenses.
Credit card servicing income increased to $41.6 million in 1993 from $28.6 million in 1992. Servicing income represents fees paid to the Company for continuing to service accounts which have been securitized. Such fees approximate 2% of securitized receivables.
Total interchange income earned represents approximately 1.4% of credit card purchases. The amount of inter-change paid to the securitization trusts ranges from 1% to 2% of securitized balances and is included in credit card securitization income. Interchange income decreased 39% to $18.8 million in 1993 from $30.7 million in 1992 due to a larger proportion of interchange revenues being included in securitization income. Other credit card revenues, which include credit insurance, cash advance fees and other credit card related revenues, were basically flat year-to-year due to an increasing proportion of credit card revenues becoming part of securitization income. Additionally, the amortization of annual fee income on owned credit card receivables previously had been included in other credit card revenues; beginning in 1993, this amoritization is included as a com-ponent of net interest income.
During 1993, the Company securitized $608 million of mortgage loans compared to $385 million in 1992. In 1993, increased credit losses on the securitized portfolio decreased income from mortgage banking activities by approximately $14 million. Increased prepayments also de-creased income from mortgage banking activities by $14 million in 1993. Consequently, mortgage banking income of $24.1 million was relatively flat compared with 1992. See Note 1 to Consolidated Financial Statements for a description of mortgage banking income.
Noninterest revenues of $193.1 million in 1992 increased $59.7 million or 45% from $133.4 million in 1991 primarily due to increases in credit card securitization and servicing income.
ADVANTA CORP. AND SUBSIDIARIES
Operating expenses of $174.6 million for 1993 increased $37.0 million or 27% from $137.6 million in 1992, driven by a 34% growth in average managed receivables. The increase in operating expenses can be primarily attrib-uted to: (a) a $13.9 million, or 27%, increase in salaries and employee benefits with a 22% increase in the number of employees from 1992, (b) a $4.9 million increase in marketing expenses as the Company promoted its finan-cial products as well as enhanced its general public visibility, (c) a $3.6 million increase in external processing resulting primarily from a 26% increase in the number of accounts managed year-to-year, (d) a $5.1 million increase in professional fees as the Company invested in long-term planning projects, and (e) an overall increase in credit card related costs due to a 27% increase in the number of accounts managed.
Operating expenses of $137.6 million for 1992 were up $29.8 million or 28% from $107.8 million in 1991 while average managed receivables grew 34%. This increase in operating expenses can be primarily attributed to: (a) a $9.0 million, or 21%, increase in salaries and employee benefits with a 23% increase in the number of employees year-to-year, (b) a $5.7 million increase in marketing expenses to market the Company's financial products and enhance its general visibility, (c) a $2.3 million increase in credit card fraud losses, due to the growth in managed credit card receivables and a higher incidence of fraud, and (d) an overall increase in credit card related costs due to a 15% increase in the number of accounts managed. In 1991, credit card fraud losses included $3.9 million related to the acceleration of charge-offs (see discussion in "Asset Quality" on page 30). The operating expense ratio fell to 4.4% in 1992 from 4.6% in 1991.
INCOME TAXES The Company's consolidated income tax expense was $45.3 million for 1993, or an effective tax rate of 37%, compared to tax expense of $29.1 million, or 38%, in 1992 and tax expense of $14.2 million, or 36%, in 1991. The decrease in the effective tax rate from 1992 to 1993 resulted from a higher level of tax-free income, while the increase in the effective tax rate from 1991 to 1992 resulted from higher pretax income and less tax-free income year-to-year.
ASSET/LIABILITY MANAGEMENT - - - ------------------------------------------------------------------------------- The financial condition of Advanta Corp. is managed with a focus on maintaining high credit quality standards, disci-plined interest rate risk management and prudent levels of leverage and liquidity.
INTEREST RATE SENSIVITY Interest rate sensitivity refers to the net interest income volatility resulting from changes in interest rates, product spread variability and mismatches in the repricing intervals between interest-rate-sensitive assets and liabilities.
The Company attempts to minimize the impact of market interest rate fluctuations on net interest income and net income by regularly evaluating the risk inherent in its asset and liability structure, including securitized assets. This risk arises from continuous changes in the Company's asset/liability mix, market interest rates, the yield curve, prepayment trends and the timing of cash flows. Computer simulations are used to evaluate net interest income volatility under varying rate, spread and volume projections over monthly time periods of up to two years.
In managing its interest rate sensitivity position, the Company periodically securitizes, sells and purchases assets, alters the mix and term structure of its retail and institutional funding base and complements its basic business activities by changing the investment portfolio and short-
ADVANTA CORP. AND SUBSIDIARIES
term asset positions. The Company has primarily utilized variable rate funding in pricing its credit card securitization transactions in an attempt to match the pricing dynamics of the underlying receivables sold to the trusts. Although credit card receivables are priced at a spread over the prime rate, they generally contain interest rate floors. These floors have the impact of converting the credit card receivables to fixed rate receivables in a low interest rate environment. In instances when a significant portion of credit card receivables are at their floors, the Company may convert part of the underlying funding to a fixed rate by using interest rate hedges, swaps and fixed rate securitizations. In pricing mortgage and lease securitizations, primarily fixed rate fund-ing is used as nearly all of the receivables sold to investors carry a fixed rate.
Interest rate fluctuations affect net interest income at virtually all financial institutions. While interest rate volatility does have an effect on net interest income, other factors also contribute significantly to changes in net inter-est income. Specifically, within the credit card portfolio, pricing decisions and customer behavior regarding convenience usage affect the yield on the portfolio. These factors may counteract or exacerbate income changes due to fluc-tuating interest rates. The Company closely monitors interest rate movements, competitor pricing and consumer behavioral changes in its ongoing analysis of net interest income sensitivity.
LIQUIDITY, FUNDING, AND CAPITAL RESOURCES The Company's goal is to maintain an adequate level of liquidity, both long- and short-term, through active management of both assets and liabilities. During 1993, the Company, through its subsidiaries, securitized $1.0 billion of credit card receivables, $608 million of mortgage loans and $68 million of lease receivables. Cash generated from these transactions was temporarily invested in short-term, high quality investments at money market rates awaiting redeployment to pay down deposits and to fund future credit card, mortgage loan and lease receivable growth. See Consolidated Statements of Cash Flows for more information regarding liquidity, funding and capital resources. In addition, see Note 5 to Consolidated Financial Statements and Supplemental Schedules thereto for additional information regarding the Company's investment portfolio.
Over the last six years, the Company has accessed the securitization market to efficiently support its growth strate-gy. While securitization should continue to be a reliable source of funding for the Company, other funding sources are available and include deposits, subordinated debt, medium-term notes and the ability to sell assets and raise additional equity.
At December 31, 1993, the Company was carrying $668 million of loans available for sale. The fair value of such loans was in excess of their carrying value at year end. In connection with managing liquidity and asset/liability management, the Company had $308 million of investments available for sale at December 31, 1993. See Note 18 to Consolidated Financial Statements for fair value disclosures.
In August 1993, the Company's principal subsidiary, Colonial National Bank USA ("Colonial National" or the "Bank"), sold $50 million of subordinated notes which had received an investment-grade rating and qualified as Tier 2 capital.
The following table details the composition of the deposit base at year end for each of the past five years.
ADVANTA CORP. AND SUBSIDIARIES
It is expected that deposits will increase slightly in 1994, as the Bank is likely to expand its asset base within the limits permitted under the Competitive Equality Banking Act of 1987 ("CEBA"). As a grandfathered institution under CEBA, the Company must limit the Bank's asset growth to 7% per annum. For the fiscal CEBA year ended September 30, 1993, the Bank's average assets did not exceed the allowable amount and, accordingly, the Bank was in full compliance with CEBA growth limits.
Deposits at December 31, 1993 include $38 million of deposits at Colonial National Financial Corp. ("CNF"), a Utah state-chartered, FDIC- insured industrial loan corporation (a wholly-owned subsidiary of the Company). CNF's assets or operations are not currently material to the Company, and the Company does not expect them to become material in the near term.
During 1993, the debt securities of Advanta Corp. achieved investment-grade ratings from the nationally recognized rating agencies. These ratings have allowed the Company to further diversify its funding sources. In November 1993, the Company filed a shelf registration statement with the Securities and Exchange Commission for $1 billion of debt securities, and subsequently sold $150 million of three-year notes under this registration statement. The Company also anticipates selling up to an additional $500 million of medium-term notes as needed. In addition, steady building of liquidity and capital in 1993 and 1992 was achieved as a result of $76.5 million of dividends from subsidiaries in 1993 and $40.0 million in 1992, and retained earnings of $69.3 million in 1993 and $44.0 million in 1992. The Board of Directors currently intends to have the Company pay regular quarterly dividends to its shareholders, maintaining a 20% premium on the dividend paid on the Class B shares; however, the Company plans to reinvest the majority of its earnings to support future growth.
During 1993, the Company raised $90 million in new equity through a 3.0 million share (pre-split) Class B common stock offering. Proceeds were used to support future growth.
Other elements contributed to liquidity at the subsidiary level (other than the Bank) in 1993. Advanta Mortgage Corp. USA ("Advanta Mortgage") had lines of credit totaling $190 million, which, because of other available funding sources, were not renewed when they expired in December 1993. Advanta Leasing Corp. ("Advanta Leasing") also has lines of credit totaling approximately $86 million.
While there are no specific capital requirements for Advanta Corp., the Office of the Comptroller of the Currency requires that Colonial National maintain a risk-based capital ratio of at least 8%. Colonial National's risk-based capital ratio of 12.06% at December 31, 1993 was in excess of the required level and, in fact, exceeded the mini-mum required capital level of 10% for designation as a "well capitalized" depository institution. The Company intends to take the necessary actions to maintain Colonial National as a "well capitalized" bank. In addition, the Company is subject to various rate setting rules and capital regulations related to the Advanta Insurance Companies. At December 31, 1993, the Company was in full compliance with these rules and regulations.
CAPITAL EXPENDITURES The Company spent $11.3 million for capital expenditures in 1993, primarily for the purchase of a building, improvements to that building and additional space in other build-ings, office and voice communication equipment and furniture and fixtures. This compared to $5.3 million for capital expenditures in 1992 and $4.2 million in 1991.
In 1994, the Company anticipates capital expenditures to exceed those of 1993 as its facilities are expanding and the Company is continuing to upgrade its voice and comm-unication systems.
In 1994, the Company anticipates that its marketing expenditures will exceed those of 1993 as the Company continues to manage account retention, originate new accounts and develop new consumer products for its customers.
CREDIT RISK MANAGEMENT - - - ------------------------------------------------------------------------------- Management regularly reviews the loan portfolio in order to evaluate the adequacy of the reserve for credit losses. The evaluation includes such factors as the inherent credit quality of the loan portfolio, past experience, current eco-nomic conditions, projected credit losses and changes in the composition of the loan portfolio. The reserve for credit losses is maintained for on-balance sheet receivables. The on-balance sheet reserve is intended to cover all credit losses inherent in the owned loan portfolio. With regard to securitized assets, anticipated losses and related recourse reserves are reflected in the calculations of Securitization Income and Amounts Due From Securitizations. Recourse reserves are intended to cover all probable credit losses over the life of the securitized receivables.
ADVANTA CORP. AND SUBSIDIARIES
The reserve for credit losses on a consolidated basis was $31.2 million, or 2.4% of receivables, at December 31, 1993, down from $40.2 million, or 4.0% of receivables, in 1992. Due to improved credit quality, this reserve level resulted in higher reserve coverage of impaired assets (nonperforming assets and accruing loans past due 90 days or more on credit cards) of 138.6% at December 31, 1993, compared to 127.4% at December 31, 1992. Reserve cover-age of impaired credit card assets was 183.7% at December 31, 1993, down slightly from 187.6% at year end 1992.
The reserve for credit losses on a consolidated basis increased to $40.2 million, or 4.0% of receivables, in 1992 up from $36.4 million, or 2.9% of receivables, in 1991. This reserve level and a decrease in impaired assets resulted in higher reserve coverage of impaired assets.
ASSET QUALITY
Impaired assets include both nonperforming assets (mortgage loans and leases past due 90 days or more, real estate owned, credit card receivables due from cardholders in bankruptcy, and off-lease equipment) and accruing loans past due 90 days or more on credit cards. The carrying values for both real estate owned and equipment held for lease or sale are based on net realizable value after taking into account holding costs and costs of disposition and are reflected in other assets.
On the total managed portfolio, impaired assets were $95.1 million, or 1.8% of receivables, at year end 1993 compared to $92.7 million, or 2.5% of receivables, in 1992. Nonperforming assets on the total managed portfolio were $63.6 million, or 1.2% of receivables, compared to $57.8 million, or 1.6%, in 1992. A key credit quality statistic, the 30-plus-day delinquency rate on managed credit cards, dropped to 2.4% from 3.7% a year ago. The total managed charge-off rate for 1993 was 2.9%, compared to 3.4% for 1992. The charge-off rate on managed credit cards was 3.5% for 1993, down from 4.5% for 1992.
On the total owned portfolio, impaired assets were $22.5 million, or 1.8% of receivables, in 1993 compared to $31.6 million, or 3.2%, in 1992. Gross interest income that would have been recorded in 1993 and 1992 for owned nonperforming assets, had interest been accrued through-out the year in accordance with the assets' original terms, was approximately $1.5 million and $1.8 million, respectively. The amount of interest on nonperforming assets included in income for 1993 and 1992 was $.3 million and $.5 million, respectively.
Past due loans represent accruing loans that are past due 90 days or more as to collection of principal and interest. Credit card receivables, except those on bankrupt, decedent and fraudulent accounts, continue to accrue interest until the time they are charged off at 186 days contractual delinquency. In contrast, all mortgage loans and leases are put on nonaccrual when they become 90 days past due. Owned credit card receivables past due 90 days or more and still accruing interest were $11.0 million or 1.0% of receivables at December 31, 1993, compared to $16.3 million, or 2.2% of receivables, a year ago.
Through 1990, when the Company received notice that a credit cardholder had filed a bankruptcy petition or was deceased, the Company established a reserve equal to the full balance of the receivable. The receivable, if not paid, would be charged off in accordance with the Com-pany's normal credit card charge-off policy at 186 days contractual delinquency. Likewise, receivables in accounts identified as fraudulent would be reserved against and written off (as an operating expense) when they became 186 days contractually delinquent. These policies are consistent with many leading competitors in the credit card industry.
During 1991, the Company adopted a new policy for the charge-off of bankrupt, decedent and fraudulent credit card accounts. Under the new policy, the Company charges off bankrupt or decedent accounts within 30 days of notification and accounts suspected of being fraudulent after a 90-day investigation period, unless the investigation shows no evidence of fraud. Consequently, in 1991, both newly identified bankrupt, decedent and fraudulent accounts, as well as those previously identified, were written off. The 1991 charge-off rates included in the following tables exclude the effect of this acceleration.
With respect to the mortgage loan business, in 1993 the Company continued to face several difficult challenges: softening real estate values, increased prepayments and a higher level of charge-offs. The managed charge-off rate on mortgage loans increased from .8% in 1992 to 1.3% in 1993. The 1993 charge-off amount includes $3.0 million of accelerated charge-offs. The managed mortgage charge-off rate in 1994 is anticipated to stay at a high level.
ADVANTA CORP. AND SUBSIDIARIES
The following tables provide a summary of reserves, impaired assets, delinquencies and charge-offs for the past five years:
(1) Restated, where necessary, to exclude interest advances on the serviced mortgage portfolio to be consistent with presentation of owned portfolio. (2) The 1991 charge-off rates are normalized to exclude the acceleration of the charge-off of bankrupt and decedent accounts related to the adoption of a new credit card charge-off policy in 1991. Including these amounts, the charge-off rates for 1991 were 3.8% and 5.3% on a consolidated-managed and credit card-managed basis, respectively.
ADVANTA CORP. AND SUBSIDIARIES
(1) The 1991 charge-off rates are normalized to exclude the acceleration of the charge-off of bankrupt and decedent accounts related to the adoption of a new credit card charge-off policy in 1991. Including these amounts, the charge-off rates for 1991 were 4.7% and 5.8% on a consolidated-owned and credit card-ownedbasis, respectively.
ADVANTA CORP. AND SUBSIDIARIES
ITEM 8. | 96638 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Omitted in accordance with General Instruction J.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Omitted in accordance with General Instruction J. See "Management's Discussion and Analysis of the Results of Operations" following the Notes to Financial Statements (Item 8).
ITEM 8. | 99193 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference from Annual Report, page 22, section entitled "Selected Financial Data."
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated by reference from the Annual Report, pages 20-21, section entitled "Management's Discussion and Analysis."
ITEM 8. | 52477 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The following financial information for the years 1989 through 1993 included in the Company's 1993 Annual Report to Stockholders is incorporated by reference in this Annual Report on Form 10-K:
Five-Year Financial Highlights, page 18.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following information included in the Company's 1993 Annual Report to Stockholders is incorporated by reference in this Annual Report on Form 10-K:
Management's Discussion and Analysis, pages 19 through 23.
ITEM 8. | 277821 | 1993 |
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations
Northern States Power Company, a Minnesota corporation (the Company), has one significant subsidiary, Northern States Power Company, a Wisconsin corporation (the Wisconsin Company), and several other subsidiaries, including Viking Gas Transmission Company (Viking) and NRG Energy, Inc. (NRG), both Delaware corporations. The Company and its subsidiaries collectively are referred to herein as NSP.
The following discussion and analysis by management focuses on those factors that had a material effect on NSP's financial condition and results of operations during 1993 and 1992 and should be read in connection with the Financial Statements and Notes thereto. Trends and contingencies of a material nature are discussed to the extent known and considered relevant.
Liquidity and Capital Resources
Financial Condition and Cash Flows - With rate increases granted in 1993, NSP's financial condition remained strong and its cash flows and earnings from operations improved from 1992, despite cooler-than-average summer weather. NSP's 1992 cash flows and earnings before accounting changes were significantly reduced by unusual weather, including the coolest summer in 77 years. The 1992 earnings included $45.5 million from a change in accounting for unbilled revenues, which did not affect cash flows or customer rates. During 1993, NSP continued to meet its long-range objectives for capital structure of approximately 45-50 percent common equity and 40-45 percent debt. The pretax interest coverage ratio before accounting changes, excluding AFC, was 3.9 in 1993 and 3.1 in 1992. NSP's objective range for interest coverage is 3.5-5.0.
Financing Requirements - NSP's need for capital funds is primarily related to the construction of plant and equipment to meet the needs of its electric and gas utility customers and to fund equity commitments or other investments in its non-regulated businesses. Total NSP capital expenditures (including AFC and excluding business acquisitions) were $362 million in 1993. Of that amount, $284 million related to replacements and improvements of NSP's electric system and $36 million involved construction of natural gas distribution facilities. Internally generated funds provided 99 percent of NSP's capital expenditures for 1993 and 85 percent of the $1.8 billion in capital expenditures incurred for the five-year period 1989-1993. NSP estimates that its utility capital expenditures will be $396 million in 1994. Of that amount, $316 million is scheduled for electric facilities and $43 million for natural gas facilities. Internally generated funds from utility operations are expected to provide approximately 80 percent of 1994 utility capital expenditures and approximately 95 percent of the $1.8 billion in utility capital expenditures estimated for the five-year period 1994-1998. These utility capital expenditure estimates include approximately $100 million of anticipated expenditures for pollution control facilities required under the Clean Air Act. In addition to utility capital expenditures, expected financing requirements for the 1994-1998 period include approximately $390 million to retire long-term debt and meet first mortgage bond sinking fund requirements.
NSP expects to obtain external capital for these requirements by issuing long-term debt, common stock and preferred stock. Utility financing requirements for the period 1994-1998 may be affected by factors such as load growth, changes in capital expenditure levels, rate increases allowed by regulatory agencies, new legislation, changes in environmental regulations and other regulatory requirements.
NSP expects to invest significant amounts in non-regulated projects, including domestic and international power projects. Projects currently being pursued include joint ventures to acquire electric generating plants in Australia and Germany, and open-cast coal mining operations in Germany. Non-regulated projects are expected to be financed primarily through project debt. The remaining project costs are expected to be funded through equity investments from NSP and other investors. Over the long-term, NSP's equity investments are expected to be financed through internally generated funds or NSP's issuance of common stock and debt. Although they may vary depending on the success, timing and level of involvement in projects currently under consideration, potential capital requirements for NSP's non-regulated projects are estimated to be approximately $130 million in 1994 and approximately $540 million for the five-year period 1994-1998. These amounts include expected equity investments by NSP of approximately $60 million for the Australia project in 1994 and up to $100 million for the Germany projects through 1996.
In addition to capital expenditures, NSP invested $159 million in 1993 to acquire three energy-related businesses. (See Note 4 to the Financial Statements.) NSP continues to evaluate opportunities to enhance shareholder returns through business acquisitions. Long-term financing may be required for such acquisitions.
Financing Flexibility - NSP's ability to finance its utility construction program at a reasonable cost and to provide for other capital needs depends on its ability to earn a fair return on investors' capital. Financing flexibility is enhanced by providing working capital needs and a high percentage of total capital requirements from internal sources, and having the ability, if necessary, to issue long-term securities and obtain short-term credit. Access to securities markets at a reasonable cost is determined in a large part by credit quality. The Company's first mortgage bonds are rated AA- by Standard & Poor's Corporation, Aa2 by Moody's Investors Service, Inc., AA- by Duff & Phelps, Inc., and AA by Fitch Investors Service, Inc. Ratings for the Wisconsin Company's first mortgage bonds are generally comparable. These ratings reflect only the views of such organizations and an explanation of the significance of these ratings may be obtained from each agency. The Company's and the Wisconsin Company's first mortgage indentures place limits on the amount of first mortgage bonds that may be issued. The Minnesota Public Utilities Commission (MPUC) and the Public Service Commission of Wisconsin (PSCW) have jurisdiction over securities issuance. At Dec. 31, 1993, with an assumed interest rate of 8 percent, the Company could have issued about $1.8 billion of additional first mortgage bonds under its indenture and the Wisconsin Company could have issued about $280 million of additional first mortgage bonds under its indenture. NSP expects to maintain adequate access to long-term and short-term debt markets in 1994.
The Company registered $600 million of first mortgage bonds with the Securities and Exchange Commission (SEC) in December 1993. Depending on capital market conditions, the Company expects to issue approximately $450 million of this debt in 1994, primarily for refinancings, with the remainder issued over the next several years, for the purpose of raising additional capital or redeeming outstanding securities.
The Company's Board of Directors has approved short-term borrowing levels up to 10 percent of capitalization. The Company has received regulatory approval for $350 million in short-term borrowing levels. The Company had approximately $106 million in commercial paper debt outstanding as of Dec. 31, 1993. The Company plans to keep its credit lines at or above the level of commercial paper borrowings. Commercial banks presently provide credit lines of approximately $215 million. These credit lines make short-term financing available in the form of bank loans.
The Company's Articles of Incorporation authorize the maximum amount of preferred stock that may be issued. Under these provisions, the Company could have issued all $460 million of its remaining authorized, but unissued preferred stock at Dec. 31, 1993, and remained in compliance with all interest and dividend coverage requirements.
The level of common stock authorized, under the Company's Articles of Incorporation, is 160 million shares. Registration Statements filed with the SEC provide for the sale of up to 1,650,000 shares of common stock under the Company's Dividend Reinvestment and Stock Purchase Plan, Executive Long-Term Incentive Award Stock Plan, and Employee Stock Ownership Plan (ESOP) as of Dec. 31, 1993. The Company may issue new shares or purchase shares on the open market for its stock plans. (See Note 6 to the Financial Statements for discussion of stock awards outstanding.) As discussed below, the Company issued new common stock in 1993 under a general stock offering and under its shareholder, employee and customer stock programs. At Dec. 31, 1993, the total number of common shares outstanding was 66,879,577. The Company does not plan any general stock offerings for 1994.
1993 Financing Activity - During 1993, NSP engaged in numerous financing activities. The Company issued 4,281,217 shares of common stock. Of these shares, 2.6 million were sold to a group of underwriters on May 20, 1993. The offering price to the public was $43.625 per share, with net proceeds of $110 million to the Company. Of the remaining new shares, 940,000 shares were issued under the Dividend Reinvestment and Stock Purchase Plan, 174,308 shares were issued under the Executive Long-Term Incentive Award Stock Plan and 566,909 shares were issued to the ESOP.
On Oct. 30, 1993, the Company redeemed all 350,000 shares of its $7.84 series Cumulative Preferred Stock at $103.12 per share, plus accrued dividends through Oct. 31, 1993.
During 1993, the Company issued $350 million, and the Wisconsin Company issued $150 million, of long-term debt to refinance higher rate debt, redeem preferred stock, repay scheduled maturities of debt and extend the term of short-term borrowings. In addition, $116 million of long-term debt was issued by subsidiaries to finance the acquisitions of Viking and the Minneapolis Energy Center. (See Note 4 to the Financial Statements.) In connection with the early redemption of $453 million of long-term debt, NSP incurred approximately $14 million in reacquisition premiums, which will be amortized over the term of the newly issued debt.
Results of Operations
NSP's results of operations during 1993 and 1992 were primarily dependent on the operations of the Company's and Wisconsin Company's utility businesses consisting of the generation, transmission and sale of electricity and the distribution, transportation and sale of natural gas. NSP's utility revenues are dependent on customer usage which varies with weather conditions, general business conditions, the state of the economy and the cost of energy services, the recovery of which is determined by various regulatory authorities. The historical and future trends of NSP's operating results have been and are expected to be impacted by the following factors:
Weather - NSP's earnings can be dramatically impacted by unusual weather. Mild weather, mainly a cool summer, reduced 1993 earnings by an estimated 18 cents. However, this was an improvement over 1992 when a warm winter and the coolest summer in 77 years reduced earnings by an estimated 51 cents.
Operating Contingency - The Company is experiencing uncertainty regarding its ability to store used nuclear fuel from its Prairie Island nuclear generating facility. The facility stores its used nuclear fuel on an interim basis in a storage pool in the plant, pending the availability of a U. S. Department of Energy high-level radioactive waste storage or permanent disposal facility, or a private interim storage facility. At current operating levels, the pool will be filled in 1994 so the Company has proposed to augment Prairie Island's interim storage capacity by using steel containers for dry storage of used nuclear fuel on the plant site. Without additional onsite storage or significant modification of normal plant operations, Prairie Island Unit 2 would be shutdown in May 1995 and Prairie Island Unit 1 would be shutdown in February 1996. These two units supply about 20 percent of the Company's output. The Company has obtained a Certificate of Need from the MPUC allowing use of a limited number of steel containers, providing adequate storage at least through the year 2001. The Nuclear Regulatory Commission has also issued a license approving a dry storage facility on the plant site for Prairie Island's used fuel. However, in June 1993, the Minnesota Court of Appeals decided that the additional temporary storage facilities must be approved by the Minnesota Legislature. The Company has requested such approval from the Legislature and expects a decision on this issue during the current session, which began on Feb. 22, 1994. Although hearings have begun, the Company cannot predict what action the Minnesota Legislature will take. If operations at Prairie Island cease, the Company estimates that the present value of the cost of supplying replacement power and recovering its investment in the plant and unrecognized decommissioning costs will be $1.8 billion. The Company would request recovery of these costs, including a return on its investment, through utility rates. However, at this time the need for such costs and the regulators' ultimate response to such a request is unknown. (See Note 15 to the Financial Statements regarding the possible effects on operating results of the potential shutdown of the Company's Prairie Island nuclear power generating facility.)
Regulation - NSP's utility rates are approved by the Federal Energy Regulatory Commission (FERC) and state commissions. Rates are designed to recover plant and operating costs and an allowed return, using an annual period upon which rate case filings are based. NSP's utility companies request increases in customers' rates as needed and file them with the governing commissions. The rates charged to retail customers in Wisconsin are reviewed and adjusted biennially. Because rate increases are not requested annually in Minnesota, NSP's primary jurisdiction, the impact of inflation on operating costs continues to be a factor affecting NSP's earnings, shareholders' equity and other financial results. Except for Wisconsin electric operations, NSP's rate schedules provide for cost-of-energy adjustments to billings and revenues for changes in the cost of fuel for electric generation, purchased power and purchased gas. For Wisconsin electric operations, the biennial retail rate review process considers changes in electric fuel and purchased energy costs in lieu of a cost-of-energy adjustment clause. In addition to changes in operating costs, other factors affecting rate filings are sales growth, conservation programs and demand-side management efforts.
Rate Increases - During 1992 and 1993, NSP filed for 1993 rate increases in Minnesota, North Dakota, South Dakota and Wisconsin to offset increasing costs for purchased power commitments, depreciation, property taxes, postretirement benefits and other expenses. NSP received approvals for approximately $102 million of annualized rate increases for retail customers in those states as well as wholesale customers in Minnesota and Wisconsin. These rate changes increased 1993 revenues by approximately $83 million; the full impact of these increases will be realized in 1994. On Jan. 31, 1994, three intervenors filed an appeal of the MPUC's decision concerning the method of calculating the rate of return on common equity granted in the Minnesota electric and gas rate cases. The amount at issue is approximately $7 million in annual revenues for the Company. (See Note 2 to the Financial Statements for further discussion of 1993 rate case results.)
In 1993, NSP filed for 1994 rate increases for North Dakota retail electric and Wisconsin retail gas customers. NSP received approval for approximately $2.6 million of rate increases in these two jurisdictions, effective January 1994. No significant rate filings in other jurisdictions are expected for 1994.
Acquisitions - NSP made three strategically important business acquisitions in 1993. These include a gas pipeline, an energy services marketing business, and a steam heating and chilled water cooling system business. (See Note 4 to the Financial Statements for more discussion of these acquisitions, including the pro forma results of these acquisitions on an annual basis.)
Competition - The Energy Policy Act of 1992 (the Act) is expected to bring comprehensive and significant changes to the electric utility industry. Many provisions of the Act are expected to increase competition in the industry in the next few years. The Act's reform of the Public Utility Holding Company Act (PUHCA) promotes creation of wholesale power generators and authorizes the FERC to require utilities to provide wholesale transmission services to third parties. The legislation allows utilities and non-regulated companies to build, own and operate power plants nationally and internationally without being subject to restrictions that previously applied to utilities under the PUHCA. Other producers may compete for NSP's customers as a result of such PUHCA reform. Management believes this legislation will promote the continued trend of increased competition in the electric energy markets.
Many states are considering proposals to require "retail wheeling", which is the delivery of power generated by a third party to retail customers. Retail wheeling represents yet another development of a competitive electric industry. NSP management plans to continue its efforts to be a low-cost supplier of electricity and an active participant in the competitive market for electricity.
During 1992 and 1993, the FERC issued a series of orders (together called Order 636) addressing interstate natural gas pipeline service restructuring. This restructuring will "unbundle" each of the services - sales, transportation, storage and ancillary services - traditionally provided by the gas pipeline companies. Order 636 ended the traditional pipeline sales service function, which in the past had met local distribution companies' (LDCs) needs for reliability of supply and flexibility for meeting varying load conditions. NSP believes some uncertainty remains as to whether the new unbundled services under Order 636 will prove to be as reliable and flexible as the traditional sales service. The implementation of Order 636 also will apply more pressure on all LDCs to keep gas supply and transmission pricing for large customers competitive in light of the alternatives now available to these customers. Interstate pipelines will be allowed to recover, subject to negotiations with customers, 100 percent of prudently incurred transition costs attributable to Order 636 restructuring. Although negotiations are in process, NSP estimates that it will be responsible for less than $10 million of transition costs, over a proposed five-year period. NSP's regulatory commissions have previously approved recovery of similar restructuring charges in retail gas rates. New service agreements went into effect between NSP and its pipeline transporters on Nov. 1, 1993. NSP does not expect these new agreements under Order 636 to materially affect its cost of gas supply. NSP's acquisitions of Viking and a gas marketing business (as discussed in Note 4 to the Financial Statements) have enhanced the ability to participate in the more competitive gas transportation business. In implementing Order 636, Viking incurred no restructuring costs.
Impact of Non-Regulated Investments - NSP expects to invest significant amounts in non-regulated projects, including domestic and international power production projects through NRG, as described previously under "Financing Requirements". Depending on the success and timing of involvement in these projects, NSP's non-regulated earnings are expected to increase materially in the next few years. However, the projects generating the increased earnings may present additional risk. Current and future investments in international projects are subject to uncertainties prior to final legal closing, and continuing operations are subject to foreign government and partnership actions. NRG plans to hedge its exposure to currency fluctuations to the extent permissible by hedge accounting requirements. NRG will use well-established financial instruments of sufficient credit quality to protect the economic value of foreign-currency denominated assets. (With respect to risk of potential losses from unsuccessful non-regulated projects, see Note 1 to the Financial Statements for discussion of capitalized expenditures for projects under development.)
Employee Compensation and Benefits - In 1993, NSP conducted an extensive review of its employee compensation and benefits, and retiree benefits. As a result, several changes will be implemented, commencing in 1994, that will support NSP's goal of providing market-based compensation and benefits. These changes, which include no base wage increase for non-union employees in 1994, are expected to keep compensation and benefit costs comparable to 1993 levels. NSP's labor agreements with its five local unions expired on Dec. 31, 1993. An interim agreement with the unions expires March 31, 1994. Although NSP's final offer for settlement (made on Feb. 4, 1994) was rejected by the union membership on March 14, 1994 and an authorization to strike was approved, the parties resumed discussions on March 21, 1994. NSP is not able to predict the outcome of negotiations at this time.
Environmental Matters - Like other utilities, the Company has been named as a potentially responsible party at eight waste disposal sites and is in the process of investigating the remediation of 14 former coal-gasification and other sites. The Company has recorded an estimate of the probable costs to be incurred in connection with remediation of these sites. To the extent costs are not recovered from insurers or other parties, the Company expects to seek recovery of such costs in future ratemaking proceedings.
In general, NSP has been experiencing a trend toward more environmental monitoring and compliance costs. This trend has caused and may continue to cause slightly higher operating expenses and capital expenditures. The timing and amount of environmental costs, including those for site remediation, are currently unknown. In 1993, 1992 and 1991, the Company spent about $15 million, $20 million and $6 million, respectively, for capital expenditures on environmental improvements at utility facilities. The Company expects to incur approximately $9 million in capital expenditures for compliance with environmental regulations in 1994. (See Note 15 to the Financial Statements for further discussion of these and other environmental contingencies that could affect NSP.)
Wholesale Customers - In 1992, nine of the Company's 19 municipal wholesale electric customers created a joint action municipal power agency to serve their future power supply needs and notified the Company of their intent to terminate their power supply agreements with the Company effective in July 1995 or July 1996. These nine customers currently represent approximately $24 million in annual revenues and a maximum demand load of approximately 150 megawatts.
In 1992 and 1993, the Company signed long-term power supply agreements with the remaining 10 municipal customers. The agreements commit the customers to purchase power from the Company for up to 13 years (through 2005) at fixed rates rising at up to 3 percent per year. The 10 customers represent approximately $8 million in current annual revenue and a maximum demand load of approximately 55 megawatts. The rates contained in the agreements were accepted by the FERC on Feb. 23, 1994.
During October 1993, the Company signed an electric power agreement to provide Michigan's Upper Peninsula Power Company (UPPCO) with up to 90 megawatts of baseload service, peaking service options and load regulation service options for 20 years beginning in January 1998 through December 2017. Load regulation service is designed to change the level of power delivery during each hour to match UPPCO's load requirements. The rates, terms and conditions of the agreement are subject to FERC approval. The Michigan Public Utilities Commission must also approve the transaction. Beginning in 1998, annual revenues of approximately $12 million-$16 million are expected to be provided under the agreement, depending on contract options that UPPCO can exercise.
Legislative Changes - The Omnibus Budget Reconciliation Act of 1993 (the Act) was signed into law on Aug. 10, 1993. The only provision of the Act that had a significant effect on NSP was the increase in the federal corporate income tax rate from 34 percent to 35 percent retroactive to Jan. 1, 1993. The effect of the higher tax rate was an increase of about $3.2 million in income tax expense. Most of this cost increase was offset by higher revenues from 1993 rate increases approved in Minnesota. (See Note 2 to the Financial Statements.) Deferred tax liabilities were increased for the rate change by approximately $32 million. However, due to regulatory deferral of utility tax adjustments, earnings were reduced only by immaterial adjustments to deferred tax liabilities for non-regulated operations.
Wind-Generated Power - In October 1993, the Company signed a 25-year agreement for the purchase of 25 megawatts of wind-generated electric capacity, and associated energy to be produced in Minnesota. The wind generating plant is expected to be fully operational by May 1994. This contract is the first phase of the Company's plan to obtain 100 megawatts of wind-generated electricity by 1997. The Company can recover the cost of energy purchases through cost-of-energy adjustment clauses in electric rates.
Accounting Changes - As discussed in Note 13 to the Financial Statements, in 1993, NSP adopted Statement of Financial Accounting Standards (SFAS) No. 106 - - Employers' Accounting for Postretirement Benefits Other than Pensions and began recording postretirement benefits on an accrual basis. NSP's utility companies had previously been allowed rate recovery for postretirement benefits as paid. In the 1993 rate increases discussed above, NSP's utility companies obtained rate recovery for substantially all of the increased costs (approximately $20 million) accrued under SFAS No. 106 in 1993. Due to rate recovery of higher costs, there was no material impact on NSP's operating results from this accounting change. Recent changes in interest rates have resulted in different actuarial assumptions used in the benefit cost calculations for postretirement benefits. Due to offsetting changes in other actuarial assumptions and demographics, NSP's benefit costs for such plans are not expected to increase from these changes in 1994. (See Note 13 to the Financial Statements for more information on changes in actuarial assumptions.)
NSP also adopted in 1993 SFAS No. 109 - Accounting for Income Taxes. Because the provisions of SFAS No. 109 are not materially different than the tax accounting procedures previously used by NSP, there was virtually no impact on earnings or financial condition.
In 1992, the Company changed its accounting method for recognizing revenue. Earnings in 1992 increased by 88 cents per share, including 73 cents related to prior years, from recording estimated unbilled revenues for utility service in Minnesota, North Dakota and South Dakota. (See Note 3 to the Financial Statements for more information on the effects of this accounting change.)
In 1994, NSP will be required to adopt SFAS No. 112 - Employers' Accounting for Postemployment Benefits. This standard will require the accrual of certain postemployment costs (such as injury compensation and severance) that are payable in future periods. The impact of adopting SFAS No. 112 is expected to be immaterial.
The Financial Accounting Standards Board (FASB) has announced preliminary plans to change the accounting for stock compensation expense effective in 1997 with disclosure requirements effective in 1994. Also, the FASB has approved a proposed change in employers' accounting for employee stock ownership plans effective in 1994. Based on NSP's review of these future accounting changes, NSP does not expect a material impact on its results of operations or financial condition.
NSP currently follows predominant industry practice in recording its environmental liabilities for plant decommissioning and site exit costs as a component of utility plant. The FERC and the SEC currently are evaluating the financial presentation of these obligations, which could require a reporting reclassification as early as 1994.
1993 Compared with 1992 and 1991
NSP's 1993 earnings per share were $3.02, up 71 cents from the $2.31 earned before accounting changes in 1992 and equal to the $3.02 earned from continuing operations in 1991. In addition to the revenue and expense changes discussed below, 1993 earnings were impacted by a higher average number of common and equivalent shares outstanding for earnings-per-share calculations in 1993 due to the stock issuances discussed previously under "1993 Financing Activity."
Electric Revenues and Production Expenses
Revenues - Sales to retail customers, which account for more than 90 percent of NSP's electric revenue, increased 4.0 percent in 1993 and decreased 2.3 percent in 1992. Cool summer weather reduced sales in 1992 and, to a lesser extent, in 1993. During 1993, NSP added 14,353 retail customers, a 1.1-percent increase. Total sales of electricity, including wholesale, increased 7.3 percent in 1993.
On a weather-adjusted basis, sales to retail customers are estimated to have increased 2.1 percent in 1993 and 2.8 percent in 1992. Retail sales growth for 1994 is estimated to be 3.4 percent over 1993, or 2.2 percent on a weather-adjusted basis.
Sales to other utilities increased 22.2 percent in 1993 due to higher demand from utilities in flood-stricken Midwestern states.
The table below summarizes the principal reasons for the electric revenue changes during the past two years.
(Millions of dollars) 1993 vs 1992 1992 vs 1991 Retail sales growth (excluding weather impacts) $32 $34 Estimated impact of weather on retail sales volume 34 (85) Rate changes 74 20 Sales to other utilities 20 (2) Cost of energy clauses and other (8) (7) Total revenue increase (decrease) $152 $(40)
The 1992 sales growth is net of a $1.4-million revenue decrease, and 1992 cost-of-energy clause change is net of an $11 million revenue increase from recording unbilled revenues, which were not recorded in 1991.
Electric Production Expenses - Fuel expense for electric generation increased $19.4 million, or 6.6 percent, in 1993, compared with a decrease of $20.4 million, or 6.5 percent, in 1992. Total output from NSP's generating plants increased 8.4 percent in 1993 and decreased 3.1 percent in 1992. The fuel expense increase in 1993 was due to higher output to meet sales demand, partially offset by lower cost of fuel. The fuel expense decrease in 1992 was due to lower output (because the cool summer reduced demand) and lower cost of fuel. The lower cost of fuel per megawatt hour of generation in 1993 and 1992 reflects the increased use of low-cost purchases as discussed below.
Purchased power costs increased $53.0 million, or 34.1 percent, in 1993 and $20.0 million, or 14.7 percent, in 1992. The increase in 1993 was largely due to a demand expense increase of $42 million for the capacity charges from the power purchase agreements with Manitoba Hydro-Electric Board (MH), as discussed in Note 15 to the Financial Statements. Energy purchased from other utilities increased in both 1993 and 1992 due to economically priced energy available to meet growing retail demand and sales opportunities to other utilities that provided net ratepayer benefit. Demand expenses in 1994 are expected to increase $22 million over 1993 levels due to the MH agreements.
Revenues are adjusted for changes in electric fuel and purchased energy costs from amounts currently included in approved base rates through fuel adjustment clauses in all jurisdictions except as noted below for Wisconsin. While the lag in implementing these billing adjustments is approximately 60 days, an estimate of the adjustments is recorded in unbilled revenue in the month costs are incurred. In Wisconsin, the biennial retail rate review process considers changes in electric fuel and purchased energy costs in lieu of a fuel adjustment clause.
Gas Revenues and Purchases
Revenues - NSP categorizes gas sales as firm (primarily space heating customers) and interruptible (commercial/industrial customers with an alternate energy supply). Firm sales in 1993 increased 17.0 percent over 1992 sales, while firm sales in 1992 decreased 5.6 percent from 1991. Warm weather in the first quarter of 1992 is the main cause for both of these variations. NSP added 11,728 firm gas customers in 1993, a 3.1-percent increase.
On a weather-adjusted basis, firm sales are estimated to have increased 7.2 percent in 1993 and 3.6 percent in 1992. NSP estimates 1994 firm gas sales to decrease by 2.9 percent relative to 1993, with a 2.2-percent decrease on a weather-adjusted basis due to an unbilled revenue adjustment in 1993. Without this adjustment, estimated weather-adjusted firm gas sales would have increased 0.9 percent in 1993 and would be estimated to increase 0.7 percent in 1994.
Interruptible gas deliveries, including sales of gas purchased for resale and customer-owned gas that NSP transported, increased 15.3 percent in 1993 and decreased 0.9 percent in 1992.
The table below summarizes the principal reasons for the gas revenue changes during the past two years.
(Millions of dollars) 1993 vs 1992 1992 vs 1991 Sales growth $17 $7 Estimated impact of weather on sales volume 28 (24) Acquisition of Viking Gas 9 Rate changes 9 Purchased gas adjustment and other 30 15 Total revenue increase (decrease) $93 $(2)
The 1992 sales growth is net of a $1.5-million decrease from recording unbilled revenues, which were not recorded in 1991.
Purchased Gas - The cost of gas purchased and transported increased $61.7 million, or 28.0 percent, in 1993 due to higher sendout and higher purchased gas prices. In 1992, the cost of gas purchased and transported increased $9.0 million, or 4.3 percent, due to higher purchased gas prices, somewhat offset by lower sendout relative to 1991. The average cost per thousand cubic feet (mcf) of gas sold in 1993 was 13.3 percent higher than it was in 1992, when the cost was 7.1 percent higher than it was in 1991. NSP views the increases in 1992 and 1993 as a recovery from unsustainably low wellhead gas prices in the 1990-91 period. Revenues are adjusted for changes in purchased gas costs from amounts currently included in approved base rates through purchased gas adjustment clauses.
Other Operating Expenses and Factors
Other Operation, Maintenance and Administrative and General - These expenses, in total, decreased by $27.2 million, or 4.0 percent, compared with an increase of 1.8 percent in 1992. The 1993 decrease was the result of fewer scheduled plant maintenance outages, reduced employee levels and lower administrative costs. The 1992 increase was the result of higher levels of scheduled plant and distribution system maintenance and higher employee wages. Wages in 1993 included an accrual of $14 million for incentive compensation. Due to lower earnings as a result of mild weather, compensation in 1992 did not include incentive amounts. (See Note 7 to the Financial Statements for a summary of administrative and general expenses.)
Conservation and Energy Management - Costs in 1993 were higher than in 1992 and 1991 because NSP's regulators have approved higher expenditure levels for conservation and demand-side management efforts.
Depreciation and Amortization - The increases in depreciation for all periods reflect higher levels of depreciable plant and, in 1993, changes in the depreciable lives of certain property. (See Note 1 to the Financial Statements.)
Property and General Taxes - Property and general taxes increased in each of the reported periods primarily as a result of higher property tax rates and property additions. Property taxes in 1992 were reduced by $4.5 million due to revisions to accrued 1991 taxes (payable in 1992) based on final tax statements.
Income Taxes - The variations in income taxes are primarily attributable to fluctuations in pretax book income. Taxes in 1993 also increased about $3 million due to a 1-percent increase in the federal tax rate. (See Note 9 to the Financial Statements for a detailed reconciliation of the statutory tax rate to the actual effective tax rate.)
Allowance for Funds Used During Construction (AFC) - The differences in AFC for the reported periods are attributable to varying levels of construction work in progress and lower AFC rates associated with increased use of low-cost short-term borrowings.
Other Income and Deductions-Net - Other income and deductions increased $9.7 million in 1993 and decreased $0.8 million in 1992. The increase in 1993 was due to higher non-regulated operating income from improved refuse-derived fuel (RDF) operations and acquired businesses. Non-regulated operating income in 1992 reflects one-time expenses from unsuccessful energy projects and reduced profitability of RDF operations. Decreases in interest income and non-regulated operating income in 1992 were offset by lower expenses for regulatory compliance and legal contingencies. Interest income declined in 1992 due to decreases in the amount of investments held. (See Note 7 to the Financial Statements for a summary of amounts included in other income and deductions.)
Interest Charges - Interest on long-term debt increased in 1993 due to new debt issued to finance business acquisitions and to refinance short-term borrowings. The increase was partially offset by interest savings from refinancing debt at lower rates. Other interest charges have increased due to amortization of refinancing costs, including debt issuance costs and reacquisition premiums.
Item 8 | 72903 | 1993 |
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the year ended December 31, 1993 the Company reported a loss to common shares of $84.1 million, or $0.94 per share. The loss for the year includes a $99.3 million charge for the impairment of oil and gas properties (see ' -- Results of Operations') and a $38.6 million restructuring charge (see Items 1 and 2. 'Business and Properties -- Corporate Restructuring Program'). The restructuring charge is comprised of losses on property dispositions of $27.8 million, long-term debt repayment penalties of $8.6 million and accruals for certain personnel benefits and related costs of $2.2 million. At December 31, 1993 the Company's long-term debt totalled $449.7 million, a portion of which the Company intends to refinance to reduce required debt amortization in the near-term and provide additional financial flexibility in the current low oil price environment.
GENERAL
As an independent oil and gas producer, the Company's results of operations are dependent upon the difference between the prices received for oil and gas and the costs of finding and producing such resources. A substantial portion of the Company's crude oil production is from long-lived fields where EOR methods are being utilized. The market price of the heavy (i.e., low gravity, high viscosity) and sour (i.e., high sulfur content) crude oils produced in these fields is lower than sweeter, light (i.e., low sulfur and low viscosity) crude oils, reflecting higher transportation and refining costs. The lower price received for the Company's domestic heavy and sour crude oil is reflected in the average sales price of the Company's domestic crude oil and liquids (excluding the effect of hedging transactions) for 1993 of $12.70 per barrel, compared to $16.94 per barrel for West Texas Intermediate crude oil (an industry posted price generally indicative of spot prices for sweeter light crude oil). In addition, the lifting costs of heavy crude oils are generally higher than the lifting costs of light crude oils. As a result of these narrower margins, even relatively modest changes in crude oil prices may significantly affect the Company's revenues, results of operations, cash flows and proved reserves. In addition, prolonged periods of high or low oil prices may have a material effect on the Company's financial position.
Crude oil prices are subject to significant changes in response to fluctuations in the domestic and world supply and demand and other market conditions as well as the world political situation as it affects OPEC, the Middle East and other producing countries. (See Items 1 and 2, "Business and Properties -- Current Markets for Oil and Gas"). The period since mid-1990 has included some of the largest fluctuations in oil prices in recent times, primarily due to the political unrest in the Middle East. The actual average sales price (unhedged) received by the Company ranged from a high of $23.92 per barrel in the fourth quarter of 1990 to a low of $9.83 per barrel for the two months ended February 28, 1994. The Company's average sales price for its 1993 oil production was $12.93 per barrel. Based on operating results of 1993, the Company estimates that a $1.00 per barrel increase or decrease in average sales prices would have resulted in a corresponding $21.6 million change in 1993 income from operations and a $16.2 million change in 1993 cash flow from operating activities. The Company also estimates that a $0.10 per Mcf increase or decrease in average sales prices would have resulted in a corresponding $5.8 million change in 1993 income from operations and a $4.4 million change in 1993 cash flow from operating activities. The foregoing estimates do not give effect to changes in any other factors, such as the effect of the Company's hedging program or depreciation and depletion, that would result from a change in oil and natural gas prices.
In the third quarter of 1990 the Company initiated a hedging program with respect to its sales of crude oil and in the third quarter of 1992 a similar program was initiated with respect to the Company's sales of natural gas. See Items 1 and 2. 'Business and Properties -- Current Markets for Oil and Gas.'
During 1992 and 1993, certain significant events occurred which affect the comparability of prior periods, including the merger of Adobe with and into the Company in May 1992, the formation of the Santa Fe Energy Trust in November 1992 and implementation of the corporate restructuring
program adopted in October 1993. The corporate restructuring program includes (i) the concentration of capital spending in the Company's core operating areas, (ii) the disposition of non-core assets, (iii) the elimination of the $0.04 per share quarterly Common Stock dividend and (iv) the recognition of $38.6 million of restructuring charges. See Note 2 to the Consolidated Financial Statements and Items 1 and 2, 'Business and Properties -- Corporate Restructuring Program.' In addition, the Company's results of operations for 1993 include a charge of $99.3 million for the impairment of oil and gas properties.
The Company's capital program will be concentrated in three domestic core areas -- the Permian Basin in Texas and New Mexico, the offshore Gulf of Mexico and the San Joaquin Valley of California -- as well as its productive areas in Argentina and Indonesia. The domestic program includes development activities in the Delaware and Cisco-Canyon formations in west Texas and southeast New Mexico, a development drilling program for the offshore Gulf of Mexico natural gas properties and relatively low risk infill drilling in the San Joaquin Valley of California. Internationally, the program includes development of the Company's Sierra Chata discovery in Argentina with gas sales expected to commence in early 1995 and the Salawati Basin Joint Venture in Indonesia. See Items 1 and 2. 'Business and Properties -- Domestic Development Activities' and '--International Development Activities.'
The Company's non-core asset disposition program includes the sale of its natural gas gathering and processing assets to Hadson (completed in December 1993), the sale to Vintage of certain southern California and Gulf Coast oil and gas producing properties (completed in November 1993) and the sale to Bridge of certain Mid-Continent and Rocky Mountain oil and gas producing properties and undeveloped acreage (expected to be completed during April 1994). See Items 1 and 2. 'Business and Properties -- Corporate Restructuring Program' for a description of the transactions with Hadson, Vintage and Bridge. In the first quarter of 1994, the Company sold the remaining 575,000 Depositary Units which it held in Santa Fe Energy Trust (the 'Trust') for $11.3 million and its interest in certain other oil and gas properties for $8.3 million. As a result of the Vintage and Bridge dispositions, the Company has sold properties having combined production during 1993 of 4.1 MBbls per day of oil and 21.7 MMcf per day of natural gas and estimated proved reserves of approximately 16.7 MMBOE.
The restructuring program also includes an evaluation of the Company's capital and cost structures to examine ways to increase flexibility and strengthen the Company's financial performance. In this respect, in 1994 the Company intends to refinance a portion of its existing long-term debt and is currently evaluating a combination of debt and equity financing arrangements with which to effect the refinancing.
In May, 1992, Adobe, an oil and gas exploration and production company, was merged with and into the Company. The acquisition was accounted for as a purchase and the results of operations of the properties acquired are included in the Company's results of operations effective June 1, 1992. Pursuant to the Adobe Merger, the Company issued 5,000,000 shares of its convertible preferred stock and assumed approximately $175.0 million of long-term debt and other liabilities. Pursuant to the Adobe Merger, the Company also acquired Adobe's proved reserves and inventory of undeveloped acreage. As of December 31, 1991, Adobe's estimated proved reserves totaled approximately 53.2 MMBOE (net of 6.9 MMBOE attributable to Adobe's ownership in certain gas plants), of which approximately 58% was natural gas (approximately 66% of Adobe's estimated domestic proved reserves were natural gas). Approximately 72% of the discounted future net cash flow of Adobe's estimated domestic proved reserves was concentrated in three areas of operation -- offshore Gulf of Mexico, onshore Louisiana and in the Spraberry Trend in west Texas. In addition, Adobe's international operations consisted of certain production sharing arrangements in Indonesia, in respect of which approximately 6.0 MMBOE of estimated proved reserves had been attributed to Adobe's interest as of December 31, 1991. The location of the Adobe Properties enhanced the Company's
existing domestic operations and added significant operations to the Company's international program.
In November 1992, 5,725,000 Depositary Units consisting of interests in the Trust were sold in a public offering. After payment of certain costs and expenses, the Company received $70.1 million and 575,000 Depositary Units. For any calendar quarter ending on or prior to December 21, 2002, the Trust will receive additional royalty payments to the extent necessary to distribute $0.40 per Depositary Unit per quarter. The source of such payments, if needed, will be limited to the Company's remaining royalty interest in certain of the properties conveyed to the Trust. The aggregate amount of such payments will be limited to $20.0 million on a revolving basis. The Company was required to make an additional royalty payment of $362,000 with respect to the distribution made by the Trust for operations during the quarter ended December 31, 1993. Based upon current prices, the Company believes that a support payment will be required for the quarter ending March 31, 1994, the amount of which has not been determined. See Items 1 and 2. 'Business and Properties -- Santa Fe Energy Trust.'
RESULTS OF OPERATIONS
The following table sets forth, on the basis of the BOE produced by the Company during the applicable annual period, certain of the Companys costs and expenses for each of the three years ended December 31, 1993.
1993 1992 1991 Production and operating costs per BOE (a)------------------------------ $ 4.76 $ 5.02 $ 5.17 Exploration, including dry hole costs per BOE---------------------------- 0.90 0.84 0.72 Depletion, depreciation and amortization per BOE--------------- 4.44 4.79 4.09 General and administrative costs per BOE-------------------------------- 0.94 1.01 1.07 Taxes other than income per BOE (b)-------------------------------- 0.79 0.80 1.05 Interest, net, per BOE (c)----------- 0.94 1.58 1.43
(a) Excluding related production, severance and ad valorem taxes.
(b) Includes production, severance and ad valorem taxes.
(c) Reflects interest expense less amounts capitalized and interest income.
1993 COMPARED WITH 1992
Total revenues increased approximately 2% from $427.5 million in 1992 to $436.9 million in 1993 principally due to an increase in oil and natural gas production offset by a decline in average oil prices. Average daily oil production increased 7% from 62.5 MBbls in 1992 to 66.7 MBbls in 1993, principally due to increased domestic and Indonesian production. The average price realized per Bbl of oil during 1993 was $12.93, a decrease of 14% versus the average price of $14.96 in 1992. Natural gas production increased 31% from 126.3 MMcf per day in 1992 to 165.4 MMcf per day in 1993, primarily reflecting the effect of a full year's production from the Adobe Properties. Average natural gas prices realized increased approximately 11% from $1.70 per Mcf in 1992 to $1.89 per Mcf in 1993.
Production and operating costs increased $10.4 million in 1993, primarily reflecting the effect of a full year's costs for the Adobe Properties; however, on a BOE basis such costs declined from $5.02 per barrel in 1992 to $4.76 per barrel in 1993. Exploration costs were $5.5 million higher than in 1992 primarily reflecting higher geological and geophysical costs and higher dry hole costs. Depletion, depreciation and amortization ('DD&A') increased $6.4 million in 1993 primarily reflecting a full year's expense on Adobe Properties partially offset by reduced amortization rates with respect to certain unproved properties. DD&A for 1993 includes $12.1 million with respect to the properties sold to Vintage and Bridge. On a BOE basis, DD&A decreased by $0.35 per Bbl, from $4.79 to $4.44 per Bbl. General and administrative costs increased $1.4 million principally due to a $1.8 million charge related to the adoption of Statement of Financial Standards No. 112 -- 'Employer's Accounting for Postemployment Benefits'. Taxes (other than income) increased by $3.0 million in 1993 primarily reflecting the effect of the Adobe Properties.
Costs and expenses for 1993 also include $99.3 million in impairments of oil and gas properties and $38.6 million in restructuring charges. The Company estimates the impairments taken in 1993 will result in a reduction of DD&A in 1994 of approximately $20.0 million. The restructuring charges include losses on property dispositions of $27.8 million, long-term debt repayment penalties of $8.6 million and accruals of certain personnel benefits and related costs of $2.2 million. In connection with the property dispositions effected during 1993 (See '-- Liquidity and Capital Resources'), the Company sold properties having combined production during 1993 of 4.1 MBbls per day of oil and 21.7 MMcf per day of natural gas and combined estimated proved reserves of approximately 16.7 MMBOE. The Company's income from operations for 1993 includes $8.5 million with respect to such operations.
Interest income in 1993 includes $6.8 million related to a $10 million refund received as a result of the completion of the audit of the Company's federal income tax returns for 1971 through 1980. The decrease in interest expenses during 1993 reflects a decrease in the Company's debt outstanding and a $5.7 million credit related to a revision to a tax sharing agreement with the Company's former parent. Other income and expenses of 1993 includes a $4.0 million charge related to the accrual of a contingent loss with respect to the operations of a former affiliate of Adobe.
1992 COMPARED WITH 1991
Total revenues increased approximately 13% from $379.8 million in 1991 to $427.5 million in 1992 principally due to an increase of approximately $53.2 million attributable to production from properties acquired in the Adobe Merger and an increase of approximately $10.7 million and $10.2 million in revenues from the Company's domestic and Argentine properties, respectively, offset in part by a decline of $32.0 million in crude oil hedging revenues. Oil production increased 13% from 55.5 MBbls per day in 1991 to 62.5 MBbls per day in 1992, reflecting a 3.4 MBbl per day increase in domestic oil production and a 3.6 MBbl per day increase in production in Argentina and Indonesia. The average price realized per barrel of oil during 1992 decreased to $14.96, a decrease of 7% versus the average price of $16.16 in 1991, primarily reflecting a $32.0 million decrease in hedging revenues. Natural gas production increased 33% from 95.2 MMcf per day in 1991 to 126.3 MMcf per day in 1992 as a result of properties acquired in the Adobe Merger. Average natural gas prices realized increased approximately 14% from $1.49 per Mcf in 1991 to $1.70 per Mcf in 1992.
Total operating expenses of the Company increased $54.6 million from $315.4 million in 1991 to $370.0 million in 1992 primarily reflecting costs associated with the Adobe Merger. Production and operating costs in 1992 were $18.8 million higher than in 1991, primarily reflecting costs related to the Adobe Properties and increased fuel costs associated with the Company's EOR projects. On a BOE basis, production and operating costs declined from $5.17 per barrel in 1991 to $5.02 per barrel in 1992, primarily reflecting the lower cost structure of the Adobe Properties. Exploration costs were $6.8 million higher than in 1991 primarily reflecting higher geological and geophysical costs with respect to foreign projects. Depletion, depreciation and amortization costs were $39.7 million higher in 1992 due to the acquisition of the Adobe Properties and, to a lesser extent, adjustments to oil and gas reserves with respect to certain producing properties. General and administrative costs increased $3.1 million principally due to a $1.2 million charge related to certain stock awards which fully vested upon consummation of the Adobe Merger and certain other merger-related costs. Taxes (other than income) decreased by $2.9 million in 1992, as a result of lower accruals with respect to property taxes. The $13.6 million gain on the disposition of properties in 1992 primarily relates to the sale of certain royalty interest properties, in which the Company had no remaining financial basis.
The increase in interest expense during 1992 reflects the increase in debt as a result of the Adobe Merger. Other income and expenses for 1992 includes a $10.9 million charge for costs incurred by Adobe in connection with the Adobe Merger and paid by Santa Fe.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has generally funded capital and exploration expenditures and working capital requirements from cash provided by operating activities. Depending upon the future levels of operating cash flows, which are significantly affected by oil and gas prices, the restrictions on additional borrowings included in certain of the Company's debt agreements, together with debt service requirements and dividends, may limit the cash available for future exploration, development and acquisition activities. Net cash provided by operating activities totaled $160.2 million in 1993, $141.5 million in 1992 and $128.4 million in 1991; net cash used in investing activities in such periods totaled $121.4 million, $15.9 million and $117.2 million, respectively.
The Company's cash flow from operating activities is a function of the volumes of oil and gas produced from the Company's properties and the sales prices realized therefor. Crude oil and natural gas are depleting assets. Unless the Company replaces over the long term the oil and natural gas produced from the Company's properties, the Company's assets will be depleted over time and its ability to service and incur debt at constant or declining prices will be reduced. The Company's cash flow from operations for 1993 reflects an average sales price (unhedged) for the Company's 1993 oil production of $12.93 per barrel. For the two months ended February 28, 1994, the average sales price (unhedged) for the Company's 1994 oil production was $9.83 per barrel. If such lower oil prices prevail throughout 1994, the Company's cash flow from operating activities for 1994 will be significantly lower than that for 1993.
In October 1993, the Company's Board of Directors adopted a broad corporate restructuring program that focuses on the concentration of capital spending in core areas and the disposition of non-core assets. The Company's asset disposition program adopted in connection with the 1993 restructuring program has been substantially completed by the asset sales to Hadson, Vintage and Bridge (expected to close in April 1994), the sale of the 575,000 Depositary Units in the Trust and the sale of its interest in certain other oil and gas properties. As a result of such sales, the Company sold a total of 16.7 MMBOE of proved reserves and undeveloped acreage for a total of approximately $111.0 million, and sold certain gas gathering and processing facilities for Hadson securities.
As a part of the 1993 restructuring program, the Company eliminated its $0.04 per share quarterly dividend on its Common Stock and announced that it might spend up to $240 million in 1994 on an accelerated capital program. However, as a result of the depressed crude oil prices that have prevailed since November 1993, the Company, consistent with industry practice, is considering deferring some of its capital projects in order to prudently manage its cash flow available in the near term. Based on current market conditions, the Company estimates that 1994 capital expenditures may total between $100 million and $160 million, with the actual amount to be determined by the Company based upon numerous factors outside its control, including, without limitation, prevailing oil and natural gas prices and the outlook therefor.
The Company is a party to several long-term and short-term credit agreements which restrict the Company's ability to take certain actions, including covenants that restrict the Company's ability to incur additional indebtedness and to pay dividends on its capital stock. For a description of such existing credit agreements, see Note 7 to the Consolidated Financial Statements.
Effective March 16, 1994, the Company entered into an Amended and Restated Revolving Credit Agreement (the "Bank Facility") which consists of a five year secured revolving credit agreement maturing December 31, 1998 ("Facility A") and and a three year unsecured revolving credit facility maturing December 31, 1996 ("Facility B"). The aggregate borrowing limits under the terms of the Bank Facility are $125.0 million (up to $90.0 million under Facility A and up to $35.0 million under Facility B). Under certain circumstances, the aggregate borrowing limits under the terms of the Bank Facility may be increased to $175.0 million (up to $90.0 million under Facility A and up to $85.0 million under Facility B). Interest rates under the Bank Facility are tied to LIBOR or the bank's prime rate with the actual interest rate reflecting certain ratios based upon the Company's ability to repay its outstanding debt and the value and projected timing of production of the Company's oil and gas reserves. These and other similar ratios will also affect the Company's ability to borrow under the Bank Facility and the timing and amount of any required repayments and corresponding commitment reductions. The Bank Facility replaces the Revolving and Term Credit Agreement discussed in Note 7 to the Consolidated Financial Statements.
EFFECTS OF INFLATION
Inflation during the three years ended December 31, 1993 has had little effect on the Company's capital costs and results of operations.
ENVIRONMENTAL MATTERS
Almost all phases of the Company's oil and gas operations are subject to stringent environmental regulation by governmental authorities. Such regulation has increased the costs of planning, designing, drilling, installing, operating and abandoning oil and gas wells and other facilities. The Company has expended significant financial and managerial resources to comply with such regulations. Although the Company believes its operations and facilities are in general compliance with applicable environmental regulations, risks of substantial costs and liabilities are inherent in oil and gas operations. It is possible that other developments, such as increasingly strict environmental laws, regulations and enforcement policies or claims for damages to property, employees, other persons and the environment resulting from the Company's operations, could result in significant costs and liabilities in the future. As it has done in the past, the Company intends to fund its cost of environmental compliance from operating cash flows. See also, Items 1 and 2. 'Business and Properties -- Other Business Matters -- Environmental Regulation' and Note 12 to the Consolidated Financial Statements.
DIVIDENDS
Dividends on the Company's convertible preferred stock are cumulative at an annual rate of $1.40 per share. No dividends may be declared or paid with respect to the Company's common stock if any dividends with respect to the convertible preferred stock are in arrears. As described elsewhere herein, the Company has eliminated the payment of its $0.04 per share quarterly dividend on its common stock. The determination of the amount of future cash dividends, if any, to be declared and paid on the Company's common stock is in the sole discretion of the Company's Board of Directors and will depend on dividend requirements with respect to the convertible preferred stock, the Company's financial condition, earnings and funds from operations, the level of capital and exploration expenditures, dividend restrictions in financing agreements, future business prospects and other matters the Board of Directors deems relevant.
ITEM 8. | 86772 | 1993 |
|
30554 | 1993 |
||
ITEM 6. SELECTED FINANCIAL DATA - - --------------------------------
Selected Income Statement Data:
Selected Balance Sheet Data:
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION - - -------------------------------------------------------------------- AND RESULTS OF OPERATIONS - - -------------------------
OPERATING RESULTS 1993 VS. 1992
Net Sales in 1993 showed strength throughout the year and produced total sales revenues of $511,951,000, which exceeded the previous year by $28,019,000 or 5.8%. Unit gains were generated both in the United States and Canada. Upward selling price movements which were limited had little effect on the year's total sales.
Except for small geographical pockets indicative of specific local conditions, the sales momentum extended to areas which had been affected by adverse economic conditions in the last few years. Most noteworthy were the recoveries in New England and other sections of the Northeast and the business upsurge in southern Florida attributable to the rebuilding following the aftermath of Hurricane Andrew.
Production finishes also reflected unit growth although this market segment represents less than 10% of total sales.
Cost of products sold in 1993 was $267,494,000 which was 5.2% above the prior year. Slightly lower raw material cost levels and production efficiencies were beneficial in keeping the percentage increase .6% lower than the sales increase percentage.
However, selling, administrative and general expenses of $184,255,000 rose $14,164,000 or 8.3%. The largest single increase was for postretirement health benefits. An additional amount of approximately $2,529,000 was charged to earnings consisting of the annual service cost and the amortization of the transition liability as required by SFAS No. 106.
In addition to general inflationary increases and other factors attributable to higher sales volume, two other significant factors contributing to the increase in expenses were the second year of a renewed emphasis on media advertising amounting to approximately $1,000,000 and start-up costs of $1,491,000 associated with the introduction of a broad new line of industrial maintenance products. Sales of the new product line were limited to a market test in 1993. A broadening of distribution is planned in 1994.
Dealer business closures and slow collection continued to be prevalent and, despite tighter credit controls, resulted in high bad debt writeoffs similar to the previous year. In recent months business growth by the Company's Dealers suggest an optimistic outlook for 1994.
Other income in 1993 declined $171,000 from 1992 mostly due to reduced interest income on lower short-term investments. Income before taxes and minority interest was $60,951,000, up $552,000 or .9% over 1992. The effective income tax rate in 1993 was 39.2% compared with 38.9% in 1992. Higher profits and the 1993 tax rate increase accounted for the increased provision for income taxes of $379,000 or 1.6%.
- 11-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - - --------------------------------------------------------------- RESULTS OF OPERATIONS - - ---------------------
Net income of $36,511,000 represented an improvement of $204,000 or .6% over 1992. Earnings per share in 1993 were $3.75, up $.09 over the prior year. Dividends declared per share edged upward by $.01 to $1.68 in 1993.
The Company's New Zealand subsidiary which consists of a warehouse operation continued to concentrate on sales development in it first full year. Since its initial market test in 1991, there has been little effect on total sales and income.
If the economic recoveries in the Northeast and New England continue into 1994 and inflationary pressures are maintained under control, optimism should prevail for growth in both sales and income.
OPERATING RESULTS 1992 VS. 1991
Net Sales of $483,933,000 in 1992 surpassed the prior year by $20,961,000 or 4.5%. Without a general selling price adjustment in trade sales coatings, the increase was generated by unit gains both in the United States and Canada.
The sales gains in the United States began late in the first half of the year, leveled off for a short period and resumed momentum especially in the fourth quarter. Most areas of the country showed upward movement with noticeable improvement in the southern region, the Midwest, the Northwest, and portions of the Northeast. New England indicated an end of its slide by recovering some of the volume lost in prior years. Slow areas continued to be in the Greater New York market and in California where the economies remained sluggish. Sales in Canada reflected gains throughout the year.
Production finishes sales in the U.S. experienced good growth in 1992 largely due to the acquisition of a general industrial coatings line late in 1991. The acquired product line supplemented existing volume in production finishes coatings and has had no significant change in product mix. Sales of production finishes coatings in Canada were slow.
Cost of products sold was $254,362,000 in 1992 which was $7,747,000 or 3.1% above 1991. As a percent of sales, cost of products sold was 52.6% in 1992 compared with 53.3% in 1991. The unit sales gains were accompanied by a decrease of approximately 3% in raw material cost levels to account for the decline in the percentage.
Selling, administrative and general expenses of $170,091,000 rose $12,246,000 or 7.8% over the prior year. In addition to an inflationary effect of nearly 3.5% in operating expenses, bad debt writeoffs represented a significant increase of $1,162,000 or 17.0% over 1991. Business failures and slow collections were prevalent during the two year period. Close monitoring of accounts Receivable along with the writeoffs resulted in an improvement in the quality of the outstanding Receivables. Another major reason for the increase in expenses was the commencement of a renewed national advertising thrust directed toward
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - - --------------------------------------------------------------- RESULTS OF OPERATIONS - - ---------------------
the consumer especially in large metropolitan areas. The relocation of private label production from Gibbsboro, New Jersey to Newark, New Jersey in the latter part of 1992 also accounted for a one-time charge of approximately $500,000.
Other income in 1992 declined $759,000 from the previous year. Reduced interest rates earned on short-term securities combined with lesser amounts available for temporary investments occasioned the decrease.
Net income before taxes and minority interest was $60,399,000, up $208,000 over 1991.
The Company's effective income tax rate was 38.9% in 1992 as compared with 39.4% in 1991. The provision for income taxes decreased by $189,000 or .8%.
Net income of $36,307,000 in 1992 was $370,000 or 1% above 1991. Earnings per share were $3.66 in 1992, and improvement of $.12 over 1991. Dividends declared per share were $1.67 compared with $1.62 in the prior year.
The Company's warehouse operation in New Zealand which opened in 1991 showed some indication of growth but had little effect on either net sales or net income.
FINANCIAL POSITION AND LIQUIDITY
During 1993 the financial strenth of the Company continued to be evidenced in the ability of the cash flows from operations to meet operating and capital requirements.
Net cash flows provided by operating activities amounted to $32,282,000 in 1993 compared with $39,972,000 in 1992 and $33,772,000 in 1991.
The decrease in operating cash flows of 1993 vs. 1992 was attributable to the additional support required for accounts and notes receivable and for the higher inventories of merchandising material which is reflected in prepaid expenses.
Net cash flows used in investing activities showed a significant increase in 1993 over the prior year.
The completion of the property renovation for a corporate technical and administrative center in Flanders, New Jersey accounted for the increase of over $2,017,000 in capital expenditures of 1993 compared with 1992. The continued reduction in short-term investments was a reflection of the use of internal funds for the Flanders building project as well as, in part, the accounts receivable support.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - - --------------------------------------------------------------- RESULTS OF OPERATIONS - - ---------------------
The cash flows used in financing activities declined over $4,800,000 principally due to lower requirements for the acquisition of treasury stock. Generally, the Company finances its stock repurchases from its working capital in accordance with the conditions described at Part II, Item 5 above. It is expected that any future purchases will be similarly financed.
During the three years ended December 31, 1993 the Company purchased 141,048; 218,110 and 178,683 shares, respectively, of its common stock. In addition, a capital contribution of 42,000 shares was received by the Company in 1991 through a bequest of a deceased senior executive.
Sales of treasury stock are made to employees under an Employees' Stock Purchase Plan. During 1992 and 1991, the Company sold 300 and 229,100 shares, respectively, to employees. In addition, the Company distributed 876; 1,432 and 2,004 shares to non-executive sales employees in 1993, 1992 and 1991, respectively.
During 1993 borrowing by the Company was largely limited to short-term line of credit uses by the Canadian subsidiary. The subsidiary in New Zealand also utilized local bank loans for a majority of its capital requirements.
In 1994 the Company will continue with a major expansion of its production and warehouse facility at Mesquite, Texas. The project which is expected to amount to $8,500,000, is anticipated to consist of several phases with completion in 1995. The closing of the Houston plant and the transfer of production to the Mesquite facility is planned upon completion of the building project at Mesquite. A warehouse addition at an estimated cost of $800,000 is also in progress at the Pell City, Alabama plant.
The renovation of the interior offices at the general administrative offices location in Montvale, New Jersey, at a cost of approximately $1,000,000, is expected to be completed by mid 1994. In addition, the relocation of the Company's Jacksonville, Florida plant, which is located adjacent to the Gator Bowl, will commence within the next year due to the awarding of an NFL football franchise to the city. The property occupied by the plant is included in the local development project. Negotiations are being conducted with the appropriate authorities for property appraisals and a determination of relocation costs.
It is likely that a limited amount of short-term bank borrowing may be necessary to supplement funds from operating cash flows to finance the several construction projects.
OTHER MATTERS
The Company places importance on its environmental responsibilites. Compliance with current laws concerning environmental protection has not resulted in significant capital expenditures and has
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - - --------------------------------------------------------------- RESULTS OF OPERATIONS - - ---------------------
not had a material adverse effect on the Company's earnings or its financial postion. The Company does not anticipate that future costs associated with current laws governing environmental protection will have a material effect upon its capital expenditures, earnings or competitive postion.
For information regarding Financial Accounting Standards that have been issued but not yet adopted by the Company refer to Note 6 of the Notes to Consolidated Financial Statements.
ITEM 8. | 276999 | 1993 |
Item 6. SELECTED FINANCIAL DATA
Pursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Page 24 of Ogden's 1993 Annual Report to Shareholders.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Pages 22 and 23 of Ogden's 1993 Annual Report to Shareholders.
Item 8. | 73902 | 1993 |
Item 6. Selected Financial Data - --------------------------------
The selected financial information included in the condensed balance sheet on page 61 of the 1993 Annual Report is incorporated herein by reference. Summarized results of operations may be found in the six-year Summary of Operations on pages 56 and 57 of the 1993 Annual Report.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition - -------------------------------------------------------------------- and Results of Operations -------------------------
"Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 8 through 34 of the 1993 Annual Report is incorporated herein by reference.
Item 8. | 774203 | 1993 |
Item 6. Selected Financial Data
Entergy Corporation. Refer to information under the heading "Entergy Corporation and Subsidiaries Selected Financial Data - Five- Year Comparison," which information is incorporated herein by reference.
AP&L. Refer to information under the heading "Arkansas Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
GSU. Refer to information under the heading "Gulf States Utilities Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
LP&L. Refer to information under the heading "Louisiana Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
MP&L. Refer to information under the heading "Mississippi Power & Light Company Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
NOPSI. Refer to information under the heading "New Orleans Public Service Inc. Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
System Energy. Refer to information under the heading "System Energy Resources, Inc. Selected Financial Data - Five-Year Comparison," which information is incorporated herein by reference.
Item 7. | Item 7 "Financial Statements and Exhibits".
A current report on Form 8-K, dated January 18, 1994, was filed with the SEC on January 18, 1994, reporting information under Item 5 "Other Materially Important Events".
A current report on Form 8-K, dated February 1, 1994, was filed with the SEC on February 8, 1994, reporting information under Items 2 and 7.
Entergy Corporation, AP&L, GSU, LP&L, MP&L and NOPSI
Current Reports on Form 8-K, dated December 31, 1993, were filed by these companies on January 3, 1994 reporting the consummation of the Entergy Corporation - GSU merger under Item 5 (in the case of AP&L, LP&L, MP&L and NOPSI), Items 2 and 7 (in the case of Entergy Corporation and GSU).
EXPERTS
All statements in Part I of this Annual Report on Form 10-K as to matters of law and legal conclusions, based on the belief or opinion of System Energy or any System operating company or otherwise, pertaining to the titles to properties, franchises and other operating rights of certain of the registrants filing this Annual Report on Form 10-K, and their subsidiaries, the regulations to which they are subject and any legal proceedings to which they are parties are made on the authority of Friday, Eldredge & Clark, 2000 First Commercial Building, 400 West Capitol, Little Rock, Arkansas, as to AP&L and as to Entergy Services in regards to flood litigation; Monroe & Lemann (A Professional Corporation), 201 St. Charles Avenue, Suite 3300, New Orleans, Louisiana, as to LP&L and NOPSI; and Wise Carter Child & Caraway, Professional Association, Heritage Building, Jackson, Mississippi, as to MP&L and System Energy.
The statements attributed to Clark, Thomas & Winters, a professional corporation, as to legal conclusions with respect to GSU's rate regulation in Texas under Item 1. "Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, "Rate and Regulatory Matters," have been reviewed by such firm and are included herein upon the authority of such firm as experts.
The statements attributed to Sandlin Associates regarding the analysis of River Bend Construction costs of GSU under Item 1. "Rate Matters and Regulation - Rate Matters - Retail Rate Matters - GSU" and in Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements and GSU's Financial Statements, "Rate and Regulatory Matters", have been reviewed by such firm and are included herein upon the authority of such firm as experts.
ENTERGY CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
ENTERGY CORPORATION
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Vice President and March 14, 1994 Lee W. Randall Chief Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); W. Frank Blount, John A. Cooper, Jr., Brooke H. Duncan, Lucie J. Fjeldstad, Kaneaster Hodges, Jr., Robert v.d. Luft, Kinnaird R. McKee, Paul W. Murrill, James R. Nichols, Eugene H. Owen, John N. Palmer, Robert D. Pugh, H. Duke Shackelford, Wm. Clifford Smith, Bismark A. Steinhagen, and Walter Washington (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
ARKANSAS POWER & LIGHT COMPANY
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
ARKANSAS POWER & LIGHT COMPANY
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, John A. Cooper, Jr., Cathy Cunningham, Richard P. Herget, Jr., Tommy H. Hillman, Donald C. Hintz, Kaneaster Hodges, Jr., Jerry D. Jackson, R. Drake Keith, Jerry L. Maulden, Raymond P. Miller, Sr., Roy L. Murphy, William C. Nolan, Jr., Robert D. Pugh, Woodson D. Walker, Gus B. Walton, Jr., Michael E. Wilson (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
GULF STATES UTILITIES COMPANY
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
GULF STATES UTILITIES COMPANY
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Vice President and March 14, 1994 Lee W. Randall Chief Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Robert H. Barrow, Frank F. Gallaher, Frank W. Harrison, Jr., Donald C. Hintz, Jerry L. Maulden, Paul W. Murrill, Eugene H. Owen, M. Bookman Peters, Monroe J. Rathbone, Jr., Sam F. Segnar, Bismark A. Steinhagen, James E. Taussig, II. (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
LOUISIANA POWER & LIGHT COMPANY
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
LOUISIANA POWER & LIGHT COMPANY
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, John J. Cordaro, Donald C. Hintz, William K. Hood, Jerry D. Jackson, Tex R. Kilpatrick, Joseph J. Krebs, Jr., Jerry L. Maulden, H. Duke Shackelford, Wm. Clifford Smith (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
MISSISSIPPI POWER & LIGHT COMPANY
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
MISSISSIPPI POWER & LIGHT COMPANY
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, Frank R. Day, John O. Emmerich, Jr., Norman B. Gillis, Jr., Donald C. Hintz, Jerry D. Jackson, Robert E. Kennington, II, Jerry L. Maulden, Donald E. Meiners, John N. Palmer, Sr., Clyda S. Rent, Walter Washington, Robert M. Williams, Jr. (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
NEW ORLEANS PUBLIC SERVICE INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
NEW ORLEANS PUBLIC SERVICE INC.
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer)
Edwin Lupberger (Chairman of the Board, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Michael B. Bemis, James M. Cain, John J. Cordaro, Brooke H. Duncan, Norman C. Francis, Donald C. Hintz, Jerry D. Jackson, Jerry L. Maulden, Anne M. Milling, John B. Smallpage, Charles C. Teamer, Sr. (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
SYSTEM ENERGY RESOURCES, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. The signature of the undersigned company shall be deemed to relate only to matters having reference to such company and any subsidiaries thereof.
SYSTEM ENERGY RESOURCES, INC.
By /s/ Lee W. Randall Lee W. Randall, Vice President and Chief Accounting Officer
Date: March 14, 1994
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above-named company and any subsidiaries thereof.
Signature Title Date
/s/ Lee W. Randall Lee W. Randall Vice President and Chief March 14, 1994 Accounting Officer (Principal Accounting Officer)
Donald C. Hintz (President, Chief Executive Officer and Director; Principal Executive Officer); Gerald D. McInvale (Senior Vice President and Chief Financial Officer; Principal Financial Officer); Edwin Lupberger (Chairman of the Board), Jerry D. Jackson, Jerry L. Maulden (Directors).
By: /s/ Lee W. Randall March 14, 1994 (Lee W. Randall, Attorney-in-fact)
EXHIBIT 23(a)
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Post-Effective Amendment Nos. 2, 3, 4A, and 5A on Form S-8 to Registration Statement No. 33-54298 of Entergy Corporation on Form S-4, and the related Prospectuses, of our reports dated February 11, 1994 (which express an unqualified opinion and include explanatory paragraphs as to uncertainties because of certain regulatory and litigation matters), appearing in this Annual Report on Form 10-K of Entergy Corporation for the year ended December 31, 1993.
We also consent to the incorporation by reference in Registration Statements Nos. 33-36149, 33-48356 and 33-50289 of Arkansas Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Arkansas Power & Light Company for the year ended December 31, 1993.
We also consent to the incorporation by reference in Registration Statements Nos. 33-46085, 33-39221 and 33-50937 of Louisiana Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Louisiana Power & Light Company for the year ended December 31, 1993.
We also consent to the incorporation by reference in Registration Statements Nos. 33-53004, 33-55826 and 33-50507 of Mississippi Power & Light Company on Form S-3, and the related Prospectuses, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of Mississippi Power & Light Company for the year ended December 31, 1993.
We also consent to the incorporation by reference in Registration Statement No. 33-57926 of New Orleans Public Service Inc. on Form S-3, and the related Prospectus, of our reports dated February 11, 1994, appearing in this Annual Report on Form 10-K of New Orleans Public Service Inc. for the year ended December 31, 1993.
We also consent to the incorporation by reference in Registration Statement No. 33-47662 of System Energy Resources, Inc. on Form S-3, and the related Prospectus, of our reports dated February 11, 1994 (which express an unqualified opinion and include an explanatory paragraph as to an uncertainty resulting from a regulatory proceeding), appearing in this Annual Report on Form 10-K of System Energy Resources, Inc. for the year ended December 31, 1993.
/s/ Deloitte & Touche
DELOITTE & TOUCHE New Orleans, Louisiana March 14, 1994
EXHIBIT 23(b)
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of Gulf States Utilities Company on Form S-3 (File Numbers 33-49739 and 33-51181) and Form S-8 (File Numbers 2-76551 and 2-98011) of our reports, dated February 11, 1994, on our audits of the financial statements and financial statement schedules of Gulf States Utilities Company as of December 31, 1993 and 1992, and for the years ended December 31, 1993, 1992 and 1991, which reports include explanatory paragraphs related to rate-related contingencies, legal proceedings and changes in accounting for income taxes, postretirement benefits, unbilled revenue and power plant materials and supplies and are included in this Annual Report on Form 10-K.
/s/ Coopers & Lybrand
Coopers & Lybrand
Houston, Texas March 14, 1994
EXHIBIT 23(c)
CONSENT OF EXPERTS
We consent to the reference to our firm under the heading "Experts" in this Annual Report on Form 10-K. We further consent to the incorporation by reference of such reference to our firm into Arkansas Power & Light Company's ("AP&L") Registration Statements (Form S-3, File Nos. 33-36149, 33-48356 and 33-50289) and related Prospectuses, pertaining to AP&L's First Mortgage Bonds and Preferred Stock.
Very truly yours,
/s/ Friday, Eldredge & Clark
FRIDAY, ELDREDGE & CLARK
Date: March 14, 1994
EXHIBIT 23(d)
CONSENT
We consent to the reference to our firm under the heading "Experts", and to the inclusion in this Annual Report on Form 10-K of Gulf States Utilities Company ("GSU") of the statements of legal conclusions attributed to us herein (the Statements of Legal Conclusions) under Part I, Item 1. Business - "Rate Matters and Regulation" and in the discussion of Texas jurisdictional matters set forth in Note 2 to GSU's Financial Statements and Note 2 to Entergy Corporation and Subsidiaries Consolidated Financial Statements appearing as Item 8. | 7323 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
PART II (Continued)
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The information under the caption "Management's Discussion and Analysis" contained in the 1993 Annual Report to Stockholders is incorporated in this Item 7 by reference.
ITEM 8. | 55785 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference to pages 36 and 37, Notes 1 through 4, 9 and 13 of Notes to Consolidated Financial Statements on pages 43 through 46, 50 through 51 and 56 through 57, and Earnings Outlook on pages 34 through 35 of Cooper's 1993 Annual Report to Shareholders.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated by reference to pages 10 through 21 and 25 through 35 of Cooper's 1993 Annual Report to Shareholders, excluding the last sentence of the first paragraph on page 25.
ITEM 8. | 24454 | 1993 |
313616 | 1993 |
||
Item 6 SELECTED FINANCIAL DATA - ------ -----------------------
The information required by Item 6 is incorporated herein by reference to "Selected Consolidated Financial Data" in the Financial Information of the Company's 1993 Annual Report to shareholders.
Item 7 | Item 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------ --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
The information required by Item 7 is incorporated herein by reference to the "Management's Discussion and Analysis of Consolidated Results of Operations and Financial Condition" in the Financial Information section of the Company's 1993 Annual Report to shareholders.
See "Rates" under Item 1 "Business" for an update to the discussion of the Company's base rate proceeding in the District of Columbia.
Item 8 | 79732 | 1993 |
Item 6. SELECTED FINANCIAL DATA.
Selected financial data for the five years ended December 31, 1993, appearing on page 32 of the Registrant's Proxy Statement dated March 21, 1994, is incorporated herein by reference.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Management's Discussion and Analysis of Financial Condition and Results of Operations, appearing on pages 21 through 31 of the Registrant's Proxy Statement dated March 21, 1994, is incorporated herein by reference.
Item 8. | 732714 | 1993 |
Item 6. Custodian of Investments (a) The Committee has appointed Vanguard Fiduciary Trust Company, P.O. Box 1101 Vanguard Financial Center, Valley Forge, Pennsylvania 19482, as independent Plan Trustee. The Trustee and the Company have entered into a trust agreement setting forth the Trustee's responsibilities under the Plan including maintaining custody of the Plan's investments and records of accounts for participants.
(b) The Trustee receives no compensation from the Plan.
(c) Vanguard Fiduciary Trust Company meets certain ERISA financial criteria and the Company is not required to secure or provide bonds as evidence of financial guarantee.
Item 7. | Item 7. Reports of Participating Employees During each quarter of the plan year, each participant receives an individual participant statement disclosing the status of his or her account during the preceding quarter.
Item 8. | 352947 | 1993 |
Item 6. Selected Financial Data
Year ended December 31, 1993 1992 1991 1990 1989 Rental and service income $17,953,526 $21,494,257 $21,092,058 $20,988,232 $20,779,131 Interest on short- term investments 31,346 161,231 192,197 265,821 265,637 Admin. expenses 679,625 653,998 584,826 438,035 505,203 Gain on sale of property 3,606,825 None None None None Extraordinary items: Gain on forgive- ness of debt 1,234,176 None None None None Gain on fore- closure of properties 8,432,686 None None None None Net income (loss) 9,901,817 (5,099,275) (5,662,553) (5,484,230) (7,509,077) Net income (loss) per Limited Part- nership Interest 112.63 (58.00) (64.41) (62.38) (85.41) Tax income (loss) 19,678,422 (8,936,053) (9,011,828) (7,759,553)(10,053,658) Tax income (loss) per Limited Part- nership Interest 210.88 (70.82) (88.80) (67.70) (105.11) Cash and cash equivalents 1,160,704 223,828 427,569 413,669 353,928 Total investment properties, net of accumulated depreciation 69,892,901 98,081,597 101,655,358 105,218,999 114,405,379 Total assets 73,333,165 100,416,387 104,489,888 110,712,217 117,303,591 Purchase price, promissory and mortgage notes payable 84,130,907 120,086,011 120,708,225 122,370,278 127,406,328 Properties owned on December 31 10 13 13 13 14
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Balcor Realty Investors 84-Series II, A Real Estate Limited Partnership (the "Partnership") is a limited partnership formed in 1983 to invest in and operate income-producing real property. The Partnership raised $87,037,000 through the sale of Limited Partnership Interests and utilized these proceeds to acquire fourteen real property investments. Titles to the Southern Hills, Rancho Mirage and Highland Ridge apartment complexes were relinquished through foreclosure during January 1990, March 1993 and May 1993, respectively. The Partnership also sold the Butterfield Village Apartments in April 1993. The Partnership continues to operate the ten remaining properties.
Operations
Summary of Operations
The Partnership sold Butterfield Village Apartments in April 1993 and relinquished titles to the Rancho Mirage and Highland Ridge apartment complexes to the lenders through foreclosure in March and May 1993, respectively. The latter two properties were in receivership in 1993 and, in accordance with the Partnership's accounting policies, no operations were recorded during 1993. Both of these properties generated losses during 1992. This, along with the gain recognized on the sale of Butterfield Village Apartments during 1993, resulted in the recognition of income before extraordinary items during 1993 as compared to a loss during 1992. The Partnership realized further income during 1993 as a result of the extraordinary gains recognized in connection with the foreclosures, as well as the gain recognized in connection with the forgiveness of debt related to the Ridgetree II refinancing in April 1993.
During 1992 and the latter part of 1991, the Partnership modified or refinanced loans collateralized by four of its properties. In addition, the Partnership placed two of its properties in substantive foreclosure as of September 30, 1992 whereby interest expense is recognized only to the extent paid. The combined effect of these events resulted in a decrease in interest expense on purchase price, promissory and mortgage notes payable during 1992. This decrease in interest expense was the primary reason for the decrease in the net loss during 1992 as compared to 1991. Further discussion of the Partnership's operations are summarized below.
1993 Compared to 1992
As mentioned above, the Partnership sold the Butterfield Village Apartments in April 1993 and did not record operations during 1993 for the Highland Ridge and Rancho Mirage apartment complexes as a result of their receivership status. As a result, the Partnership experienced decreases in rental and service income, interest expense on purchase price, promissory and mortgage notes payable, depreciation, property operating expense, maintenance and repair expense, real estate taxes and property management fees during 1993 as compared to 1992. Increased occupancy levels and/or rental rates at seven of the Partnership's properties during 1993 partially offset the above decrease in rental and service income, and consequently, property management fees.
The loan collateralized by the Seabrook Apartments was originally financed by a bond issuance which matured in 1992. During the third quarter of 1992, the Partnership received interest income from the trustee of the bonds. This, as well as lower interest rates earned on short-term investments in 1993, resulted in a decrease in interest income on short-term investments during 1993 as compared to 1992.
In May and June 1992, the Partnership reached settlements with the sellers of the Rosehill Pointe and Ridgetree II apartment complexes. As a result, settlement income of $273,294 was recognized in connection with these transactions during 1992.
During July 1992 and April and May 1993, the loans collateralized by the Seabrook, Ridgetree II and Meadow Creek apartment complexes, respectively, were refinanced. In addition, in accordance with the loan agreements, the interest rates on the loans collateralized by the Rosehill Pointe and Westwood Village apartment complexes were adjusted to lower rates during July and October 1993, respectively. These events contributed to the decrease in interest expense on purchase price, promissory and mortgage notes payable discussed above.
Due to the sale of the Butterfield Village Apartments and the foreclosure of the Highland Ridge Apartments, as well as the Ridgetree II and Meadow Creek refinancings and the Park Colony modification, the Partnership fully amortized the remaining financing fees related to the corresponding mortgage notes payable during 1993. This resulted in an increase in amortization expense during 1993 as compared to 1992.
Increased administrative and maintenance staff payroll expenses at the Rosehill Pointe and Spring Creek apartment complexes during 1993 partially offset the decrease in property operating expense discussed above.
During 1992, the Partnership incurred substantial expenditures for painting and cleaning and carpet replacement at the Park Colony Apartments in an effort to lease vacant units. In addition, the Partnership deferred non-critical maintenance and repair costs during 1993 at the Ridgepoint Green and Ridgepoint Way apartment complexes due to the bankruptcy filings. This contributed to the decrease in maintenance and repair expense discussed above.
During 1993, higher real estate taxes were incurred at the Meadow Creek, Spring Creek and Westwood Village apartment complexes as a result of increased tax rates and/or assessments. The additional expense partially offset the reduction in real estate tax expense due to the property dispositions discussed above and lower assessments at the La Contenta and Ridgetree II apartment complexes.
During 1993, Rosehill Pointe Apartments experienced an increase in rental rates and a decrease in interest expense, as discussed above. This improvement in operations resulted in a decrease in the affiliates' participation in losses from joint ventures during 1993 as compared to 1992. In addition, interest income received during the third quarter of 1992 from the trustee of the bonds, which were collateralized by the Seabrook Apartments and matured in 1992, offset the above decrease.
During April 1993, the Partnership recognized a gain of $3,606,825 on the sale of Butterfield Village Apartments located in Tempe, Arizona.
During 1993, the Partnership recognized an extraordinary gain on forgiveness of debt of $1,234,276 in connection with the April 1993 refinancing of the Ridgetree II Apartments located in Dallas, Texas. The Partnership also recognized extraordinary gains on foreclosures of $8,432,686 in connection with the March 1993 foreclosure of the Rancho Mirage Apartments located in Phoenix, Arizona and the May 1993 foreclosure of the Highland Ridge Apartments located in Oklahoma City, Oklahoma. These properties were classified as real estate in substantive foreclosure at December 31, 1992.
1992 Compared to 1991
Increased occupancy and/or rental rates at eight of the Partnership's properties resulted in an increase in rental and service income during 1992 as compared to 1991.
During the first quarter of 1991, the Partnership was required to have restricted cash invested in short-term interest bearing instruments in connection with letters of credit pledged to lenders relating to certain of the Partnership's properties. These restricted investments were released and used to repay Partnership obligations later in 1991. This, as well as lower interest rates earned on short-term investments during 1992, resulted in a decrease in interest income on short-term investments during 1992 as compared to 1991.
The Partnership reached a settlement with the seller of the Ridgetree II Apartments, which was executed in June 1992. Prorations due from the seller pursuant to the terms of the original management and guarantee agreement on this property were previously written off due to uncertain collectibility. Pursuant to the settlement agreement, the parties have released all claims and causes of action against one another, and the Partnership received cash of $157,000 and was relieved of certain other liabilities by the seller. Settlement income of $153,057 was recognized in connection with this transaction. The Partnership and the seller have no further obligations to one another with respect to this property.
The Partnership also reached a settlement with the seller of the Rosehill Pointe Apartment for proration amounts the seller owed the Partnership pursuant to the terms of the original management and guarantee agreement. The joint venture which owns the property received $70,266 in June 1992 and $140,554 in December 1992, pursuant to the terms of the settlement which was executed in May 1992. Settlement income of $120,237 was recognized in connection with this transaction. The Partnership and the seller have no further obligations to one another with respect to this property.
The principal paydown made during November 1991 on a portion of the loan collateralized by the Meadow Creek Apartments, the July 1992 refinancing of the loan collateralized by the Seabrook Apartments, and the November 1991 modification of the loan collateralized by the Butterfield Village Apartments resulted in a decrease in interest expense on purchase price, promissory and mortgage notes payable during 1992 as compared to 1991. In addition, the placement of the Rancho Mirage and Highland Ridge apartment complexes in substantive foreclosure as of September 30, 1992, whereby the Partnership recognizes interest only to the extent paid, also contributed to the decrease in interest expense.
Interest rates incurred on working capital borrowings from the General Partner were lower during 1992 as compared to 1991. This is the primary reason for the decrease in interest expense on short-term loans during 1992 as compared to 1991.
As a result of higher expenditures for utilities, insurance and payroll expenses at the Highland Ridge, Park Colony, Rancho Mirage, Ridgepoint Green and Ridgepoint Way apartment complexes, property operating expenses increased during 1992 as compared to 1991.
The Partnership incurred higher expenditures in 1992 for roof and structural repairs and carpet replacement at the Butterfield Village, Rancho Mirage, Ridgepoint Green and Ridgepoint Way apartment complexes. In addition, the Partnership incurred expenditures for balcony repairs and floor coverings at the Meadow Creek Apartments, and incurred substantial expenditures for painting and cleaning and carpet replacement at the Park Colony Apartments in an effort to lease certain vacant units. As a result, maintenance and repair expenses increased during 1992 as compared to 1991.
Legal fees incurred in connection with the bankruptcy filing for the La Contenta Apartments caused administrative expenses to increase during 1992 as compared to 1991.
Interest expense decreased at the Seabrook Apartments during 1992 due to the July 1992 refinancing of the loan collateralized by the property. As a result, the affiliates' participation in losses from joint ventures decreased during 1992 as compared to 1991.
Liquidity and Capital Resources
The Partnership received funds from investing activities relating to the sale of the Butterfield Village Apartments in April 1993. The Partnership used cash to fund certain of its financing activities which included the repayment of the mortgage note on the Butterfield Village Apartments in connection with the sale, the net repayment of a portion of the borrowings from the General Partner and the payment of principal on the loans collateralized by the Partnership's properties. Proceeds received from the refinancings of the Meadow Creek and Ridgetree II loans were not sufficient to repay the prior loans and related fees, and the Partnership also used its cash reserves to fund the respective shortfalls. In addition, cash was used to fund the Partnership's operating activities. The payment of administrative expenses, interest expense on the General Partner loan and the funding of capital and operating escrows related to the refinancings offset the cash flow generated by the Partnership's properties.
The Partnership is largely dependent on loans from the General Partner and owes approximately $7,776,000 to the General Partner at December 31, 1993 in connection with funds advanced for working capital purposes. These loans are expected to be repaid from available cash flow from future property operations, or from proceeds received from the disposition of the Partnership's real estate investments prior to any distributions to the Limited Partners from these sources.
The General Partner may continue to provide additional short-term loans to the Partnership or to fund working capital needs or property operating deficits, although there is no assurance that such loans will be available. Should such short-term loans not be available, the General Partner will seek alternative third party sources of financing working capital. However, the current economic environment and its impact on the real estate industry make it unlikely that the Partnership would be able to secure financing from third parties to fund working capital needs or operating deficits. Should additional borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of some of its properties to satisfy these obligations.
During 1993, eight of the Partnership's remaining ten properties generated positive cash flow while two generated marginal cash flow deficits. During 1992, five of the Partnership's thirteen properties generated positive cash flow while five generated marginal cash flow deficits and three generated significant cash flow deficits. As discussed above, titles to the Rancho Mirage and Highland Ridge apartment complexes were relinquished to the lenders through foreclosure in March 1993 and May 1993, respectively and the Butterfield Village Apartments were sold in April 1993. The Partnership classifies the cash flow performance of its properties as either positive, a marginal or a significant cash flow deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered to be significant if it exceeds $250,000 annually or 20% of the property's rental and service income.
The Park Colony Apartments generated a significant cash flow deficit during 1992, whereas during 1993 the property generated a marginal deficit. Substantial expenditures were incurred in 1992 to repair vacant units which has resulted in increased occupancy and improved operations. The La Contenta and Meadow Creek apartment complexes, which generated marginal cash flow deficits during 1992, generated positive cash flow during 1993 due to increased occupancy and/or rental rates, as well as decreased operating expenses. The Ridgetree II Apartments, which also generated a marginal cash flow deficit during 1992, generated positive cash flow during 1993 due to the reduced debt service payments required by the refinancing. The Ridgepoint Green and Ridgepoint Way apartment complexes, which generated significant cash flow deficits during 1992, generated positive cash flow during 1993 due to the suspension of debt service payments by the Partnership effective January 1993. Debt service payments were suspended in an effort to negotiate a modification of the loans collateralized by the properties. The lender subsequently placed the loans in default, and in April 1993, the Partnership, through its subsidiaries owning these properties, filed for protection under Chapter 11 of the U.S. Bankruptcy Code. Had the Partnership paid the suspended debt service payments, both properties would have generated marginal cash flow deficits for 1993. While the bankruptcy proceedings continue, the Partnership will remit partial debt service payments to the lender equal to monthly net cash flow from the property. The Partnership and the lender have tenatively agreed on the terms of a modification of the loans and an agreement is expected to be finalized in March 1994. See Item 3. Legal Proceedings for additional information.
Suspension of debt service payments may lead to a renegotiation of terms with lenders which would permit the Partnership to continue to own properties or may lead to foreclosure or other action by lenders which would result in the relinquishment of title to properties in satisfaction of the outstanding mortgage loan balances.
While the cash flow of certain of the Partnership's properties has improved, the General Partner continues to pursue a number of actions aimed at improving the cash flow of the Partnership's properties including refinancing of mortgage loans, improving property operating performance, and seeking rent increases where market conditions allow. Despite improvements during 1993 in the local economies and rental markets where certain of the Partnership's properties are located, the General Partner believes that continued ownership of many of the properties is in the best interests of the Partnership in order to maximize potential returns to Limited Partners. As a result, the Partnership will continue to own these properties for longer than the holding period for the assets originally described in the prospectus.
Each of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. See Note 3 of Notes to Financial Statements for information concerning outstanding balances, maturity dates, interest rates, etc. related to each of these mortgage loans. During 1994, the $7,100,000 mortgage loan collateralized by the Spring Creek Apartments matures. As a result of the downturn experienced by the real estate industry over the last few years, many banks, savings and loans and other lending institutions have tightened mortgage lending criteria and are generally willing to advance less funds with respect to a property than many lenders were willing to advance during the 1980's. As a result, in certain instances it may be difficult for the Partnership to refinance a property in an amount sufficient to retire in full the current mortgage financing with respect to the property. In the event negotiations with the existing lender for a loan modification or with new lenders for a refinancing are unsuccessful, the Partnership may sell the collateral property or other properties to satisfy an obligation or may relinquish title to the collateral property in satisfaction of the outstanding mortgage loan balance.
In July 1991, the Partnership suspended debt service payments on the loan collateralized by the Rancho Mirage Apartments in an effort to negotiate a modification of the loan. Negotiations were unsuccessful, and in March 1993, the Partnership relinquished title to the lender through foreclosure. See Note 13 of Notes to Financial Statements for additional information.
In April 1992, the modification period relating to the mortgage loan collateralized by the Highland Ridge Apartments expired and the loan reverted to its previous terms. While negotiating for a further modification of the loan, the Partnership remitted partial debt service payments to the lender equal to monthly net cash flow from the property. During July 1992, the lender filed foreclosure proceedings and a receiver was appointed in September 1992. Negotiations for a modification were unsuccessful, and in May 1993, the Highland Ridge Apartments was relinquished to the lender through foreclosure. See Note 13 of Notes to Financial Statements for additional information.
In April 1993, the first mortgage loan collateralized by Ridgetree II Apartments was refinanced with new first and second mortgage loans from an unaffiliated lender. Simultaneously, other first mortgage loans collateralized by properties owned by partnerships affiliated with the General Partner were also refinanced. All of these loans had been held directly or indirectly by the Resolution Trust Corporation and have been purchased by Lexington Mortgage Company, an independent third party. While the mortgage loan collateralized by Ridgetree II Apartments was current, many of the other mortgage loans were in default either with respect to monthly debt service requirements or the loan had matured and the properties were unable to repay the balloon payments that were due. The new loans were deposited into a trust, the beneficial interests of which were sold to unaffiliated investors. Lehman Brothers, an affiliate of the General Partner, acted as firm underwriter for the sale of the beneficial interests in the trust and received underwriting compensation from a third party in accordance with market practices. A subordinated portion of the beneficial interests in the trust continues to be owned by Lehman Brothers.
The new loans include, among other things, principal balance or mortgage rate reductions, or maturity extensions, or a combination thereof. The terms of the new loans on Ridgetree II Apartments decreased the interest rate from 11% to 10.05%, extended the maturity date from September 1, 1996 to May 1, 2000, and included a principal reduction which was partially funded by a principal payment by the Partnership and was partially due to forgiveness of debt by the lender or a voluntary contribution from an affiliate of the General Partner. See Note 4 of Notes to Financial Statements for additional information.
In May 1993, the first mortgage loan collateralized by Meadow Creek Apartments was refinanced with a new $5,200,000 first mortgage loan from an unaffiliated lender. The original loan bore interest at 10% and was to mature in September 1993, whereas the new loan bears interest at 8.54% and matures on June 1, 1998. See Note 4 of Notes to Financial Statements for additional information.
In December 1993, the General Partner completed a modification of the loan collateralized by the Park Colony Apartments, whereby the interest rate was reduced from 10.25% to 9.375% and the maturity date was extended from July 1, 1996 to January 1, 1999. See Note 4 of Notes to Financial Statements for additional information.
In April 1993, the Partnership sold the Butterfield Village Apartments located in Tempe, Arizona in an all cash sale for $9,385,000. After payment of the underlying mortgage and selling costs, the Partnership received proceeds of approximately $2,950,000 from the sale. A portion of these proceeds was used to reduce the outstanding short-term borrowings due to the General Partner. See Note 12 of Notes to Financial Statements for additional information.
The Westwood Village Apartments is located near the Dallas/Ft. Worth Airport. As previously reported, the airport board is pursuing an expansion plan with the Federal Aviation Authority to build two additional runways on airport property. A proposed plan provides for varying levels of compensation to single family homeowners for the expected loss in value to their homes as a result of increased air traffic and heightened noise levels. However, no similar compensation is planned for the majority of apartment complex owners in the area, including the Partnership. In July 1993, the Partnership, certain affiliates of the General Partner which also own affected properties and other unaffiliated property owners jointly filed a lawsuit to obtain equitable compensation. The plaintiffs expect to file a motion for summary judgement with a hearing expected to be held during the first half of 1994.
Although investors have received certain tax benefits, the Partnership has not commenced distributions. Future distributions will depend on improved cash flow from the Partnership's remaining properties and proceeds from future property sales, as to both of which there can be no assurances. In light of the results to date and current market conditions, the General Partner does not anticipate that the investors will recover a substantial portion of their investment.
Inflation has several types of potentially conflicting impacts on real estate investments. Short-term inflation can increase real estate operating costs which may or may not be recovered through increased rents depending on general or local economic conditions. In the long-term, inflation will increase operating costs and replacement costs and may lead to increased rental revenues and real estate values.
Item 8. | 740582 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Information required by this item is incorporated by reference to the Registrant's 1993 Annual Report to Shareholders.
ITEM 7 | ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
General. The following table sets forth for the periods indicated certain items of the Company's Consolidated Financial Statements expressed as a percentage of the Company's total revenues:
Backlog. The following table sets forth the Company's backlog at December 31, 1991, 1992 and 1993
The Company's backlog generally represents units under contract for which a full deposit has been received, any statutory rescission right has expired, and in the case of a borrower, such borrower has been qualified for a mortgage loan. The Company generally fills all backlog within twelve months. The Company estimates that the period between receipt of a sales contract and delivery of the completed home to the purchaser is four to eight months. The Company's backlog historically tends to increase between January and May. Trends in the Company's backlog are subject to change from period to period for a number of economic conditions including consumer confidence levels, interest rates and the availability of mortgages. In 1989, 1990 and throughout part of 1991, the operations of the Company, and the housing industry in general, reflected a nationwide recession. The recession, and
resulting lack of consumer confidence, contributed to a decline in the number of new sales contracts received by the Company. During the second quarter of 1991, the Company began to receive a higher level of sales contracts, primarily as a result of increased consumer confidence and lower mortgage rates. This trend has continued through the twelve-month period ended December 31, 1993.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992
The Company's revenues from home sales increased $8.9 million (or 9.9%) during the calendar year 1993 as compared to the same period in 1992. The Company delivered 771 homes in 1993 compared to 708 in 1992, with an increase of 1.0% in the average selling price of homes delivered (from $126,300 to $127,500). The number of new contracts signed (788) and the aggregate dollar value of those new contracts ($108.2 million) increased in 1993 from 743 and $91.2 million in 1992.
Other operating revenues increased to $3.6 million during 1993 from $3.2 million in 1992 due to larger occupancy rate on our rental apartments. Interest, rentals and other income increased to $3.3 million in 1993 from $2.9 million in 1992 due to additional interest on short term investments and the increased number of units subject to recreation leases.
Cost of home sales increased to $80.7 million in 1993 from $70.2 million in 1992 as a result of an increase in the number of homes delivered. As a percentage of home sales, cost of home sales increased to 82.1% from 78.5%.
Selling, general and administrative expenses ("S,G & A") increased to $16.0 million in 1993 from $14.5 million in 1992, but as a percentage of total revenues, these expenses remained at 15.1%. The $2.6 million (or 35.2%) increase in the Company's interest cost incurred in 1993 as compared to the same period in 1992 was primarily attributable to the larger outstanding debt following the issuance of the 12 12% Senior Notes due 2003 in January 1993.
Net income decreased to $2.6 million in 1993 from $5.1 million in the comparable period in 1992, due mainly to the reduced margins from the sale of homes and the effect of $999,288, net of taxes of an extraordinary item from the write-off of unamortized debenture and loan costs. The reasons for lower margins are the inability to meaningfully increase selling prices, increased competition which resulted in the absorption of higher construction costs and the impact of higher capitalized interest.
RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991
The Company's revenues from home sales increased $19.3 million (or 27.6%) during the calendar year 1992 as compared to the same period in 1991. The Company delivered 708 homes in 1992 compared to 614 in 1991, with an increase of 10.6% in the average selling price of homes delivered (from $114,200 to $126,300). The number of new contracts signed (743) and the aggregate dollar value of those new contracts ($91.2 million) increased in 1992 from 629 and $74.3 million in 1991.
Other operating revenues decreased to $3.2 million during 1992 from $3.7 million in 1991, primarily as a result of the absence of revenues from the operation of its golf course sold in January 1992. Interest, rentals and other income decreased to approximately $3.5 million from $7.5 million, reflecting a gain of $4.6 million from the sale of the Company's corporate headquarters building in 1991, and a gain of $500,000 from the sale of the golf course in 1992. Cost of home sales increased to $70.2 million in 1992 from $53.5 million in 1991 as a result of an increase in the number of homes delivered. As a percentage of home sales, cost of home sales increased to 78.5% from 76.3% due to increased competition, the absorption of higher construction costs and the impact of higher previously capitalized interest.
Selling, General and Administrative Expenses ("S,G & A") decreased to $14.5 million in 1992 from $14.6 million in 1991 and, as a percentage of total revenues, these expenses decreased to 15.1% from 17.5% in the same period for 1991. The $1.7 million (or 18.5%) decrease in the Company's interest cost incurred in 1992 as compared to the same period in 1991 was primarily attributable to lower interest rates and lower borrowings.
Net income decreased to $5.1 million in 1992 from $5.2 million in the comparable period in 1991. The 1991 figure included a $2.9 million after tax gain from the sale of the Company's corporate headquarters building.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financing needs depend primarily upon sales volume, asset turnover, land acquisition and inventory balances. The Company has financed its working capital need through funds generated by operations, borrowings and the periodic issuance of common stock.
During 1991, 1992 and 1993, as a consequence of recessionary conditions and well-publicized real estate problems, many commercial banks, savings and loans and other lending institutions curtailed real estate lending or adopted more stringent lending policies, often as the result of regulatory agency measures. As a result, the availability of borrowed funds, especially for the acquisition and development of land, was greatly reduced.
In January 1993, the Company completed the issuance of $70.0 million of its 12 1/2% Senior Notes due 2003. These Notes were offered at the price of 97.242% and, after the underwriting discount, the net proceeds to the Company of $66.0 million were used to repay an existing bank credit facility ($35.0 Million) and the outstanding balance on its 12 7/8 % Subordinated Debentures ($19.4 Million). Under the Indenture, the Company is able to enter into another credit facility which may or may not be secured for up to $20.0 million. The Company believes that the proceeds derived from the sale of the Notes after the debt repayment, additional borrowing permitted under the Indenture and amounts generated from operations provide funds adequate to finance its home building activities and meet its debt service requirements.
The Company believes that a strategy of conservative land acquisition and community development should position it to take advantage of the anticipated upturn in the real estate market. The Company does not have any current commitments for capital expenditures and believes the proceeds from its offering will provide adequate liquidity on both a short and long term basis.
On November 23, 1993, the Company declared a dividend of $.15 per share on its Class A common stock and $.175 on its Class B common stock to shareholders of record as of December 14, 1993, which dividends were paid on January 11, 1994. The Company intends to reestablish the payment of semi-annual dividends. The payment of cash dividends is at the discretion of the Board of Directors and will depend upon results of operations, capital requirements, the Indenture, the Company's financial condition and such other factors as the Board of Directors of the Company may consider. There can be no assurance as to the amount, if any, or timing of cash dividends.
INFLATION
The Company, as well as the home building industry in general, may be adversely affected during periods of high inflation, primarily because of higher land and construction costs. In addition, higher mortgage interest rates may significantly affect the affordability of permanent mortgage financing to prospective purchasers. Inflation also increases the Company's cost of labor and materials. The Company attempts to pass through to its customers any increases in its costs through increased selling prices. During the last two years the Company has experienced a reduction in gross margins on the sale of homes. In some part these reduced margins are the result of the Company being unable to raise selling prices and pass on increased construction costs. There is no assurance that inflation will not have a material adverse impact on the Company's future results of operations.
ACCOUNTING METHODS
During 1987, the Company changed its method of accounting for income taxes to conform to Statement of Financial Accounting Standards No. 96 "Accounting for income Taxes, " which requires the liability method as measured by the provisions of the enacted tax laws. The amount of deferred taxes payable is recognized under the liability method at the date of the Consolidated Financial Statements. During 1992, the Financial Accounting Standards Board adopted Statement of Financial Accounting Standards No. 109, which supersedes Statement of Financial Accounting Standards No. 96, and became effective for fiscal years beginning after December 15, 1992. The effect of the adoption of this Statement did not have a material effect on the Consolidated Financial Statements.
ITEM 8 | 74928 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA The selected financial data begins on page 86 in the Appendix.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion and analysis is presented beginning on page 17 in the Appendix and should be read in conjunction with the related financial statements and notes thereto included under Item 8. | 72971 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA(1) -----------------------------------
(1) In thousands, except per share amounts and current ratio.
(2) In 1993, includes sales of $10,682 and net income of $238 related to the purchase of Obalex. In 1991, includes sales of $17,030 and a net loss of $1,045 related to the purchase of PCI. In 1989, includes sales of $34,538 and net income of $150 related to the purchase of Ferembal.
(3) Includes income for the cumulative effect of accounting change of $460 ($.15 per share primary and $.14 per share fully-diluted) and an extraordinary charge of $1,502 ($.49 per share primary and $.44 per share fully-diluted) in 1992. Includes income for an extraordinary item of $22 ($.01 per share both primary and fully-diluted), and $127 ($.10 per share primary and $.08 per share fully-diluted) in 1990 and 1989, respectively.
(4) The 1991 weighted average shares outstanding include 1,020 shares and 255 warrants to purchase shares sold in June 1991 for net proceeds of $29,453. The 1990 weighted average shares outstanding include 460 shares sold in January 1990 for net proceeds of $6,756.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ------------------------------------------------------------------------ RESULTS OF OPERATIONS ---------------------
The information required by this item is incorporated herein by reference to the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report to Stockholders for the year ended December 31, 1993.
ITEM 8. | 103392 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The Company meets the conditions set forth in General Instruction J(2)(a) and (b) of Form 10-K and is therefore omitting, pursuant to General Instruction J(2), the information called for by this Item.
ITEM 7. | ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS.
The Company's 1993 net loss of $59.7 million was significantly less than the 1992 net loss of $781.3 million. Included in the 1992 loss is $609.6 million related to one-time charges to recognize the cumulative effect of adopting the following new accounting standards: Financial Accounting Standards Board ("FASB") Statement No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and FASB Statement No. 109, "Accounting for Income Taxes." Even excluding the one-time 1992 charges, 1993 results were significantly improved from the 1992 loss of $171.7 million.
The following table summarizes selected earnings and other data:
With I/N Tek and I/N Kote having reached the end of their learning curves and completion of major upgrades at the steelmaking operations, the Company's modernization program is complete. In addition, a new
six-year labor contract at the Company is in place. These factors, coupled with the Company's turnaround strategy launched in 1991 to improve performance by increasing revenues, reducing costs and enhancing asset utilization, are anticipated to provide the basis for continued improvement in 1994 operating results.
The 1993 financial results were negatively affected by approximately $30 million due to the unfavorable impact on steel operations of the scheduled outage of the largest blast furnace at the Indiana Harbor Works for a mini-reline. In addition, there was a $22.3 million charge taken for the early closure of the Company's remaining cokemaking facilities due to their inability to meet environmental regulations and deteriorating operating performance. Partially offsetting these unfavorable items was a $24 million LIFO profit recognition due to inventory reductions.
Net sales increased 14 percent in 1993 to $2.17 billion due almost entirely to an increase in shipments to 4.8 million tons. The average selling price for 1993 was virtually unchanged from 1992. The Company operated at 83 percent of its raw steelmaking capability in 1993, compared with 79 percent in 1992.
In 1992, a slower-than-expected shift in galvanized products to I/N Kote, as well as the initial recognition of interest and depreciation expense associated with the I/N Kote facility, added approximately $40 million to operating losses. Also, an outage of the No. 7 Blast Furnace reduced production by 140,000 tons, which increased the operating loss by nearly $30 million. These 1992 problems, coupled with an addition of $12 million to a reserve for environmental matters, more than offset the benefits of reduced costs and a $23 million gain on the sale of half of Inland's 25 percent interest in Walbridge Coatings.
The Company embarked in 1991 on a three-year turnaround program to significantly reduce its underlying cost base by year-end 1994. The 1991 restructuring charge of $205 million provided for the write-off of facilities, an environmental reserve and the cost of an estimated 25 percent reduction in the workforce. Employment has been reduced by approximately 2,300 people from the end of 1991 through year-end 1993, and an additional 1,200 jobs are expected to be eliminated by the end of 1994. The 1993 effect of this program represents a savings of approximately $140 million in employment costs and $10 million in decreased depreciation expense. However, the savings from reduced employment was partially offset by increased wages under the Company's labor agreements and increased medical benefit costs as the Company began to accrue in 1992 for postretirement medical benefits.
By year-end 1992 and throughout 1993, I/N Tek was operating near capacity and producing consistently high-quality steels. In August 1993, I/N Kote was operating near design capacity and, by year-end 1993, had achieved product qualification at all major customers. Under the I/N Kote partnership agreement, the Company supplies all of the steel for the joint venture and, with certain limited exceptions, is required to set the price of that steel to assure that I/N Kote's expenditures do not exceed its revenues. During 1993, the Company's sales price approximated its cost of production, but was still significantly less than the market value for cold-rolled steel. Beginning in 1993, I/N Kote expenditures included principal payments and provision for return on equity to the partners. Therefore, the Company's ability to realize a satisfactory price on its sales to I/N Kote depends on the facility achieving near capacity operations and obtaining appropriate pricing for its products.
The Company's remaining cokemaking facilities were closed by year-end 1993. The Company determined that it was uneconomical to repair the coke batteries sufficiently to continue cost-effective operations that would comply with current environmental laws. To replace the Company-produced coke, the Company entered into a long-term contract and other arrangements to purchase coke. In addition, the Company and NIPSCO, a local utility, formed a joint venture which constructed and is operating a pulverized coal injection facility at the Indiana Harbor Works. This facility injects coal directly into the blast furnaces and is expected to reduce coke requirements by approximately 30 percent, or 600,000 tons a year, when fully operational. The joint venture commenced operations in the third quarter of 1993.
FASB Statement No. 106 requires that the cost of retiree medical and life insurance benefits be accrued during the working years of each employee. Previously, retiree medical benefits were expensed as incurred after an employee's retirement. Adoption of this standard in 1992 did not and will not affect cash flow as liabilities for health care and life insurance benefits are not pre-funded and cash payments will continue to be
made as claims are submitted. The net present value of the unfunded benefits liability as of December 31, 1993, calculated in accordance with that Statement was approximately $943 million. The expense provision for these benefits for 1993 was $86 million, which was $39 million more than the cash benefit payments for the year. The unfunded liability will continue to grow, since accrual-basis costs are expected to exceed cash benefit payments for several more years. The reported year-end benefits liability and postretirement benefits cost for the year reflect changes made during the year incorporating the favorable effects of the new United Steelworkers of America labor contract and revised actuarial assumptions incorporating more current information regarding claim costs and census data, partially offset by a reduction in the discount rate used to calculate the benefits liability. (See Note 6 to the consolidated financial statements for further details.)
FASB Statement No. 109 requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Without the change, the Company would not have been able to reduce its 1993 and 1992 losses by credits for deferred tax benefits of $30 million and $418 million, respectively. At December 31, 1993, the Company had a net deferred tax asset of $417 million of which $396 million relates to the temporary difference arising from the adoption of FASB Statement No. 106. While the Company believes it is more likely than not that taxable income generated through future profitable operations will be sufficient to realize all deferred tax assets, a secondary source of future taxable income could result from tax planning strategies, including the Company's option of changing from the LIFO method of accounting for inventories to the FIFO method (such change would have resulted in approximately $240 million of additional taxable income as of year-end 1993 which would serve to offset approximately $85 million of deferred tax assets) and selection of different tax depreciation methods. After assuming such change in accounting for inventories, the Company would need to recognize approximately $900 million of taxable income over the 15-year net operating loss carryforward period and the period in which the temporary difference related to the FASB Statement No. 106 obligation will reverse, in order to fully realize its net deferred tax asset. Additionally, in accordance with the Industries tax sharing agreement, if the Company is unable to use all of its allocated tax attributes (net operating loss carryforwards and tax credit carryforwards) in a given year but other companies in the Industries group are able to utilize them, then the Company will be paid for the use of its attributes. The Company believes that it is more likely than not that it will achieve such taxable income level. (See Note 7 to the consolidated financial statements for further details regarding this net deferred tax asset.)
ITEM 8. | 50548 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
See the "Five-Year Financial Summary" on page A-26 of the attached Appendix, which is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
See the "Financial Review" on pages A-26 through A-50 of the attached Appendix, which is incorporated herein by reference.
ITEM 8. | 101382 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data with respect to the Company and its subsidiaries are set forth on pages to of this Annual Report.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of Operations is set forth on pages to of this Annual Report.
ITEM 8. | 840216 | 1993 |
107832 | 1993 |
||
Item 6. Selected Financial Data
The section entitled "Selected Financial Data" in the Company's 1993 Annual Report to Shareholders is hereby incorporated by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's 1993 Annual Report to Shareholders is hereby incorporated by reference.
Item 8. | 714655 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA. In response to this Item the information set forth in Table 2 on page 24 in the Annual Report is incorporated herein by reference. ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In response to this Item the information set forth on pages 10 through 51 in the Annual Report is incorporated herein by reference. ITEM 8. | 36995 | 1993 |
Item 6. SELECTED FINANCIAL DATA
Reference is made to "Financial History" on page 14 and "Management's Discussion and Analysis" on pages 15 and 16 of Kaydon's 1993 Annual Report to Stockholders, which is incorporated herein by reference.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Reference is made to "To Our Stockholders" on pages 2 through 4 and "Management's Discussion and Analysis" on pages 15 and 16 of Kaydon's 1993 Annual Report to Stockholders, which is incorporated herein by reference.
Item 8. | 740694 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated herein by reference to page 35 of Registrant's 1993 Annual Report to Stockholders attached to this filing as Exhibit 13.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this item is incorporated herein by reference to pages 26 through 34 of Registrant's 1993 Annual Report to Stockholders attached to this filing as Exhibit 13.
ITEM 8. | 35527 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
SUMMARY OF SELECTED FINANCIAL DATA (In thousands except per share amounts)
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Comparison of the Company's Operating Results for the Years Ended December 31, 1993 and 1992
The Company owns a diversified portfolio of transportation equipment from which it earns operating lease revenue and incurs operating expenses. The Company also raises investor equity through syndicated partnerships and invests the equity raised in transportation equipment which it manages on behalf of its investors. The Company earns various fees and equity interest from syndication and investor equipment management activities.
The Company's transportation equipment held for operating leases is mainly equipment built prior to 1988. As trailer equipment ages, the Company is generally replacing it with newer equipment. However, aged equipment for other equipment types may not be replaced. Rather, proceeds from the liquidation of other equipment types may be invested in trailers or in other Company investment opportunities. Failure to replace equipment may result in shorter lease terms and higher costs of maintaining and operating aged equipment and in certain instances, limited remarketability.
During 1992 the Company embarked on a strategic restructuring plan designed to identify underperforming assets in its own transportation equipment portfolio for both valuation adjustments and sale opportunities, to reduce senior indebtedness primarily from the proceeds of such sales and associated interest costs, and to reduce the operational cost structure. During 1993, the Company continued to execute on this strategy and realized significant progress in the restructuring plan. Below is an analysis of the impact the restructuring plan had on operations for the year. Following is an analysis of other operational factors that impacted the financial results for 1993.
Restructuring Plan: Impact on Operating Results
Results from sales of equipment that were designated in 1992 as assets held for sale demonstrated the intended purpose of the asset sale strategy. Assets with a net book value of approximately $24.9 million were sold at a gain of $2.4 millon in 1993. During 1992 there were sales having a net book value of $14.6 million and corresponding gains of $2.0 million. The Company had $9.3 million in equipment held for sale at December 31, 1993 versus $29.9 million at December 31, 1992.
The proceeds generated by sales of equipment, combined with excess operating cash flow, have been used to reduce senior indebtedness from $100 million as of July 1992 to $45 million as of December 31, 1993. Outstanding senior and other secured debt was reduced by $37.2 million in 1993. This reduction in outstanding debt resulted in a decrease in interest expense of $1.5 million in 1993.
Sales of equipment impacted operational results in several other areas as well. Operating lease revenues decreased by $6.2 million versus 1992 due to the reduced asset base. This included sale of most of the railcar fleet, an 18% reduction in the aircraft fleet, and a 13% reduction in both trailers and marine containers. The reduction in the lease fleet also accounted for a $1.7 million decrease in depreciation expense versus 1992.
Review of the Company's equipment portfolio and identification of underperforming assets led to valuation adjustments charged to operations for reductions in carrying values of assets. These adjustments amounted to $2.2 million in 1993 as compared to $36.2 million in 1992. Equipment types that were subject to valuation adjustments in 1993 were primarily containers, trailers and railcars. Equipment types that were subject to valuation adjustments in 1992 were primarily commuter aircraft and trailers. The Company continues to review the performance and carrying values of its transportation equipment portfolio in relation to expected net realizable values. Future adjustments to the carrying value of the Company's equipment may occur if permanent impairments are identified.
The strategic restructuring of operations led to a reduction in operations support costs of approximately $4.0 million for 1993. These decreases result from the reduction in the Company's portfolio of assets, efficiencies gained in accounting functions as well as the closing of the PLM Rental headquarters office and subsequent consolidation of its functions in San Francisco. The Company's sales office in London was closed in 1993 and other cost savings measures were implemented. Employee count was reduced from 247 at December 31, 1992 to 209 at December 31, 1993.
During 1992 and 1993, the Company settled its long-standing class action litigation and other material litigation resulting in a reduction of litigation costs. The Company also charged to expense in 1992 certain capitalized costs as a result of restructuring of the Company's senior loan agreement. Litigation and other charges amounted to $7.6 million in 1992.
Other Operational Factors: Impact on Operating Results Revenue:
The Company's total revenue for the years ended December 31, 1993 and 1992 were $69.7 million and $75.0 million, respectively. The above analysis of the restructuring plan explains a $6.2 million negative variance in lease revenue. Various other factors impacting revenues in 1993 are explained below:
Operating lease revenue was unfavorably impacted by lower utilization of interim bridge financing to acquire equipment for resale to one or more of the Company's affiliated partnerships or to independent parties. In 1993, the bridge financing was shared with either EGF VI or EGF VII. During the period that equipment is acquired by use of the bridge facility, the lease revenue generated by this equipment is earned by the Company. This revenue is offset by corresponding equipment operating costs as well as by the interest accruing on the interim debt. There was a decrease of $1.3 million in leasing revenue resulting from lower utilization of the bridge facility in 1993 versus 1992.
Management fees remained relatively constant at $10.8 million between 1993 and 1992. These fees are, for the most part, based on the revenues generated by equipment under management. The managed equipment portfolio grows correspondingly with new syndication activity. Affiliated partnership and investment program surplus operating cash flows and loan proceeds invested in additional equipment favorably influence management fees. While equipment under management increased from 1992 to 1993, lease rates for affiliated partnerships and investment programs fell so that gross revenues, which give rise to the management fees, remained relatively constant. Equipment managed at year end 1993 and 1992 (measured at acquisition cost) amounted to $1,141,000,000 and $1,082,000,000, respectively.
Commission revenue and other fees are derived from raising syndicated equity and acquiring and leasing equipment for Company sponsored investment programs. Commission revenue consists of placement fees which are earned on the amount of equity raised. Acquisition and lease negotiation fees are earned on the amount of equipment purchased and leased on behalf of syndicated investment programs. These fees are governed by applicable program agreements and securities regulations. The Company also receives a residual interest in additional equipment acquired by affiliated partnerships. Income is recognized on residual interests based upon the general partner's share of the present value of the estimated disposition proceeds of the equipment portfolios of the affiliated partnerships.
Placement fees in 1993 decreased $1.7 million (18%) from 1992 as a result of less syndicated equity being raised. Equity raised in 1993 decreased to $92,462,000 from $111,123,000 in 1992. Acquisition and lease negotiation fees and other fees increased $5.0 million in 1993 from the 1992 levels. Equipment placed in service, or remarketed, totalled $186,606,000 in 1993 and $93,185,000 in 1992. At December 31, 1993 cash resources available to certain investment programs would permit additional equipment acquisitions of approximately $19 million. These cash resources are expected to be used by the programs to acquire additional equipment in 1994. In 1993, the Company ranked as the number one equipment leasing syndicator in the United States, as reported by Stanger, an industry trade publication.
Costs and Expenses:
Certain costs and expense reductions related to the effects of the restructuring plan, as detailed above resulted in specific expense reductions in 1993 versus 1992 totalling $39.7 million as follows: equipment valuation adjustments of $34.0 million, depreciation of $1.7 million and operation support costs of $4.0 million. Various other factors impacting 1993 expenses are explained below:
Commission expenses are primarily incurred by the Company in connection with the syndication of investment partnerships. Commissions are also paid to certain of the Company's employees directly involved in leasing activities. The 1993 commission expenses decreased $2.3 million (21%) from 1992 levels reflecting the decrease in syndicated equity raised in 1993 versus 1992.
General and administrative expenses increased $2.6 million (32%) during 1993. A portion of the increase relates to reclassification of certain activities previously classified as operations support. While headcount has decreased as discussed above, there have been certain severance related costs that reduce the favorable cost comparison for the periods reported. Additionally, professional service costs were $1.0 million higher in 1993.
Interest income decreased $0.6 million (11%) in 1993 primarily due to the decrease in the interest rates applicable to restricted cash deposits and marketable securities.
Other income (expense) was an expense of a $0.3 million in 1993 versus income of $0.5 million in 1992. Included is a charge of $0.7 million in 1993 resulting from accelerating certain expenses related to the Company interest rate swap agreement required by its senior loan agreement.
The Company's income taxes include foreign, state and federal elements and reflect a provision of 19% in 1993 and a benefit of 46% in 1992. The effective tax rate varies from the statutory rate in 1993 due to non-recurring tax credits and the change in the effect of the ESOP dividend due to implementation of FASB 109. The 1992 benefit of 46% differs from the statutory rate due primarily to the effect of the ESOP dividend as prescribed under FASB 96.
As a result of all the foregoing, net income to common shares for the year ended December 31, 1993 was $1,432,000 compared to net loss to common shares of $25,271,000 in 1992.
Comparison of Company's Operating Results for the Years ended December 31, 1992 and 1991
Restructuring Plan: Impact of Operating Results
Revenues:
Sales of equipment, pursuant to the restructuring plan announced in the third quarter of 1992, had a negative impact on lease revenue during 1992. Rail and aircraft revenue declined by $3.4 million in 1992 due to the Company's reduction in the aircraft fleet from 50 aircraft on December 31, 1991 to 39 aircraft as of December 31, 1992 and its railcar fleet from 614 railcars on December 31, 1991 to 407 railcars on December 31, 1992.
As part of the restructuring plan the Company sold certain underperforming assets having a net book value of $14.6 million for a gain of $2.0 million. This compared to a gain on the sale of transportation equipment in 1991 of $0.1 million.
Costs and Expenses
The restructuring plan had a negative impact on the expenses of the Company. In 1992, the Company reduced the carrying value of certain assets, primarily aircraft and trailers, by $36.2 million. This resulted from the Company's decision to exit certain market niches and from permanent declines in the net realizable value of equipment. During 1991 the Company reduced the carrying value of one aircraft by $0.4 million.
The Company also recorded a nonrecurring charge in 1992 of $7.6 million for litigation and other costs. This related to settlement of litigation as well as expenses incurred in the course of addressing lawsuits arising in the normal course of business operations. The Company also charged to expense certain capitalized costs as a result of restructuring the Company's senior loan agreement. The sale of equipment in 1992 caused a reduction in depreciation expenses of $0.8 million.
Other Operational Factors: Impact on Operating Results
The Company's total revenue for the years ended December 31, 1992 and 1991 were $75.0 million and $72.8 million, respectively. The results of the restructuring plan account for a negative impact on revenues of $3.4 million. Various other factors affected revenues in 1992 and are explained below:
Operating lease revenue increased $2.5 million in 1992 compared to 1991. Trailer revenues increased $4.4 million in 1992 due to the Company's decision to acquire more trailers for its per diem rental operations, increased utilization of trailers, and increased revenue from its new storage unit division. During 1992, there was an increase of $0.8 million in leasing revenue resulting from equipment being held on an interim basis for resale to its sponsored programs.
Management fees and partnership interests. Management fees decreased $0.4 million (3%) in 1992 over the fees earned in 1991. While equipment under management increased from 1991 to 1992, lease revenues of affiliated partnerships and investment programs fell slightly. Equipment oversupply, weaker demand and lower interest rates all contributed to lower lease rates in commercial aircraft and marine vessels in 1992. Equipment managed at year end 1992 and 1991 (measured at acquisition cost) amounted to $1,082,000,000 and $1,036,000,000, respectively. Income from partnership interests decreased $1.1 million (22%) primarily due to a retroactive special allocation of income in 1991.
Commission revenue and other fees. Placement fees in 1992 increased $1.6 million (20%) from 1991 as a result of more syndicated equity being raised. Equity raised in 1992 increased to $111,123,000 from $93,092,000 in 1991. In 1992, the Company ranked as the number one diversified transportation equipment syndicator and number two overall equipment syndicator in the United States.
Acquisition and lease negotiation fees and other fees decreased 31% in 1992 from 1991 levels. Equipment placed in service by the Company's affiliated partnerships totalled $93,185,000 in 1992 and $120,699,000 in 1991. At December 31, 1992, cash resources available to certain investment programs would permit additional equipment acquisitions of approximately $25 million. These cash resources were used by the investment programs to acquire additional equipment in 1993.
Costs and Expenses:
Certain cost and expense variances relating to the restructuring plan, as detailed above, resulted in specific variations as follows: increase in equipment valuation adjustments of $35.8 million and a decrease in depreciation expense of $0.8 million. Various other factors impacting 1992 expenses are explained below:
Operations support expense increased $2.4 million (11%) in 1992 from 1991 levels. The change for 1992 is due principally to (i) a one-time favorable bad debt settlement received in 1991; (ii) expense incurred in the expansion of storage equipment operations; (iii) increased utilization of trailer equipment and (iv) expansion of PLM Rental operations (Company-owned trailers in daily rental operations increased to 5,000 units in 1992 from approximately 4,700 in 1991).
Commission expenses increased in 1992 $2.0 million (22%) from 1991 levels reflecting the increased in syndicated equity raised in 1992 versus 1991.
General and administrative expenses decreased $0.6 million (7%) during 1992. This expense reduction resulted primarily from the loss incurred on the sublease of the Company's former principal offices totaling $0.3 million in 1992 compared to $1.25 million in 1991. This was offset in 1992 by an increase in professional fees of $0.4 million.
Other Items:
Interest expense decreased $1.6 million (10%) in 1992 from that incurred in 1991. The decrease reflects the effect of reduced interest rates in 1992 versus 1991 which more than offset the increase in average borrowings during 1992.
Interest income decreased $1.9 million (24%) in 1992 primarily due to the decrease in the interest rates for restricted cash deposits and marketable securities.
Income taxes. The Company's income taxes include foreign, state, and federal elements and reflect a benefit of 46% in 1992 and a provision of 1% in 1991. The effective tax rate varies from the statutory rate principally due to the tax effect of the ESOP dividend.
As a result of all the foregoing, net loss to common shares for the year ended December 31, 1992 was $25,271,000 compared to net income available to common shares of $3,063,000 in 1991. This decline was primarily attributable to restructuring adjustments and litigation and other costs.
Liquidity and Capital Resources
Cash requirements have been historically satisfied through cash flow from operations, borrowings or sales of transportation equipment. During 1993 cash flow from operations was significantly impacted by the Company's restructuring plan, announced in August 1992, which plan includes the sale of equipment to pay down senior indebtedness. Equipment sales generated $16.6 million in 1992 and $27.3 million in 1993. At July 1, 1992, the outstanding principal balance on the senior secured loan totalled $100 million. At December 31, 1993, the principal balance of the senior
loan was $45 million. Reduced lease revenues resulting from a smaller transportation equipment portfolio have been offset by the lower interest expense exposure resulting from the reduction in senior indebtedness, as well as operational cost reductions implemented by the Company also as part of the restructuring plan. As a result, cash and cash equivalents are at a historical high for the Company.
Liquidity beyond 1993 will depend in part on continued remarketing of the remaining equipment portfolio at similar lease rates, continued success in raising syndicated equity for the sponsored programs, effectiveness of cost control programs, ability of the Company to secure new financings and possible additional equipment sales. Specifically, future liquidity will be influenced by the following:
(a) Debt Financing:
Senior and Subordinated Debt: On October 28, 1992, the Company's senior secured term loan agreement was amended to provide an accelerated principal amortization schedule. The amended agreement provides for the net proceeds from the sale of transportation equipment to be placed into collateral accounts to be used for principal reductions. Cash proceeds received from equipment sales totaling $43.9 million in 1992 and 1993 have contributed substantially to the $55 million reduction of this loan to $45.0 million. The Company will make an additional principal payment in the amount of $8.2 million on March 31, 1994. Final maturity of the senior secured indebtedness is June 30, 1994. The Company is presently marketing replacement financing for the senior secured indebtedness and a portion of its subordinated debt. Management of the Company believes this replacement financing will be completed prior to maturity of the senior secured debt facility.
The Company also negotiated an amendment to the Senior Subordinated Notes agreement in October 1992 adjusting certain covenants to accommodate the Company's restructuring plan.
Bridge Financing: Assets held on an interim basis for placement with affiliated partnerships have, from time to time, been partially funded by a $25.0 million short-term equipment acquisition loan facility. This facility, made available to the Company effective June 30, 1993, provides 80 percent financing, and the Company uses working capital for the non-financed costs of these transactions. The commitment for this facility expires on July 13, 1994.
This facility, which is shared with a PLM Equipment Growth Fund, allows the Company to purchase equipment prior to the designated program or partnership being identified or prior to having raised sufficient resources to purchase the equipment. During 1993 the Company bought and sold, at its cost, $18.1 million of these interim held assets to affiliated partnerships. The Company usually enjoys a spread between the net lease revenue earned and the interest expense during the interim holding period. Decreased utilization of this facility versus use of a similar facility available to the Company in 1992 resulted in lower lease revenues of $1.3 million in 1993.
(b) Equity Financing:
On August 21, 1989 the Company established a leveraged employee stock ownership plan ("ESOP"). PLM International issued 4,923,077 shares of Preferred Stock to the ESOP for $13.00 per share, for an aggregate purchase price of $64,000,001. The sale was originally financed, in part, with the proceeds of a loan (the "Bank Loan") from a commercial bank (the "Bank") which proceeds were lent on to the ESOP the ("ESOP
Debt") on terms substantially the same as those in the Bank Loan agreement. The ESOP Debt is secured, in part, by the shares of Preferred Stock while the Bank Loan is secured with cash equivalents and marketable securities. Preferred dividends are payable semi-annually on February 21 and August 21, which corresponds to the ESOP Debt payment dates. Bank Loan debt service is covered through release of the restricted cash security. While the annual ESOP dividend is fixed at $1.43 per share the interest rate on the ESOP debt varies resulting in uneven debt service requirements. With declining interest rates, the ESOP dividends for 1993 exceeded required ESOP Debt service and the excess was used for additional principal payments totalling $2.4 million in 1993. If interest rates continue at current levels it is expected that ESOP dividends during 1994 will again exceed the required ESOP Debt service. Management, as part of its overall strategic planning process, is evaluating the effectiveness of the ESOP and the Company's other qualified benefit plan.
On January 20, 1992, the Company's Board of Directors voted to suspend the $0.10 per share quarterly dividend on its common shares. This reduced cash requirements for dividend payments in 1992 by approximately $4.0 million. The amended and restated senior secured term loan agreement restricts dividend payments until its principal balance is reduced below $30 million.
(c) Portfolio Activities:
During 1993, the Company continued to execute on the restructuring plan announced effective for the second quarter of 1992. The restructuring plan was designed to identify under performing assets in the Company's own transportation equipment portfolio for both valuation and sale opportunities, reduce senior indebtedness primarily from the proceeds of such sales and associated interest costs, and reduce operational cost structures. The overall effect of this Plan will be to reduce future lease revenues and related interest, depreciation and operations support expenses allocable to the sold equipment and position the Company for future improved profitability.
The Company generated proceeds of $27.3 million from the sale of equipment during 1993. The assets sold during the year consisted primarily of aircraft, railcars, trailers and containers. The Company believes the remaining fleet of leased assets has higher earnings potential and more stable residual values than the disposed equipment.
As stated last year, the Company did not expect to commit substantial capital resources for acquisition of new transportation equipment in 1993. Accordingly, $1.5 million of transportation equipment was acquired in 1993, compared to $9.8 million in 1992. These purchases are in market niches targeted by the Company as profitable with long term growth potential.
As of the date of this report, there were commitments in place totaling approximately $9.4 million to acquire transportation equipment that is intended to be assigned to one or more of the investment programs sponsored by the Company. The purchase of this equipment will be funded by the assigned program.
(d) Syndication Activities:
The Company earns fees generated from syndication activities which enhances cash flow. In May 1993, PLM Equipment Growth and Income Fund VII ("EGF VII") became effective and selling activities commenced. Through March 25, 1994 a total of $53
million syndicated equity had been raised for this investment program of the maximum of $150 million which was registered. The Company will likely continue to offer units in EGF VII through the end of 1994.
Inflation did not have a material impact on the financial performance of the Company.
ITEM 8. | 814677 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
See Item 7 | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1993 versus 1992
Results of Operations - ---------------------
Service revenues increased $19.4 million primarily due to the effect of cars added to the railcar lease fleet since 1992 and higher repair revenues offset slightly by lower revenues from sulphur service operations. Gross profit was relatively unchanged from 1992.
In June, 1992, the Company entered into ten separate sale-leaseback transactions in which it sold for $124.9 million an aggregate of 2,073 railcars. Excluding these 1992 sale-leaseback transactions, net sales revenues in 1993 decreased approximately $7.7 million due to lower railcar and sulphur plant sales.
Other income decreased $4.4 million due to reduced interest income resulting from lower interest rates as well as lower average outstanding balance on advances to the Company's parent.
Interest expense decreased $8.8 million primarily due to a decline in the average outstanding commercial paper balance as well as a lower average effective interest rate on debt outstanding.
Provision for income taxes increased due to the effect of the increase in the federal statutory tax rate.
Net income in 1993 included an $80.0 million credit to earnings for the cumulative effect of a change in accounting principle related to accounting for income taxes. See further discussion under "Change in Accounting Principles" below.
Financial Condition - -------------------
Operating activities provided $183.8 million of cash in 1993. These funds, along with the commercial paper borrowings, net of amounts advanced to parent, were used to provide interim financing for railcar additions, service long-term debt and pay dividends to the Company's stockholder. It is the Company's policy to pay a quarterly dividend to its stockholder equal to 70% of net income. To the extent that the Company generates cash in excess of its operating needs, such funds are advanced to its parent and bear interest at commercial rates. Conversely, when the Company requires additional funds to support its operations, prior advances are repaid by its parent. No restrictions exist regarding the amount of dividends which may be paid or advances which may be made by the Company to its parent.
Management expects future cash to be provided by operating activities, commercial paper borrowings and long-term railcar financings will be adequate to provide for the continued expansion of the Company's business and enable it to meet its debt service obligations.
The Company also has a $150.0 million liquidity back-up revolving credit facility supporting the commercial paper programs. However, no borrowings have occurred under this facility and none are currently anticipated.
In 1993, the Company spent $175.8 million for the construction and purchase of railcars and other fixed assets. The Company received $15.1 million in proceeds from disposals of railcars and other fixed assets. The Company also decreased its advance to its parent company by $89.2 million. Overall, net cash used in investing activities was $72.8 million.
In May, 1993, the Company issued $100.0 million in long-term equipment trust pass through certificates to finance additions to its railcar fleet at an annual interest rate of 6.5%. Other financing activities of the Company included $8.4 million for the repayment of commercial paper obligations, $78.8 million for principal repayments on debt, $17.7 million to repay an advance to an affiliate and $90.0 million for dividends. Net cash used in financing activities was $94.9 million.
As more fully discussed in note 21 to the consolidated financial statements, on January 13, 1994, the Company acquired certain assets located in Sheldon, Texas for approximately $24.3 million. In addition, on March 2, 1994, the Company issued $100.0 million in long-term equipment trust certificates to finance additions to its railcar fleet at an annual interest rate of 6.6%.
The Company has not experienced any significant impact of inflation and changing prices on its financial position or results of operations over the last several years.
1992 versus 1991
Results of Operations - ---------------------
Revenues from railcar services increased $15.0 million from 1991 primarily due to the impact of cars added to the railcar lease fleet during 1991 and 1992. Other service revenues, primarily sulphur processing, decreased $4.8 million.
On June 30, 1992, the Company entered into ten separate sale-leaseback transactions with trusts for the benefit of certain institutional investors pursuant to which it sold (at approximately book value) an aggregate of 2,073 railcars, including 1,570 tank cars. As a result of these transactions, the Company recorded sales revenue of $124.9 million. The sale-leaseback transactions therefore account for the $124.4 million increase in consolidated net sales revenues in 1992 as compared to 1991.
Other income decreased $14.7 million primarily due to lower interest income resulting from lower interest rates on advances to the Company's parent.
Income taxes as a percentage of income before taxes decreased due to reduced effective tax rates on foreign income.
Financial Condition - -------------------
Operating activities provided $175.6 million of cash. These funds, along with the commercial paper borrowings, net of amounts advanced to parent, were used to provide interim financing for railcar additions, service long-term debt and pay dividends to the Company's stockholder.
As discussed above, the Company entered into ten separate sale-leaseback transactions that provided aggregate sales revenue of $124.9 million. Net of $145.9 million spent for the construction and purchase of railcars and other fixed assets, and $71.1 million provided by other investing activities, net cash provided by investing activities was $50.1 million.
The Company did not enter into any new railcar debt financing in 1992. The Company spent $104.3 million for the repayment of commercial paper obligations, $72.3 million for principal repayments on debt and $33.0 million for dividends.
Changes in Accounting Principles - --------------------------------
As more fully discussed in note 9 to the consolidated financial statements, effective January 1, 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." The cumulative effect of the adoption of this new standard resulted in a $80.0 million credit to earnings in 1993. The new standard, however, had no effect on the Company's cash flow.
The Financial Accounting Standards Board has issued SFAS No. 112, "Employers' Accounting for Postemployment Benefits." This statement will have no material impact on the Company's financial position or results of operations since the Company's employee benefit programs do not include significant postemployment benefits.
The Financial Accounting Standards Board has also issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." However, since the Company does not currently have investments in these types of securities, there will be no impact on the Company's consolidated financial statements.
Other Matters - -------------
The Company has certain environmental matters currently outstanding, none of which are significant to the Company's results of operations or financial condition, either individually or in the aggregate. See further discussion of such matters under the "Environmental Matters" caption of Item 1 of this Form 10-K.
ITEM 8. | 100923 | 1993 |
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Operating Results 1993 was a challenging year in several respects. The company faced recessions in Europe and Japan, negative currency effects, a soft U.S. health care market and a highly competitive pricing environment. Worldwide net sales rose 1.0 percent to $14.020 billion. This followed increases of 4.1 percent in 1992 and 2.5 percent in 1991. Sales in the United States were $7.126 billion, up about 3 percent from 1992. Internationally, sales totaled $6.894 billion, a decrease of about 1 percent from 1992. Estimatedcomponents ofsales changefrom prioryears wereasfollows (percents):
1993 1992 ______________________________________________________________________________ U.S. Int'l Worldwide U.S. Int'l Worldwide ______________________________________________________________________________ Volume 5 7 6 3 5 4 Price (2) (2) (2) --- (1) (1) Translation --- (6) (3) --- 1 1 ______________________________________________________________________________ Total 3 (1) 1 3 5 4 ______________________________________________________________________________
In the United States volume growth accelerated in 1993, helped by a slight improvement in the domestic economy; however, pricing pressures also increased, mainly in memory technologies product lines. Internationally, sales growth in local currencies was slightly better than in 1992. However, currency fluctuations, which added to international sales in 1992, reduced those sales by about 6 percent in 1993. Cost of goods sold was 60.8 percent of sales, up from 60.1 percent in 1992. The negative impact of lower selling prices and currency was partially offset by improvements due to productivity gains and lower raw material costs. In 1992, cost of goods sold decreased as a percent of sales compared to 1991 due to productivity gains and lower raw material costs which were partially offset by higher R&D spending and lower selling prices. Cost of goods sold includes manufacturing, research and development, and engineering expenses. Selling, general and administrative expenses decreased to 25.2 percent of sales as the result of several cost-reduction programs. This compares with 25.6 percent in 1992 and 24.9 percent in 1991. The 1992 increase was magnified by costs for voluntary separations, higher sales costs and modest volume growth. Worldwide employment decreased by over 1,000 in 1993, even though about 600 people were added to support continued rapid growth in developing countries. This net reduction in employment occurred with little disruption to the company.
(Percent of sales) 1993 1992 1991 ______________________________________________________________________________ Cost of goods sold 60.8 60.1 60.4 ______________________________________________________________________________ Selling, general and administrative expenses 25.2 25.6 24.9 ______________________________________________________________________________
In December 1992, 3M recognized $129 million in settlement of a patent lawsuit involving 3M orthopedic casting materials. Operating income in 1992 includes this amount, which is shown on a separate line of the Income Statement titled "legal settlement." Also in 1992, 3M recorded $115 million of special charges to enhance its competitiveness and productivity. These charges relate primarily to asset write-downs, including rationalization of manufacturing operations. Operating income in 1992 includes this amount, which is shown on a separate Income Statement line titled "special charges".
Worldwide operating income in 1993 decreased 1.9 percent to $1.956 billion. The positive impact of increased sales volume and cost control was more than offset by negative currency and pricing. Operating income in 1993 included about $53 million for manufacturing rationalizations and voluntary separations. This compared to 1992 costs of about $80 million for voluntary separation programs, in addition to the $115 million of special charges. In 1992, operating income increased 1.7 percent, following a decrease of 10.6 percent in 1991.
(Percent of sales) 1993 1992 1991 ______________________________________________________________________________ Operating Income 14.0 14.4 14.7 ______________________________________________________________________________ Interest expense was $50 million, down from $76 million in 1992 and $97 million in 1991. The declines in both 1993 and 1992 were mainly due to lower interest rates. Investment and other income totaled $96 million in 1993, which includes a $36 million benefit from tax settlements, improved investment results, and other items, many of which were of a non-recurring nature. This compared with investment and other income of $29 million in 1992 and $15 million in 1991. The company's effective tax rate was 35.3 percent of pre-tax income, the same as in 1992 and down from 36.8 percent in 1991. The 1 percent increase in the 1993 U.S. statutory corporate tax rate was offset by lower taxes on 3M International Operations, the extension of the U.S. R&D tax credit and the positive effect of revaluing deferred tax assets. The company's deferred tax assets will reverse over an extended period of time. Net income increased 2.5 percent to $1.263 billion, or $5.82 per share. In 1992, net income increased 6.8 percent to $1.233 billion, or $5.63 per share, compared with $1.154 billion, or $5.26 per share, in 1991. The company estimates that changes in the value of the U.S. dollar decreased 1993 net income by about $62 million, or 29 cents per share. Currency changes increased net income by about $1 million, or 1 cent per share, in 1992, and by $23 million, or 11 cents per share, in 1991. These estimates include the effect of translating profits from local currencies into U.S. dollars, the costs in local currencies of transferring goods between the parent company in the U.S. and international companies, and transaction gains and losses in countries not considered to be highly inflationary. Over the long term, 3M expects to meet its aggressive financial goals. These include a growth in earnings per share averaging 10 percent a year or better; return on stockholders' equity of 20 to 25 percent; return on capital employed of 27 percent or better; and 30 percent of sales from products introduced in the last four years. Earnings per share increased 3.4 percent in 1993. Currency effects reduced earnings by about 5 percent. Return on average stockholders' equity was 19.1 percent, up from 18.8 percent in 1992. This return has averaged 20.5 percent over the past 5 years. Return on capital employed was 19.1 percent, down from 19.7 percent in 1992. This return has averaged 22.1 percent over the past 5 years. In 1993 more than 25 percent of sales came from products introduced within the last 4 years.
Performance by Business Sector Industrial and Consumer Sector: In 1993, sales were up 2.6 percent to $5.4 billion. Operating income rose 2.8 percent to $849 million. Excluding special charges of $13 million in 1992, operating income rose 1.2 percent in 1993. Sales and profits showed strong growth in the Asia Pacific area and in Latin America. However, results in Europe were adversely affected by weak economies and the stronger U.S. dollar. This sector expects continued growth in the United States, Asia Pacific area and in Latin America.
Information, Imaging and Electronic Sector: In 1993, sales were down 1.7 percent to $4.5 billion. A solid increase in
unit volume was more than offset by continued price competition and negative currency translation. Operating income increased 14.0 percent to $271 million. Excluding special charges of $81 million in 1992, operating income decreased 15.0 percent. Operating profit margins were affected by price competition and currency effects, as well as by large investments in new products and efforts to streamline operations. This sector will continue to face significant price pressure in 1994.
Life Sciences Sector: In 1993, sales increased 2.6 percent to $4.1 billion. Sales growth was constrained by the stronger U.S. dollar and by the slowdown in the U.S. health care market due to uncertainty over health care reform. Operating income decreased 8.6 percent to $846 million. Excluding a net benefit of $108 million from a legal settlement and special charges, operating income increased by 3.4 percent. This sector will continue to be impacted by the uncertainty over U.S. health care reform.
Financial Position 3M's financial condition remained strong in 1993, despite a sluggish worldwide economy. Balance sheet amounts did not vary significantly from 1992. Various items, such as cash and short-term debt, can fluctuate significantly from month to month depending on short-term liquidity needs. Substantially all of the vested and earned benefits under 3M's employee retirement plans, and about half of the other postretirement benefit obligations, were funded as of December 31, 1993. The company's key inventory index, which represents the number of months of inventory, was 4.0 months, up from 3.8 months in 1992. Accounts receivable days' sales outstanding were 66 days, up one day from 1992. The company's current ratio was 1.9, unchanged from the end of 1992. Of the long-term debt outstanding at the end of 1993, $469 million was a guarantee of debt of the 3M Employee Stock Ownership Plan. Total debt was 23 percent of stockholders' equity at the end of 1993. This compared with 22 percent at year-end 1992. The company's borrowings continued to maintain AAA long-term ratings. Legal proceedings, including the silicone gel mammory prosthesis situation and environmental liabilities, are discussed in the legal proceedings section on page 8. The company believes that such matters will not pose a material risk to the financial position of the company.
Liquidity Due to a change in the financial reporting period for 3M's international companies, the 1992 Consolidated Statement of Cash Flows includes the cash provided or used by 3M's international companies for a 14-month period (November 1, 1991, to December 31, 1992). The following table is presented on a comparative basis, whereby 1992 excludes the November 1 to December 31, 1991, period for our international companies.
(Millions) 1993 1992 1991 ______________________________________________________________________________ Net cash provided by operating activities $2,091 $2,218 $1,909 Net cash used in investing activities (1,092) (1,139) (1,197) Net cash used in financing activities (1,128) (1,027) (686) Effect of exchange rate changes on cash 21 (20) (62) ______________________________________________________________________________ Net increase (decrease) in cash and cash equivalents $ (108) $ 32 $ (36) ______________________________________________________________________________ Capital expenditures $1,112 $1,225 $1,326 Depreciation 976 950 884 ______________________________________________________________________________
The company met its cash requirements primarily from operating activities. During 1993, cash flows provided by operating activities totaled $2.091 billion. This more than covered capital expenditures and dividend payments of $1.833 billion. The company's superior credit rating provides easy and ample access to global capital markets. As part of our efforts to control overall spending, capital expenditures declined 9.3 percent to $1.112 billion in 1993. This followed a decline of 7.5 percent in calendar year 1992. Stockholder dividends increased 3.8 percent to $3.32 per share in 1993. Cash dividend payments totaled $721 million. 3M has paid dividends for 78 consecutive years. On February 14, 1994 the 3M Board of Directors boosted the quarterly dividend on 3M common stock 6 percent to 88 cents a share, declared a two-for-one stock split to shareholders of record on March 15, 1994 and authorized the repurchase of up to 12 million of the company's (pre-split) shares. This share-repurchase authorization runs through February 10, 1995. The company repurchased all of the six million shares available under a previous authorization. Repurchases of 3M common stock totaled $706 million in 1993, compared with $247 million in 1992 and $240 million in 1991. Increased share repurchases in 1993 reduced the total number of shares outstanding by more than 4 million. Repurchases were made to support employee stock purchase plans and for other corporate purposes.
Future Outlook Most economists expect slightly better global economic growth this year, with the improvement coming in the second half. This combined with continued emphasis on productivity improvement and new products should help our results; however, the pricing environment is likely to remain quite competitive and currency fluctuations could have a significant, negative effect on our results again this year. Spending on research and development and capital equipment is expected to remain around 1993 levels. Employment levels should continue to decline slightly in 1994. In 1992, the Financial Accounting Standards Board issued Statement No. 112, "Employers' Accounting for Postemployment Benefits." Postemployment benefits include, but are not limited to, disability, severance and health care benefits. 3M will adopt this standard in the first quarter of 1994. This adoption will have a diminimus effect on the company's results of operations.
Item 8. | 66740 | 1993 |
|
Item 6. SELECTED FINANCIAL DATA
The selected consolidated financial data for the Company set forth below for the five years ended December 31, 1993 should be read in conjunction with the Consolidated Financial Statements.
The above financial information reflects the operations of La Gloria Oil and Gas Company since the effective date of the acquisition in the fourth quarter of 1989.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
As discussed in Notes D and F of Notes to Consolidated Financial Statements on pages 21 and 24 of this report, Crown Central Petroleum Corporation and subsidiaries (the Company) adopted the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), and No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" (SFAS 106), effective January 1, 1992. The 1992 results include the $13,403,000 cumulative effect benefit of the adoption of SFAS 109 on prior years, and the $5,631,000 net of tax cumulative effect charge of applying SFAS 106. In 1993, the Company had a net loss of $4.3 million compared to a net loss before cumulative effect of changes in accounting principles of $13.3 million in 1992, and a net loss of $6 million in 1991.
The Company's sales and operating revenues decreased 2.7% in 1993 compared to a 3.4% decrease in 1992. The Company's sales and operating revenues include all Federal and State Excise Taxes which totalled $296,228,000, $218,944,000, and $214,716,000 in 1993, 1992 and 1991, respectively. The 1993 decrease in sales and operating revenues was due to an 8.8% decrease in the average unit selling price of petroleum products and to decreases in merchandise sales of 19.9%, which were partially offset by a 2.1% increase in sales volumes and an increase in excise taxes as previously mentioned. The 1992 decrease was primarily attributable to a 6.6% decrease in the average unit selling price of petroleum products and a 12.5% decrease in merchandise sales, which were partially offset by a 3.4% increase in petroleum product sales volumes. The merchandise sales decreases resulted principally from the sale or closing throughout 1992 and 1993 of retail marketing outlets which were either not profitable or did not fit with the Company's strategic direction. The closing of these units resulted in increases in the average sales level per store in each of the last two years. There were 376, 435 and 524 retail units operating at the end of 1993, 1992 and 1991, respectively.
Gasoline sales accounted for 56.4% of total 1993 revenues (excluding excise taxes), while distillates and merchandise sales represented 30.4% and 6.0%, respectively. This compares to a dollar mix from sales of 57.1% gasoline, 28.7% distillates and 6.9% merchandise in 1992; and 56.4% gasoline, 29.3% distillates and 7.6% merchandise in 1991.
The following table depicts the sales values of the principal classes of products sold by the Company, which individually contributed more than ten percent of consolidated sales and operating revenues (excluding excise taxes) during the last three years:
Sales of Principal Products millions of dollars 1993 1992 1991 ------ ------ --------
Gasoline $817.6 $900.1 $926.1 No. 2 Fuel & Diesel 369.7 379.9 384.5
Costs and operating expenses decreased 3.3% in 1993, after decreasing 3.4% in 1992. The 1993 decrease was attributable to a decrease in the average cost per barrel consumed of crude oil and feedstocks of $2.29 or 11.2%, which was partially offset by increases in volumes sold and excise taxes as previously mentioned. The 1992 decrease was due primarily to a decrease in the average cost per barrel consumed of $1.45 or 6.6% which was partially offset by higher sales volumes.
The results of operations were affected by the Company's use of the last-in, first-out (LIFO) method to value inventory which results in a better matching of current revenues and costs. The impact of LIFO was to increase the Company's gross margins in 1993, 1992 and 1991 by $.48 per barrel ($27.7 million), $.10 per barrel ($5.8 million) and $.86 per barrel ($45.9 million), respectively. The 1992 LIFO impact is net of a $2.3 million gross margin decrease resulting from a liquidation of LIFO inventory quantities as discussed in Note B of Notes to Consolidated Financial Statements on page 19 of this report.
Total refinery throughput was: 158,000 barrels per day (bpd) in 1993, yielding 86,000 bpd of gasoline (54.5%) and 52,000 bpd of distillates (32.6%); 154,000 barrels per day (bpd) in 1992, yielding 86,000 bpd of gasoline (56.2%) and 49,000 bpd of distillates (31.9%); and 147,000 bpd in 1991, yielding 78,000 bpd of gasoline (53.1%) and 47,300 bpd of distillates (32.2%). Refinery production was slightly impacted in 1993 by a scheduled maintenance turnaround in the second quarter at the Tyler refinery, while Refinery production was more dramatically reduced in 1992 by scheduled first quarter maintenance turnarounds at both the Houston and Tyler refineries. Due to poor refining margins late in the fourth quarter of 1993, the Company announced that it had reduced runs at its Pasadena Refinery by 20%. In 1991, overall refinery production and gasoline yields were reduced by the first quarter's scheduled turnaround and extensive modification of the Houston refinery's Fluid Catalytic Cracking Unit (FCCU), which is the primary gasoline facility. The Company's finished product requirements in excess of its refinery yields and existing inventory levels are acquired thru its exchange agreements or outright purchases.
On September 28, 1993, a fire destroyed the Red Bluff truck loading rack located one mile from the Pasadena Refinery. Since the fire, the Company has supplied its terminal rack customers with refined products at nearby locations. However, due to its strategic location, the Company has experienced certain reductions in operating margins in selling the refined product formerly sold from the Pasadena Terminal rack at these alternative sites or in the bulk products market. Prior to the fire, refined products sold from the Pasadena Terminal rack approximated 4% of consolidated 1993 refined product sales volumes. The Company continues to evaluate its options, but has not made a final decision concerning the repairs to the facility.
A majority of the Company's total crude oil and related raw material purchases are transacted on the spot market. The Company selectively enters into forward hedging and option contracts to minimize price fluctuations for a portion of its crude oil and refined products.
Selling and administrative expenses decreased 10.8% in 1993 after decreasing 8.3% in 1992. The 1993 decrease resulted primarily from decreased store level and marketing administrative costs associated with the closing of retail outlets as previously discussed, and the consolidation of certain marketing field operations. The 1992 decrease is also attributable to reduced costs associated with the closing of retail outlets, and reductions resulting from the reorganization of the Company's administrative functions. At December 31, 1993, the Company operated 249 retail gasoline facilities and 127 convenience stores compared to 262 retail gasoline facilities and 173 convenience stores at December 31, 1992 and 275 retail gasoline facilities and 249 convenience stores at December 31, 1991. Despite the net reduction in 1993 of 59 operating units (13.6%) from the December 31, 1992 level, the Company experienced a 9.1% increase in total retail petroleum product margin dollars while total retail sales volumes decreased less than 1%. The Company believes its extensive retail unit analysis is now complete and that a minimal number of existing units will be closed in 1994. Selling and administrative expense costs in 1993 include $.7 million in reorganization and office closure costs, while reorganization costs of $.4 million and $1.1 million are included in selling and administrative expenses for 1992 and 1991, respectively.
Operating costs and expenses in 1993, 1992 and 1991 include $8.7 million, $7.6 million and $15.7 million, respectively, related to environmental matters and retail units that have been closed. Operating costs and expenses in 1993 also include $1.8 million of accrued non-environmental casualty related costs. Operating costs and expenses in 1992 include a $1 million reserve for the write-off of excess refinery equipment and a $1.3 million write-off of refinery feasibility studies.
Depreciation and amortization in 1993 was comparable to 1992, and is expected to remain consistent in 1994. Depreciation and amortization increased 24.5% in 1992 resulting from additional depreciation and amortization relating to the 1991 capital modification and turnaround at the Houston refinery which was completed in March 1991, as well as depreciation associated with other capital expenditures made in 1991 and amortization of the 1992 turnarounds. Additionally, $2.4 million of depreciation was recorded as a result of the step-up in basis of fixed assets as required by the adoption of SFAS 109, effective January 1, 1992.
The loss of $2.3 million from sales and abandonments in 1993 relates primarily to the write-down of the Sulphur Unit at the Houston refinery. The loss of $1.3 million from sales of property plant and equipment in 1992 includes a $.9 million write-off of abandoned equipment related to the capital modification of the Houston refinery's FCCU.
Interest and other income increased $1.4 million in 1993 and decreased $4.7 million in 1992. The 1992 decrease was due primarily to decreases in the average daily cash invested of $40.9 million and to decreases in average interest rates. Interest and other income in 1993 includes income of $.7 million from the Company's wholly-owned insurance subsidiaries compared to a loss of $1 million in 1992 and income of $.2 million in 1991.
Non-operating gains in 1991 include a favorable $2.4 million litigation settlement related to the Houston refinery property tax assessments for the years 1986 to 1989 and a favorable $1.2 million insurance settlement. There were no material net non-operating gains or losses credited or charged to income in 1993 or 1992.
Interest expense increased $.6 million in 1993 and decreased $1.1 million in 1992. The 1993 increase related to a decrease in capitalized interest as disclosed in Note C of Notes to Consolidated Financial Statements on page 20 of this report. The 1992 decrease was due to decreases in the average effective rate on cash borrowed reflecting the Company's positive results from its interest rate swap program. Increases in the average daily cash borrowed of $5.2 million in 1992 partially offset the decreased expense.
As discussed in Note D of Notes to Consolidated Financial Statements on page 22 of this report, the passage of the Tax Act of 1993 increased the Company's federal statutory income tax rate from 34% to 35% effective January 1, 1993. The effect of the change in statutory rate was to increase the Company's 1993 income tax expense and increase the net loss by $2.3 million or $.23 per share.
Liquidity and Capital Resources
The Company's cash and cash equivalents were $3.5 million lower at year-end 1993 than at year-end 1992. The decrease was attributable to $40 million of net cash outflows from investment activities which was partially offset by cash provided by operating activities of $31.3 million and cash provided by financing activities of $5.2 million.
The positive $31.3 million cash generated from operating activities in 1993 is net of an $11.2 million cash outflow relating to working capital, resulting primarily from decreases in crude oil and refined products payable and increases in the value of crude oil and finished products inventories, which was partially offset by net decreases in accounts receivable. Since the Company purchases much of its crude oil in bulk, crude oil payables fluctuate depending on when the cargo is received and when the related payment is made.
Net cash outflows from investment activities in 1993 consisted principally of capital expenditures of $40.9 million (which includes $19.1 million related to the Marketing area and $19.5 million for refinery operations) and $4 million of refinery deferred turnaround costs. The total outflows from investment activities were partially offset by proceeds from the sale of property, plant and equipment of $5.6 million.
Net cash provided by financing activities in 1993 relates primarily to the $5.5 million received from the purchase money lien as discussed in Note C of Notes to Consolidated Financial Statements on page 20 of this report.
The ratio of current assets to current liabilities at December 31, 1993 was 1.29:1 compared to 1.22:1 at December 31, 1992. If FIFO values had been used for all inventories, assuming an incremental effective income tax rate of 38.5% at December 31, 1993 and 37.5% at December 31, 1992, the ratio of current assets to current liabilities would have been 1.36:1 at December 31, 1993 and 1992.
Like other petroleum refiners and marketers, the Company's operations are subject to extensive and rapidly changing federal and state environmental regulations governing air emissions, waste water discharges, and solid and hazardous waste management activities. The Company's policy is to accrue environmental and clean-up related costs of a non-capital nature when it is both probable that a liability has been incurred and that the amount can be reasonably estimated. While it is often extremely difficult to reasonably quantify future environmental related expenditures, the Company anticipates that a substantial capital investment will be required over the next several years to comply with existing regulations. The Company had recorded a liability of approximately $16.8 million as of December 31, 1993 to cover the estimated costs of compliance with environmental regulations.
Environmental liabilities are subject to considerable uncertainties which affect the Company's ability to estimate its ultimate cost of remediation efforts. These uncertainties include the exact nature and extent of the contamination at each site, the extent of required cleanup efforts, varying costs of alternative remediation strategies, changes in environmental remediation requirements, the number and financial strength of other potentially responsible parties at multi-party sites, and the identification of new environmental sites. As a result, charges to income for environmental liabilities could have a material effect on results of operations in a particular quarter or year as assessments and remediation efforts proceed or as new claims arise. However, management is not aware of any matters which would be expected to have a material adverse effect on the Company's consolidated financial position, cash flow or liquidity.
Over the next two to three years, the Company estimates environmental expenditures at the Houston and Tyler refineries, of at least $4.9 million and $16.8 million, respectively. Of these expenditures, it is anticipated that $3.5 million for Houston and $15.8 million for Tyler will be of a capital nature, while $1.4 million and $1 million, respectively, will be related to previously accrued non-capital remediation efforts. At the Company's marketing facilities, environmental related expenditures (capital and non-capital) of at least $10.5 million are planned for 1994 and 1995, which includes $5.1 million previously accrued relating to site testing and inspections, site clean-up, and monitoring wells.
In the fourth quarter of 1993, the distillate hydrotreater at the Tyler, Texas refinery, was completed at a cost of approximately $8.2 million. This unit, which is capable of processing 10,000 barrels per day, has operated near capacity since start up and enables Crown to meet the on road distillate sulphur standard as required by the Clean Air Act. Since 1991, the Company has incurred expenditures of approximately $20.4 million in connection with engineering and equipment acquisition which would enable the Houston refinery to manufacture low sulphur distillate. These expenditures are included in Property, Plant and Equipment on the Company's Balance Sheet at December 31, 1993. This project has been temporarily halted while the Company further studies the market economics of high sulphur versus low sulphur distillate and evaluates various options for this project. The Company estimates that, depending upon the specific design and capacity, additional expenditures in the range of $50 million to $80 million would be required to complete this project. If the Company decides to install this unit, long-term capital or alternative financing arrangements will be required.
As discussed in Note C of Notes to Consolidated Condensed Financial Statements on page 20 of this report, effective as of May 10, 1993, the Company entered into a new three year Revolving Credit Facility. Management believes the new agreement will provide anticipated working capital requirements as well as support future growth opportunities. As a result of a strong balance sheet and overall favorable credit relationships, the Company has been able to maintain open lines of credit with its major suppliers.
Under the Revolving Credit Agreement, the Company had outstanding as of January 31, 1994, irrevocable standby letters of credit in the principal amount of $25.7 million for purposes in the ordinary course of business. Unused commitments totaling $99.3 million under the Revolving Credit Agreement were available for future borrowings and issuance of letters of credit at January 31, 1994.
As discussed in Note C of Notes to Consolidated Financial Statement, on page 20 of this report, effective December 1, 1993, the Company entered into a Purchase Money Lien (Money Lien) for the financing of certain service station and terminal equipment and office furnishings. On January 31, 1994, an additional $1 million was drawn on the Money Lien for terminal equipment resulting in a total of $6.5 million outstanding at January 31, 1994.
The $60 million outstanding under the Company's Note Purchase Agreement requires seven annual repayments of $8.6 million beginning in January 1995. Under the terms of the existing credit facilities, the Company has various options available to either repay or refinance this debt including short-term borrowings, long-term borrowings, lease financing and structures such as the Purchase Money Lien previously discussed.
In 1993, due to declining interest rates, the Company reduced the discount rate used to measure obligations for pension and postretirement benefits other than pensions. This change will increase the Company's 1994 net periodic pension cost, however, adjustments to other assumptions used in accounting for the Company's defined benefit plans will likely result in a minimal impact on the overall cost.
The Company's management is involved in a continual process of evaluating growth opportunities in its core business as well as its capital resource alternatives. Total capital expenditures and deferred turnaround costs in 1994 are projected to approximate the 1993 expenditures of $44.9 million. The capital expenditures relate primarily to planned enhancements at the Company's refineries, marketing store level improvements and to company-wide environmental requirements. Management anticipates funding these 1994 expenditures principally through funds from operations and existing available cash.
The Company places its temporary cash investments in high credit quality financial instruments which are in accordance with the covenants of the Company's financing agreements. These securities mature within ninety days, and, therefore, bear minimal risk. The Company has not experienced any losses on its investments.
The Company faces intense competition in all of the business areas in which it operates. Many of the Company's competitors are substantially larger and Crown's sales volumes generally represent a small portion of the overall products sold in the Company's marketing areas. Therefore, the Company's earnings are affected by the marketing and pricing policies of its competitors, as well as changes in raw material costs.
Merchandise sales and operating revenues from the Company's convenience stores are seasonal in nature, generally producing higher sales and net income in the summer months than at other times of the year. Gasoline sales, both at the Crown multi-pumps and convenience stores, are also somewhat seasonal in nature and, therefore, related revenues may vary during the year. The seasonality does not, however, negatively impact the Company's overall ability to sell its refined products.
The Company maintains business interruption insurance to protect itself against losses resulting from shutdowns to refinery operations from fire, explosions and certain other insured casualties. Business interruption coverage begins for such losses at the greater of $5 million or shutdowns for periods in excess of 25 days.
Effects of Inflation and Changing Prices
The Company's consolidated financial statements are prepared on the historical cost method of accounting and, as a result, do not reflect changes in the dollar's purchasing power. Although the level of inflation continued to remain relatively low in recent years, the Company's results are still affected by the inflationary trend of earlier years.
In the capital intensive industry in which the Company operates, the replacement costs for its properties would generally far exceed their historical costs. Accordingly, depreciation would be greater if it were based on current replacement costs. However, since replacement facilities would reflect technological improvements and changes in business strategies, such facilities would be expected to be more productive and versatile than existing facilities, thereby increasing profits and mitigating increased depreciation and operating costs.
The Company's use of LIFO to value inventories understates the value of inventories on the Company's consolidated Balance Sheet as compared to the first-in, first-out (FIFO) method.
In recent years, crude oil and refined petroleum product prices have been falling which has resulted in a net reduction in working capital requirements. If the prices increase in the future, the Company will expect a related increase in working capital needs.
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Item 8. | 25885 | 1993 |
92236 | 1993 |