Item6
stringlengths 0
952k
| Item7
stringlengths 0
638k
| name
stringlengths 2
7
| years
stringclasses 23
values |
|---|---|---|---|
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data in Exhibit 13, "Salomon Inc 1993 Annual Report Financial Information," under the caption "Five Year Summary of Selected Financial Information" on page 86, is deemed part of this Annual Report on Form 10-K and is hereby 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 contained under the following captions in Exhibit 13, "Salomon Inc 1993 Annual Report Financial Information," is deemed part of this Annual Report on Form 10-K and is hereby incorporated herein by reference:
Financial Highlights (page 1)
Overview of 1993 (on pages 13 through 19)
Segment Information (on pages 20 through 30)
Capital and Liquidity Management (on pages 31 through 38)
Risk Management (on pages 39 through 45)
ITEM 8. | 200245 | 1993 |
Item 6. Selected Financial Data.
Information required under Item 6 of Part II is set forth in Part IV Item 14(a)(1) of this Form 10-K.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Information required under Item 7 of Part II is set forth in Part IV Item 14(a)(1) of this Form 10-K.
- - -9-
Item 8. | 310433 | 1993 |
860004 | 1993 |
||
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The cash requirements of the Company arise primarily from SCE&G's operational needs, the Company's construction program and the need to fund the activities or investments of the Company's nonregulated subsidiaries. The ability of the Company's regulated subsidiaries to replace existing plant investment, as well as to expand to meet future demand for electricity and gas, will depend upon their ability to attract the necessary financial capital on reasonable terms. The Company's regulated subsidiaries recover the costs of providing services through rates charged to customers. Rates for regulated services are generally based on historical costs. As customer growth and inflation occur and the regulated subsidiaries expand their construction programs, it is necessary to seek increases in rates. As a result the Company's future financial position and results of operations will be affected by the regulated subsidiaries' ability to obtain adequate and timely rate relief.
Due to continuing customer growth, SCE&G entered into a contract with Duke/Fluor Daniel in 1991 to design, engineer and build a 385 MW coal-fired electric generating plant near Cope, South Carolina in Orangeburg County. Construction of the plant began in November 1992 with commercial operation expected in late 1995 or early 1996. The estimated price of the Cope plant, excluding financing costs and AFC but including an allowance for escalation, is $450 million. In addition, the transmission lines for interconnection with the Company's system are expected to cost $26 million. Until the completion of the new plant, SCE&G is contracting for additional capacity as necessary to ensure that the energy demands of its customers can be met.
As discussed in Note 2A of Notes to Consolidated Financial Statements, on June 7, 1993 the PSC issued an order granting SCE&G a 7.4% annual increase in retail electric rates to be implemented in two phases of $42.0 million annually effective June 1993 and $18.5 million annually effective June 1994, based on a test year.
The estimated primary cash requirements for 1994, excluding requirements for fuel liabilities and short-term borrowings, and the actual primary cash requirements for 1993 are as follows:
1994 1993 (Thousands of Dollars)
Property additions and construction expenditures, excluding allowance for funds used during construction (AFC) $506,010 $381,141 Acquisition of oil and gas producing properties - 122,621 Nuclear fuel expenditures 28,064 7,177 Maturing obligations, redemptions and sinking and purchase fund requirements 25,627 16,530 Total $559,701 $527,469
Approximately 28% of total cash requirements (excluding dividends) was provided from internal sources in 1993 as compared to 40% in 1992.
The Company has in effect a medium-term note program for the issuance from time to time of unsecured medium-term debt securities. The proceeds from the sales of these securities may be used to fund additional business activities in nonutility subsidiaries, to reduce short-term debt incurred in connection therewith or for general corporate purposes. In 1993 the Company issued $60 million of such medium-term notes. The proceeds from the sales of these securities were used for the funding of nonutility subsidiary activities. At December 31, 1993 the Company had available for issuance $67.6 million under the current registration statement.
SCE&G's First and Refunding Mortgage Bond Indenture, dated April 1, 1945 (Old Mortgage), contains provisions prohibiting the issuance of additional bonds thereunder (Class A Bonds) unless net earnings (as therein defined) for 12 consecutive months out of the 15 months prior to the month of issuance is at least twice the annual interest requirements on all Class A Bonds to be outstanding (Bond Ratio). For the year ended December 31, 1993 the Bond Ratio was 3.70. The issuance of additional Class A Bonds is restricted also to an additional principal amount equal to 60% of unfunded net property additions (which unfunded net property additions totaled approximately $219.9 million at December 31, 1993), Class A Bonds issued on the basis of retirements of Class A Bonds (which retirement credits totaled $10.9 million at December 31, 1993), and Class A Bonds issued on the basis of cash on deposit with the Trustee.
SCE&G has placed a new bond indenture (New Mortgage) dated April 1, 1993 on substantially all of its electric properties under which its future mortgage-backed debt (New Bonds) will be issued. New Bonds are expected to be issued under the New Mortgage on the basis of a like principal amount of Class A Bonds issued under the Old Mortgage which have been deposited with the Trustee of the New Mortgage (of which $157 million were available for such purpose as of December 31, 1993), until such time as all presently outstanding Class A Bonds are retired. Thereafter, New Bonds will be issuable on the basis of property additions in a principal amount equal to 70% of the original cost of electric and common plant properties (compared to 60% of value for Class A Bonds under the Old Mortgage), cash deposited with the Trustee, and retirement of New Bonds. New Bonds will be issuable under the New Mortgage only if adjusted net earnings (as therein defined) for 12 consecutive months out of the 18 months immediately preceding the month of issuance are at least twice the annual interest requirements on all outstanding bonds (including Class A Bonds) and New Bonds to be outstanding (New Bond Ratio). For the year ended December 31, 1993 the New Bond Ratio was 5.0.
On April 29, 1993 the Securities and Exchange Commission (SEC) declared effective a registration statement for the issuance of up to $700 million of New Bonds. The following series, aggregating $600 million, have been issued under such registration statement:
On June 9, 1993, $100 million, 7 5/8% Series due June 1, 2023 to repay short-term borrowings in a like amount.
On July 1, 1993, $100 million, 6% Series due June 15, 2000; and $150 million, 7 1/8% Series due June 15, 2013; and on July 20, 1993, $150 million, 7 1/2% Series due June 15, 2023, to redeem, on July 20, 1993, $382,035,000 of First and Refunding Mortgage Bonds maturing between 1999 and 2017 and bearing interest at rates between 8% and 9 7/8% per annum.
On December 20, 1993, $100 million, 6 1/4% Series due December 15, 2003 to repay short-term borrowings in a like amount.
The following additional financing transactions have occurred since December 31, 1992:
On January 15, 1993 the Company closed on an unsecured bank loan in the principal amount of $60 million, due January 14, 1994, and used the proceeds to pay off a loan in a like amount. The interest rate is the three month LIBOR plus 30 basis points and is reset quarterly. On January 14, 1994 the Company refinanced the loan with unsecured bank loans totaling $60 million, due January 13, 1995 at interest rates between 3.875% and 3.89%.
On April 15, 1993 the Company arranged for a $15 million term loan, due April 14, 1994, to repay short-term borrowings in a like amount. The interest rate is the three month LIBOR plus 16 basis points and is reset quarterly.
On June 1, 1993 SCE&G redeemed the following amounts of First and Refunding Mortgage Bonds: $35 million, 10 1/8% Series due 2009 and $13 million, 9 7/8% Series due 2009.
On June 2, 1993 the Company entered into a $123 million 90-day bank loan (90-day bank loan) to finance the acquisition by Petroleum Resources of approximately 125 billion cubic feet equivalent of natural gas reserves through the purchase of NICOR Exploration and Production Company (NICOR).
On July 1, 1993 the Company issued $60 million of medium-term notes bearing interest at the following rates and maturing on the following dates in the following amounts: $20 million, 5.76%, due July 1, 1998; $20 million, 6.15%, due July 3, 2000; and $20 million, 6.51%, due July 1, 2003. The proceeds were used to repay a portion of the 90-day bank loan discussed above.
In early August 1993 the Company issued 1,467,000 shares of common stock with net proceeds totaling $69,345,090. The proceeds were used to repay the remainder of the 90-day bank loan discussed above and for general corporate purposes.
On September 30, 1993 Pipeline Corporation sold unsecured promissory notes totaling $25 million, 6.72% due September 30, 2013. The proceeds were used to repay short-term borrowings in a like amount.
Without the consent of at least a majority of the total voting power of SCE&G's preferred stock, SCE&G may not issue or assume any unsecured indebtedness if, after such issue or assumption, the total principal amount of all such unsecured indebtedness would exceed 10% of the aggregate principal amount of all of SCE&G's secured indebtedness and capital and surplus; provided, however, that no such consent shall be required to enter into agreements for payment of principal, interest and premium for securities issued for pollution control purposes.
Pursuant to Section 204 of the Federal Power Act, SCE&G and GENCO must obtain FERC authority to issue short-term indebtedness. The FERC has authorized SCE&G to issue up to $200 million of unsecured promissory notes or commercial paper with maturity dates of 12 months or less but not later than December 31, 1995. GENCO has not sought such authorization.
The Company had $175.0 million authorized lines of credit and had unused lines of credit of $148.0 million at December 31, 1993. In addition, the Company has a credit agreement for a maximum of $75 million to finance nuclear and fossil fuel inventories, with $38.2 million available at December 31, 1993.
SCE&G's Restated Articles of Incorporation prohibit issuance of additional shares of preferred stock without consent of the preferred stockholders unless net earnings (as defined therein) for the 12 consecutive months immediately preceding the month of issuance is at least one and one-half times the aggregate of all interest charges and preferred stock dividend requirements (Preferred Stock Ratio). For the year ended December 31, 1993 the Preferred Stock Ratio was 2.52.
On October 12, 1993 the Company registered with the SEC 2,000,000 additional shares of the Company's common stock to be issued and sold under the Dividend Reinvestment and Stock Purchase Plan (DRP).
During 1993 the Company issued 529,954 shares of the Company's common stock under the DRP. In addition, the Company issued 705,498 shares of its common stock pursuant to its Stock Purchase-Savings Plan (SPSP). The Company has authorized and reserved for issuance, and registered under effective registration statements, 2,065,824 and 872,420 shares of common stock pursuant to the DRP and the SPSP, respectively.
In January 1994 the Company signed an agreement to sell in 1994 substantially all of the real estate assets of SCANA Development Corporation (Development Corporation) to Liberty Properties Group, Inc. of Greenville, South Carolina for $91.5 million. Under the terms of the agreement, a portion of the sales price will be received in cash at the time of closing. The remainder of the sales price, which is related to certain projects currently under construction, will be received in cash as those projects are completed. On March 4, 1994 the Company and Liberty amended the agreement regarding the sale. Under the terms of the amended agreement certain projects currently under construction will be excluded from the transaction and the sales price will be $49.6 million. All of the sales price will be received at the time of closing. The net proceeds from the sale will be used to retire Development Corporation's debt and for general corporate purposes, including the funding of other nonutility subsidiaries' business activities. The transaction will not have a material impact on the Company's financial position or results of operations.
The Company anticipates that its 1994 cash requirements of $559.7 will be met through internally generated funds (approximately 38% excluding dividends), the sales of additional equity securities and the incurrence of additional short-term and long-term indebtedness. The timing and amount of such financing will depend upon market conditions and other factors. Actual 1994 expenditures may vary from the estimates set forth above due to factors such as inflation and economic conditions, regulation and legislation, rates of load growth, environmental protection standards and the cost and availability of capital.
The Company expects that it has or can obtain adequate sources of financing to meet its projected cash requirements. Environmental Matters
The Clean Air Act requires electric utilities to reduce substantially emissions of sulfur dioxide and nitrogen oxide by the year 2000. These requirements are being phased in over two periods. The first phase has a compliance date of January 1, 1995 and the second, January 1, 2000. The Company meets all requirements of Phase I and therefore will not have to implement changes until compliance with Phase II requirements is necessary. The Company then will most likely meet its compliance requirements through the burning of natural gas and/or lower sulfur coal, the addition of scrubbers to coal-fired generating units, and the purchase of sulfur dioxide emission allowances. Low nitrogen oxide burners will be installed to reduce nitrogen oxide emissions.
The Company is continuing to refine a compliance plan that must be filed with the U.S. Environmental Protection Agency (EPA) by January 1, 1996. The Company currently estimates that air emissions control equipment will require capital expenditures of $252 million over the 1994-1998 period to retrofit existing facilities and an increased operation and maintenance cost of $31 million per year. To meet compliance requirements through the year 2003, the Company anticipates total capital expenditures of $275 million.
The South Carolina Solid Waste Policy and Management Act of 1991 requires promulgation of regulations addressing specified subjects, one of which affects the management of industrial solid waste. This regulation will establish minimum criteria for industrial landfills as mandated under the Act. The proposed regulation, if adopted as a final regulation in its present form, could significantly impact SCE&G's and GENCO's engineering, design and operation of existing and future ash management facilities. Potential cost impacts could be substantial.
As described in Note 1L of Notes to Consolidated Financial Statements, the Company has an environmental assessment program to identify and assess current and former operations sites that could require environmental cleanup. As site assessments are initiated, an estimate is made of the amount of expenditures, if any, necessary to investigate and clean up each site. These estimates are refined as additional information becomes available; therefore actual expenditures could significantly differ from the original estimates. Amounts estimated and accrued to date ($19.6 million) for site assessments and cleanup of regulated operations have been deferred and are being amortized and recovered through rates over a ten-year period. Estimates to date include, among other things, the costs estimated to be associated with the matters discussed in the following paragraphs.
The Company and its principal subsidiary, SCE&G, each own two decommissioned manufactured gas plant sites which contain residues of by-product chemicals. The Company and SCE&G have each maintained an active review of their respective sites to monitor the nature and extent of the residual contamination.
In September 1992 the EPA notified SCE&G, the City of Charleston and the Charleston Housing Authority of their potential liability for the investigation and cleanup of the Calhoun Park Area Site in Charleston, South Carolina. This site originally encompassed approximately 18 acres and included properties which were the locations for industrial operations, including a wood preserving (creosote) plant and one of SCE&G's decommissioned manufactured gas plants. The original scope of this investigation has been expanded to approximately 30 acres including adjacent properties owned by the National Park Service and the City of Charleston, and private properties. The site has not been placed on the National Priority List, but may be added before cleanup is initiated. The potentially responsible parties (PRP) have agreed with the EPA to participate in an innovative approach to site investigation and cleanup called "Superfund Accelerated Cleanup Model," allowing the pre-cleanup site investigations process to be compressed significantly. The PRPs have negotiated an administrative order by consent for the conduct of a Remedial Investigation/Feasibility Study (RI/FS) and a corresponding Scope of Work. Actual field work began November 1, 1993 after final approval and authorization was granted by EPA. SCE&G is also working with the City of Charleston to investigate potential contamination from the manufactured gas plant at the city's aquarium site.
During 1993 SCE&G settled its obligations at the Yellow Water Road Superfund Site near Jacksonville, Florida, the Spencer Transformer and Equipment Site in West Virginia and Elliott's Auto Parts in Benton, Arkansas. No further expenses are anticipated for these sites.
SCE&G has been listed as a PRP and has recorded liabilities, which are not considered material, for the Macon-Dockery waste disposal site near Rockingham, North Carolina, the Aqua-Tech Environmental, Inc. site in Greer, South Carolina and a landfill owned by Lexington County in South Carolina.
Litigation
In January 1994 SCE&G, acting on behalf of itself and the PSA (as co-owners of Summer Station), reached a settlement with Westinghouse Electric Corporation (Westinghouse) resolving a dispute involving steam generators provided by Westinghouse to Summer Station which are defective in design, workmanship and materials. Terms of the settlement are confidential. SCE&G had filed an action in May 1990 against Westinghouse in the U.S. District Court for South Carolina; an order dismissing this suit was issued on January 12, 1994.
Regulatory Matters
On June 7, 1993 the PSC issued an order on SCE&G's pending electric rate proceeding allowing an authorized return on common equity of 11.5%, resulting in a 7.4% annual increase in retail electric rates, or a projected $60.5 million annually on a test year basis. These rates are to be implemented in two phases over a two-year period: phase one, effective June 1993, producing $42.0 million annually, and phase two, effective June 1994, producing $18.5 million annually, on a test year basis.
The Company's regulated business operations are likely to be impacted by the National Energy Policy Act (NEPA) and FERC Order No. 636. NEPA is designed to create a more competitive wholesale power supply market by creating "exempt wholesale generators" and by potentially requiring utilities owning transmission facilities provide transmission access to wholesalers. Order No. 636 is intended to deregulate the markets for interstate sales of natural gas by requiring that pipelines provide transportation services that are equal in quality for all gas suppliers whether the customer purchases gas from the pipeline or another supplier. In the opinion of the Company, it will be able to meet successfully the challenges of these altered business climates.
Other
In November 1992 the Financial Accounting Standards Board issued Statement No. 112 "Employers' Accounting for Postemployment Benefits." The Statement, which is effective for calendar year 1994, establishes certain conditions for the recognition of costs of benefits to former employees after employment but before retirement. The Statement requires recognition of the obligation to provide postemployment benefits if such obligation is attributable to services previously rendered, the obligation relates to rights which vest, payment of the benefits is probable and the amount of such benefits can be reasonably estimated. The Company does not anticipate that application of this Statement will have a significant impact on results of operations or financial position.
RESULTS OF OPERATIONS
Earnings and Dividends
Earnings per share of common stock, the percent increase (decrease) from the previous year and the rate of return earned on common equity for the years 1991 through 1993 were as follows:
1993 1992 1991 Earnings per share $3.72 $2.84 $3.37 Percent increase (decrease) in earnings per share 31.0% (15.7%) (24.1%) Return earned on common equity (year-end) 12.6% 10.1% 13.2%
1993 Earnings per share and return on common equity increased in 1993 primarily due to a higher electric sales margin and additional nonoperating income.
1992 Earnings per share and return on common equity in 1992 decreased primarily due to the recording of an $11.1 million (after interest and income taxes) reserve against earnings related to the August 31, 1992 retail electric rate ruling from the South Carolina Supreme Court (see Note 2F of Notes to the Consolidated Financial Statements) and increases in other operating and interest expenses.
The Company's financial statements include AFC. AFC is a utility accounting practice whereby a portion of the cost of both equity and borrowed funds used to finance construction (which is shown on the balance sheet as construction work in progress) is capitalized. Both an equity and debt portion of AFC are included in nonoperating income as noncash items which have the effect of increasing reported net income. AFC represented approximately 5.8% of income before income taxes in 1993, 5.5% in 1992 and 3.9% in 1991.
In 1993 the Company's Board of Directors raised the quarterly cash dividend on common stock to 68.5 cents per share from 67 cents per share. The increase, effective with the dividend payable on April 1, 1993, raised the indicated annual dividend rate to $2.74 per share from $2.68. The Company has increased the dividend rate on its common stock in 40 of the last 41 years.
Electric Operations
Electric sales margins for 1993, 1992 and 1991 were as follows:
1993 1992 1991 (Millions of Dollars)
Electric revenues $940.1 $829.5 $867.2 Less: Fuel used in electric generation 228.7 206.2 224.9 Purchased power 13.0 7.3 9.8 Margin $698.4 $616.0 $632.5
1993 The increase in electric sales margin from 1992 to 1993 is primarilya result of increased residential and commercial KWH sales due to weather and customer growth, an increase in retail electric rates beginning in June 1993 and the recording in 1992 of a $14.6 million reserve as discussed below.
1992 The 1992 electric sales margin decreased from 1991 due to therecording of a $14.6 million reserve, before interest and income taxes, related to the August 31, 1992 ruling from the South Carolina Supreme Court (see Note 2F of Notes to Consolidated Financial Statements) and a $1.9 million billing related litigation settlement included in 1991 electric operating revenues.
Warmer weather and an increase in the number of electric customers resulted in an all-time peak demand record of 3,557 MW on July 29, 1993. The previous year's record of 3,380 MW was set on July 13, 1992.
Gas Operations
Gas sales margins for 1993, 1992 and 1991 were as follows:
1993 1992 1991 (Millions of Dollars)
Gas revenues $320.2 $305.3 $276.7 Less: Gas purchased for resale 209.7 191.6 171.9 Margin $110.5 $113.7 $104.8
1993 In 1993 the gas sales margin decreased from 1992 as a result of higher gas prices which reduced Pipeline Corporation's sales due to the competitiveness of alternative fuels. This reduction was partially offset by increases in higher margin residential and commercial sales and increased transportation volumes.
1992 The gas sales margin for 1992 increased from 1991 as a result of recoveries of $4.2 million allowed under a weather normalization adjustment which became effective the first billing cycle in December 1991; increases in residential usage due to cooler weather during 1992; and increased transportation volumes.
Other Operating Expenses and Taxes
Increases (decreases) in other operating expenses, including taxes, are presented in the following table:
Increase (Decrease) From Prior Year Classification 1993 1992 (Millions of Dollars)
Other operation and maintenance $ 9.6 $ 11.0 Depreciation and amortization 4.5 5.6 Income taxes 29.1 (16.6) Other taxes .6 4.6 Total $43.8 $ 4.6
, 1993 Other operation and maintenance expenses increased for 1993 primarily due to the implementation of Financial Accounting Standards Board Statement No. 106 (see Note 1J of Notes to Consolidated Financial Statements) pursuant to the June 1993 PSC electric rate order and the amortization of environmental expenses. The depreciation and amortization increase reflects additions to plant in service. The increase in income taxes corresponds to the increase in income and reflects the increase in the corporate tax rate from 34% to 35% retroactive to January 1, 1993.
1992 Other operation and maintenance expenses increased for 1992 primarily due to increases in administrative and general expenses, increases in nuclear regulatory fees and nuclear and transmission systems maintenance. The increase in depreciation and amortization expense reflects additions to plant in service. Income taxes decreased primarily due to the tax impact of the rate refund (see Note 2F of Notes to Consolidated Financial Statements) and to other decreases in income. Other taxes increased primarily from higher property taxes caused by property additions and increased millage rates. In addition to the above, other taxes increased due to increases in state license fees.
Other income, net of income taxes, increased approximately $14.7 million in 1993 primarily due to additional income from Petroleum Resources related to higher natural gas prices and additional income resulting from the acquisition of NICOR in June 1993.
Interest Expense
Increases (decreases) in interest expense are presented in the following table:
Increase (Decrease) From Prior Year Classification 1993 1992 (Millions of Dollars)
Interest on long-term debt, net $5.6 $4.3 Other interest expense (.1) 1.2 Total $5.5 $5.5
1993 Interest on long-term debt increased approximately $5.6 million in 1993 compared to 1992 due to the issuance of $72.4 million medium-term notes during the latter part of 1992 and $60 million medium-term notes in July 1993 to finance acquisitions of natural gas reserves and the issuance of $200 million of SCE&G's First Mortgage Bonds to finance utility construction. The resulting increases more than offset the interest savings resulting from the redemption and refinancing of $382 million of First and Refunding Mortgage Bonds with the proceeds from the issuance of $400 million of First Mortgage Bonds by SCE&G at lower interest rates.
1992 Interest on long-term debt increased approximately $4.4 million in 1992 compared to 1991 due to the issuances of $145 million and $155 million of First and Refunding Mortgage Bonds on July 24, 1991 and August 29, 1991, respectively, which more than offset the decreases in interest expense resulting from the repayment of debt and lower interest rates on remaining debt.
ITEM 8. | 754737 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA.
The following tables set forth certain information concerning the insurance operations of the Company and its general operations, and should be read in conjunction with, and are qualified in their entirety by, the Consolidated Financial Statements and the notes thereto appearing elsewhere in this report. This selected financial data has been derived from the audited Consolidated Financial Statements of the Company and its subsidiaries. The "Pre-Acquisition" information set forth below is not included in the Company's Consolidated Financial Statements relating to periods prior to the Company's acquisition of Acceptance in April 1990.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis of financial condition and results of operations of the Company and its consolidated subsidiaries is based upon the consolidated financial statements, and the notes thereto included herein.
Results of Operations
Year Ended December 31, 1993 Compared to Year Ended December 31, 1992.
The Company's net income increased by $8.5 million from 1992 to 1993 as net income improved from a loss of $.9 million for the year ended December 31, 1992 to income of $7.6 million for the year ended December 31, 1993. This increase was attributable primarily to four factors: 1) improved underwriting results combined with an increase in premiums earned, 2) growth in the investment income of the Company, 3) continued reduction in the general and administrative expenses of the Company, and 4) a reduction in interest expense. In addition, the real estate interests of the Company had very little impact on the change in net income for 1993 as compared to 1992.
Insurance premiums earned increased by 61.8% from 1992 to 1993. Excluding the increase in premiums written resulting from the merger with The Redland Group, Inc. ("Redland"), the Company's direct written premiums increased a modest 11.9%. Net premiums, however, increased 45.2% due to the Company's ability to retain more premiums as a result of increased capital from the Equity Rights Offering completed in January, 1993 which raised $31.2 million. In addition, during 1993, the new Redland operations added $16.2 million in earned premiums to the Company's revenues. With the inclusion of the Redland operations for an entire year, the expansion of the Company's general agency programs as a result of the opening of a new branch office in Scottsdale, Arizona and the business opportunities developed from the Company's merger with Redland, it is expected that the growth in premium revenue will continue during 1994.
This increase in earned premium revenue translated into improved results in 1993 as compared to 1992 as the Company experienced a reduced combined loss and expense ratio from insurance operations of 100.9% during the twelve months ended December 31, 1993 as compared to 104.9% during the same period in 1992. With the inclusion of Redland, the Company's expense ratio fell slightly from 29.1% in 1992 to 28.4% in 1993. The Company's loss ratio decreased from 75.8% during 1992 to 72.5% during 1993. The results in 1992 were affected by Hurricane's Andrew and Iniki as well as reserve strengthening in the Company's workers' compensation and liquor liability lines. These events did not reoccur during 1993 contributing to the decline in the Company's loss ratio. The seasonal nature of crop insurance writings combined with unpredictable weather patterns are expected to create more volatility in the Company's quarter to quarter earnings in the future, and thus, results in one quarter will provide a less reliable forecast of subsequent quarterly results.
The Company's investment income increased 41.3% from the year ended December 31, 1992 to the year ended December 31, 1993. This increase is attributable primarily to the increase in the Company's investment portfolio from an average of $113 million during 1992 to an average portfolio of $173 million during 1993. This increase in the size of the portfolio resulted from a capital infusion of funds derived from the Company's Equity Rights Offering completed in January, 1993, the Company's ability to cede less of its premium to reinsurers as a result of this capital infusion, growth in the Company's direct premiums, and additional investment assets acquired in the merger with Redland. In terms of generating investment income, the increase in the size of the portfolio more than offset the reduction in the average yield on the investment portfolio from 7.3% during the year ended December 31, 1992 to 6.3% during the 1993 year. This reduction in average yield primarily was due to the reduced yields available for investment grade securities in the marketplace, the addition to the Company's portfolio of tax free securities which, in general, have a lower yield than equivalent taxable securities, the short term nature of Redland's portfolio, and amortization of premiums paid for certain of the Company's mortgage backed securities caused by an acceleration in the prepayment speed of the underlying mortgages. If the Company's net tax operating losses continue to diminish, the Company will seek additional opportunities in the tax free investment sector.
During 1993, the Company was able to further reduce its general and administrative expenses as compared to those experienced in 1992. Two factors served to decrease the general and administrative expenses. First, the Company combined its real estate and portfolio management operations during 1993, thus reducing administrative expenses associated with real estate activities. In addition, the Company continued to reduce expenses as a result of the consolidation of operations between the parent Company and its insurance company subsidiaries. This consolidation was initiated by the movement of the Company's home office from Bloomfield Hills, Michigan to Omaha, Nebraska in July, 1992. Offsetting decreases in general and administrative expenses were increases associated with Redland. These expenses include normal administrative expenses associated with the running of the Redland operations as well as the amortization of certain identifiable intangible assets and the excess of costs over acquired net assets. The Company does not expect further reductions in its general and administrative expenses during 1994.
The Company's interest expense continued to decline during 1993 compared to 1992. This was due primarily to a decrease in the Company's outstanding debt as well as a reduction in the Company's average interest costs on such debt. On May 28, 1992, the Company completed the sale of its 5,355,166 shares of Common Stock of Orange-co for $31 million in cash, resulting in net proceeds of approximately $29 million. The Company applied approximately $22.4 million to retire its bank term loan. On January 27, 1993, the Company successfully completed a $31.9 million Common Stock Rights Offering. Proceeds from this offering were used to retire $9.5 million of secured subordinated notes plus accrued interest thereon. Effective April 15, 1993 the holder of a $7 million secured subordinated note of one of the Company's subsidiaries, which had been assumed by the Company, exchanged such note for 875,000 shares of Common Stock and Warrants to purchase, at a price of $11 per share during a period ending January 27, 1997, 875,000 additional shares of Common Stock. All of these events reduced debt carried at higher interest rates than the Company's other bank borrowings, and therefore, with the retirement of these debts, the Company also reduced the average cost of its outstanding debt.
In March, 1994, the Company agreed to amend borrowing arrangements with its bank lenders. The new structure is a $35 million line of credit with interest payable quarterly at the prime rate or at LIBOR plus a margin of 1% to 1.75%, depending on the Company's debt to equity ratio. The line of credit will mature in four years and may be extended to five years by the bank lenders. The line of credit will be consummated once final legal documentation is completed which is anticipated to be in April, 1994. Such facility will increase the Company's borrowing capacity and, in the current interest rate environment, should reduce the interest rate which the Company pays on its debt. Since the interest rate is a floating rate, the Company has no guarantee that such reduction will be a permanent one.
Year Ended December 31, 1992 Compared to Year Ended December 31, 1991
The Company's net loss decreased $42 million to $.9 million for the year ended December 31, 1992 as compared to $42.9 million for the previous year. This decrease was mainly attributable to a $19.6 million provision for the expected loss on disposal of the Company's investment in Orange-co and a $15.3 million write- down of the Company's equity investment in Major Realty to estimated net realizable value, both recorded during the year ended December 31, 1991. The remaining approximate $7.1 million related to a decrease in general and administrative expenses of $5.7 million, a decrease in other expense of $2.6 million, principally related to a loss in 1991 which did not reoccur in 1992, a decrease in interest expense of $1.3 million, and an increase in investment income of $1.2 million. These improvements were partially offset by a $2.1 million reserve strengthening in the insurance operations and a $1.7 million incurred loss from Hurricanes Andrew and Iniki.
Insurance premiums earned increased 21.5% to $79.2 million for the year ended December 31, 1992 from $65.2 million in the previous year. This increase is attributable primarily to growth in workers' compensation, non-standard private passenger and specialty automobile and the Acceptance Risk Managers programs.
During the year ended December 31, 1992, loss and loss adjustment expenses increased 27.9% as compared to the previous year. This higher rate of growth in losses (27.9%) compared to premium revenues (21.5%) was attributable primarily to increased loss development in the Company's workers' compensation and liquor liability lines as well as losses incurred from Hurricanes Andrew and Iniki.
During 1992, through analysis of additional claims information and additional data processing capability which came "on-line," it became apparent that the liquor and workers' compensation lines of business were developing worse than had been anticipated. This judgment was based upon several factors: discussion with the claims staff and counsel regarding specific claims, adjudicated cases and the estimated effect thereof as precedents for similar claims, additional claims filed, the severity thereof, and the effect of these new claims as an indicator of additional incurred but not reported loss development. Management believes that the reserves recorded for these lines of business and events now provide adequate reserves for future payments.
Insurance operational expense ratios for the years ended December 31, 1992 and 1991 remained consistent at 29.1% and 29.0%, respectively.
In October 1991, Acceptance acquired Seaboard Underwriters, Inc. ("Seaboard"), a North Carolina-based managing general agency specializing in transportation business. Seaboard's agency commissions during the year ended December 31, 1992, aggregated approximately $4.0 million while agency expenses totaled approximately $3.7 million. Acceptance's insurance subsidiaries have been underwriting a portion of the business produced by Seaboard.
During the year ended December 31, 1991, the Company's investment strategy provided for investment principally in U.S. Government securities with maturities of two years or less as well as realizing gains within the portfolio as the interest rate environment changed. During the year ended December 31, 1992, the Company changed its investment strategy to one whereby various securities of the U.S. Government, U.S. Government agencies, corporate securities and collateralized mortgage obligations backed by U.S. Government Agency Securities were combined to result in an average duration for the entire portfolio of between 3.5 and 4 years. This change in strategy as well as an overall increase in the size of the portfolio resulted in an increase in the interest income of the portfolio. These factors combined to create an overall increase in the Company's net investment income for the year ended December 31, 1992, as compared to the previous year. U.S. Government Securities and collateralized mortgage obligations backed by U.S. Government Agency Securities comprised 74% of the entire investment portfolio as of December 31, 1992.
Revenues from the Company's real estate operations for the year ended December 31, 1992, were $2,610,000 of which $1,522,000 related to fees earned in connection with Major Group's management and real estate advisory agreement with Major Realty which terminated June 30, 1992. Included in the $1,522,000 is a non-recurring fee of $925,000 paid by Major Realty to Major Group in the form of a promissory note recorded in connection with the settlement and termination of the advisory agreement with Major Realty.
On September 25, 1992, the Company completed the merger with The Major Group, Inc. Pursuant to Settlement Agreements among the Company, Major Group and certain secured creditors (the "Term Sheet Creditors"), Major Group (1) conveyed substantially all of its assets, except for certain property located in Fort Lauderdale, Florida (the "Fort Lauderdale Commerce Center Property") and two promissory notes from Major Realty Corporation (the "Major Realty Notes"), to the Term Sheet Creditors in satisfaction of all of Major Group's obligations due to them; (2) the Fort Lauderdale Commerce Center Property and the Major Realty Notes were transferred to the Company in satisfaction of all amounts due the Company under a note of a subsidiary of Major Group, which was secured by a mortgage on the Fort Lauderdale Commerce Center Property and guaranteed by Major Group; and (3) the Company issued a promissory note in the principal amount of $500,000 payable in installments over one year to the Term Sheet Creditors in exchange for all of the Major Group preferred stock held by the Term Sheet Creditors. Assets conveyed to the Term Sheet Creditors and liabilities satisfied approximated $5.7 million. Immediately upon conclusion of these transactions, Major Group was merged into a wholly owned subsidiary of the Company.
In addition, Major Group settled certain claims by agreeing to pay $150,000 in cash and other consideration, payment of which is guaranteed by the Company, payable over a two year period and payment of the net cash proceeds from the sale of certain sewer connections not to exceed $150,000. In connection with the above, the Company issued approximately 52,000 shares of Common Stock to complete the merger.
The net effect of the transactions among Major Group, the Term Sheet Creditors and the Company upon the results of operations was insignificant.
Consolidated interest expense decreased $1.3 million from the prior year to $4.4 million for the year ended December 31, 1992. Total indebtedness was $33.6 million at December 31, 1992, a decrease of $21.9 million from $55.5 million at December 31, 1991.
At December 31, 1992, the Company had approximately $23.7 million of net operating loss carryforwards for financial reporting purposes and $14 million of net operating loss carryforwards for tax reporting purposes.
LIQUIDITY AND CAPITAL RESOURCES
The Company has included a discussion of the liquidity and capital resources requirement of the Company and the Company's insurance subsidiaries.
The Company -- Parent Only
On January 27, 1993, the Company completed a $31.9 million Common Stock Equity Rights Offering. This resulted in the issuance of 3,992,480 shares of Common Stock and an equal amount of Warrants, each Warrant providing for the purchase of one share of Common Stock exercisable at $11.00 until January 27, 1997, unless called under certain conditions. The net proceeds of approximately $31.2 million were used to retire $9.5 million of secured subordinated notes plus accrued interest thereon and increase the insurance subsidiaries capital by $12.5 million with the balance retained as working capital. With this addition to working capital, the Company has been able to meet all short term cash needs, and as of December 31, 1993 has no long term liabilities or long term commitments. The Company also assumed a $7 million secured subordinated note outstanding from one of its insurance company subsidiaries and subsequently retired said note in April, 1993 in exchange for 875,000 shares of Common Stock and 875,000 Warrants identical to those issued in the Rights Offering.
Dividends from the insurance subsidiaries are not available to the Company because of restrictive covenants set forth in the term and revolving loan agreements of the Company's insurance subsidiaries which prohibit dividends from the insurance subsidiaries to the Company without the expressed consent from the holders of the debt obligation. In March, 1994, the Company agreed to amend its borrowing arrangements with its bank lenders. The new arrangements will transfer the debt obligations from the holding companies of the insurance subsidiaries to the parent company. At such time, the new loan agreements will no longer impose restrictions on dividends from the insurance subsidiaries to the Company. The new structure is a $35 million line of credit with interest payable quarterly at the prime rate or at LIBOR plus a margin of 1% to 1.75% depending on the Company's debt to equity ratio. The line of credit will mature in four years and may be extended to five years by the bank lenders. This line of credit will be consummated once final legal documentation is completed which is anticipated to be in April, 1994.
In addition, dividends from the insurance subsidiaries to the Company are regulated by the state regulatory authorities of the states in which each insurance subsidiary is domiciled. The laws of such states generally restrict dividends from insurance companies to parent companies to certain statutorily approved limits. As of December 31, 1993, the statutory limitations on dividends from the insurance company subsidiaries to the parent without further insurance department approval are approximately $3.4 million.
Insurance Subsidiaries
The Company's insurance subsidiaries are highly liquid and are able to meet their cash requirements on a timely basis. At December 31, 1993, the insurance subsidiaries outstanding debt consisted of a $12 million term loan note, a $6,597,000 revolving promissory note and $354,000 of other borrowings. The $12 million note was collateralized by the Company's Acceptance Common Stock, with principal of $1 million plus interest at prime plus .5% or at the Company's option LIBOR plus 2.5% payable quarterly with a maturity of October 1, 1996. The revolving promissory note was collateralized by Redland Common Stock with interest payable at the Federal funds rate plus 2.75%, maturing on January 5, 1995. Both of these borrowings will be replaced in April, 1994 with the funds from the new loan arrangement described above. Servicing of these debt obligations of the insurance subsidiaries has been provided by funds derived either from tax sharing payments made by the operating subsidiaries to the Company which are sheltered by the Company's tax net operating loss carryforwards and reinvested in the insurance holding company or through dividends and/or advances.
On a longer term basis, the principal liquidity needs of the insurance company subsidiaries are to fund loss payments and loss adjustment expenses required in the operation of its insurance business. Primarily, the available sources to fund these obligations are new premiums received and to a lesser extent cash flows from the Company's portfolio operations. The Company monitors its cash flow carefully and attempts to maintain its portfolio at a duration which approximates the estimated cash requirements for loss and loss adjustment expenses. The seasonal nature of the Company's crop business generates a reverse cash flow with acquisition costs in the first part of the year, losses being paid over the summer months, and the related premium not collected until after the fall harvest. Cash flows from the crop programs are similar in nature to cash flows in the farming business.
Changes in Financial Condition
Four events occurring during 1993 strengthened the financial condition of the Company at December 31, 1993 as compared to the Company's position at December 31, 1992. These events were the completion of the Company's Equity Rights Offering, the conversion of certain subordinated notes to equity, the merger of the Company with Redland and the Company's profitable operating results for 1993.
As described earlier, the Company completed a $31.9 million Common Stock Rights Offering in January, 1993. The net proceeds of approximately $31.2 million were used to retire $9.5 million of secured subordinated notes plus accrued interest thereon and increased the insurance subsidiaries capital by $12.5 million with the balance retained as working capital.
In April, 1993, the Company retired $7 million of secured subordinated notes outstanding in exchange for 875,000 shares of Common Stock and 875,000 Warrants identical to those issued in the Equity Rights Offering.
In August, 1993, the Company completed an Exchange Agreement whereby the holders of 100% of the outstanding Redland Class B Preferred Stock, Warrants to purchase Redland Common Stock and 100% of the outstanding Redland Common Stock were validly tendered in exchange for shares of the Company's Common Stock. The Company's acquisition of Redland resulted in an increase of approximately $112 million in total assets and $96 million in total liabilities at December 31, 1993. The most significant increases in the components comprising total assets were $11 million of investments, $21 million of receivables, $54 million of reinsurance recoverable on unpaid loss and loss adjustment expenses, $5 million of prepaid reinsurance premiums and $14 million of excess of cost over acquired net assets. The most significant increase in components comprising total liabilities were $66 million of loss and loss adjustment expenses, $14 million of unearned premiums, $6 million of accounts payable on accrued liabilities and $7 million of bank borrowings.
In addition, during 1993, Company operating profit of $10.6 million and net income of $7.6 million also improved the Company's financial condition, with stockholders equity increasing 177% from $34.5 million at December 31, 1992 to $95.7 million at December 31, 1993.
These four factors combined to effect the size of the Company's investment portfolio, with investments increasing by 51.2% at December 31, 1993 as compared to the same date in 1992. Within the portfolio, the Company also restructured the distribution of its investments in order to more accurately reflect the characteristics of its operating businesses as well as to provide added flexibility to respond to changes in the Company's tax position, business mix and the interest rate environment for fixed income securities. Accordingly, the Company changed its investment policy to emphasize securities categorized as available for sale, with this category accounting for 64.9% of its securities at December 31, 1993 as compared to 32.1% of its securities at December 31, 1992. The enlargement of this category of securities will provide more flexibility for the Company to respond to the changing interest rate environment as well as to allow its portfolio to more accurately reflect the characteristics of its changing business mix. In addition, short term investments increased 153.4% from 1993 to 1992. This was principally due to the nature of the portfolio which was added from Redland. Redland's principal business operations require near term payment of most of its losses, and therefore, require a greater amount of securities kept in short term investments. In addition, the more adequate capitalization provided by the aforementioned events allowed the Company to expand its equity portfolio 323.6% from December 31, 1992 as compared to December 31, 1993. The Company believes that the increased volatility and risk of this increased equity portfolio was reasonable considering the improvement in its capital position and will allow the Company to enhance the overall yield of its investment portfolio over time.
As of December 31, 1993 and 1992, the Company held an approximate 33% equity investment in Major Realty, a publicly traded real estate company engaged in the ownership and development of its undeveloped land in Orlando, Florida. At December 31, 1993, the carrying value of the Company's investment in Major Realty approximated $5.4 million or $2.36 per share. Additionally at that date, Major Realty had stockholders equity of approximately $14,000 and the quoted market price of Major Realty on NASDAQ was $1.69 per share. The Company expects to realize a minimum of its carrying value in Major Realty based on the estimated net realizable value of Major Realty's underlying assets. The Company's estimate of net realizable value is based upon several factors including estimates from Major Realty's management, assets, appraisals and sales to date of Major Realty's assets. During 1993 and the first quarter of 1994, Major Realty sold five parcels of land amounting to 297.83 acres of land with gross sale proceeds of approximately $58.5 million. All of these sales and proceeds supported the Company's estimate of net realizable value of its investment in Major Realty.
Consolidated Cash Flows
The Company's net cash provided by operating activities increased from a negative $.7 million during 1992 to a positive $24.6 million for the year ended December 31, 1993. The Company's improved operating cash flow for the 1993 year resulted primarily from the insurance subsidiaries retaining more of their direct premium while ceding less to reinsurers. Cash flows from investing activities were effected by the investment of the proceeds from the Company's Rights Offering in January, 1993, an emphasis on purchasing securities categorized as available for sale, and faster than expected prepayments of certain of the Company's mortgage backed securities. Cash flows from financing activities were impacted by the Equity Rights Offering completed in January, 1993 including the retirement of $9.5 million of term notes from the proceeds of such Offering.
Inflation
The Company does not believe that inflation has had a material impact on its financial condition or the results of operations.
Impact of Recently Adopted Accounting Standards
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes", effective January 1, 1993. The prospective application of SFAS No. 109 resulted in no effect upon net income for the year ended December 31, 1993. SFAS No. 109 requires that the Company recognize a deferred tax asset for all temporary differences and net operating loss carryforwards and a related valuation allowance account when realization of the asset is uncertain. The Company's deferred tax asset at December 31, 1993 is $16.3 million which is offset by the valuation allowance of $16.3 million.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts", effective January 1, 1993. The effect of the application of SFAS No. 113 resulted in the reclassification of amounts ceded to reinsurers previously reported as a reduction in unearned premium and unpaid losses and loss adjustment expenses, to assets on the consolidated balance sheet. The application included a restatement of amounts as of December 31, 1992.
In April, 1993, the Financial Accounting Standards Board approved for issuance Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The standard will be adopted effective January 1, 1994. The effect of adoption of this pronouncement will be that securities designated as available for sale will be reported at market value with unrealized gains and losses reported as a separate component of stockholders' equity which is not expected to be significant.
ITEM 8. | 74783 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Incorporated herein by reference for the years 1989 through 1993 are the applicable portions of the section captioned "Summary of Selected Financial Data" of the 1993 Annual Report.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated herein by reference is management's discussion and analysis of financial condition and results of operations for the years 1993, 1992, and 1991 found under the section captioned "Financial Review" of the 1993 Annual Report.
ITEM 8. | 1800 | 1993 |
Item 6. Selected Financial Data:
"Five-Year Review of Operations" on page 15 of the 1993 Weis Markets, Inc. Annual Report to Shareholders is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations:
"Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 6 of the 1993 Weis Markets, Inc. Annual Report to Shareholders is incorporated herein by reference.
Item 8. | 105418 | 1993 |
Item 6. Selected Financial Data
The selected consolidated financial data should be read in conjunction with the Company's consolidated financial statements at December 31, 1993 and for the year then ended and with Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following should be read in conjunction with the consolidated financial statements included in Item 8. | 711513 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
HONEYWELL INC. AND SUBSIDIARIES (DOLLARS AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)
(DOLLARS AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OPERATIONS
SALES
Honeywell's 1993 sales were $5.963 billion, compared with $6.223 billion in 1992 and $6.193 billion in 1991. Both U.S. and international sales declined from 1992. U.S. sales of $3.895 billion were down 3 percent primarily due to a continuing cyclical downturn in the Space and Aviation Control commercial aviation market. International sales, which represent 35 percent of total sales, declined 6 percent from 1992 to $2.068 billion. The international sales decline was the result of negative currency effects as the dollar strengthened an average of 9 percent against local currencies in countries where Honeywell does business. This decline was partially offset by positive sales growth of 4 percent measured in local currency. U.S. export sales, including exports to foreign affiliates, were $769 million in 1993, compared with $830 million in 1992 and $808 million in 1991.
COST OF SALES
Cost of sales was $4.020 billion in 1993, or 67.4 percent of sales, compared with $4.195 billion (67.4 percent) in 1992 and $4.185 billion (67.6 percent) in 1991. Cost as a percentage of sales remained flat for 1993 during a period of tough competitive markets and stagnation for a majority of economic sectors. Honeywell remains committed to efforts to reduce operating costs and improve margins.
RESEARCH AND DEVELOPMENT
Honeywell spent $337 million, or 5.7 percent of sales, on research and development in 1993, compared with $313 million (5.0 percent) in 1992 and $301 million (4.9 percent) in 1991. Honeywell also received $405 million in funds for customer-funded research and development in 1993, compared with $390 million in 1992 and $373 million in 1991. The higher R&D percentage in 1993 reflects significant investments in next-generation technologies. The company expects to return to approximately the same rate of R&D spending in 1994 as in 1992.
OTHER EXPENSES AND INCOME
Selling, general and administrative expenses were $1.076 billion in 1993, or 18.0 percent of sales, compared with $1.197 billion (19.2 percent) in 1992 and $1.151 billion (18.6 percent) in 1991. Excluding royalties from autofocus licensing agreements (see Note 3 to Financial Statements on page 25), the percent of sales would have been 18.6 percent and 19.5 percent in 1993 and 1992, respectively. The higher percentage in 1992 was due to increased international selling expenses.
On April 16, 1993, Honeywell announced the settlement of its lawsuits against the Unisys Corporation and other parties in connection with Honeywell's 1986 purchase of the Sperry Aerospace Group. Honeywell received $70 million in cash and notes, and recorded a gain of $22 million, or $14 million ($0.10 per share) after income taxes, to offset previously incurred costs associated with the matter (see Note 3 to Financial Statements on page 25).
In April 1987, Honeywell filed suit against Minolta Camera Co. alleging that Minolta autofocus cameras infringe Honeywell patents. Subsequently, Honeywell filed similar suits against other major camera manufacturers that employ autofocus technology. In March 1992, following a jury award in Honeywell's favor, Minolta agreed to pay Honeywell $127 million in settlement of the damages and Honeywell's claims for interest and legal fees. In addition to the Minolta settlement, agreements were reached with various camera manufacturers for their use of Honeywell's patented automatic focus camera technology. The total of all autofocus settlements recorded, after associated expenses, was $10 million, or $6 million ($0.05 per share) after income taxes, in 1993 and $288 million, or $171 million ($1.24 per share) after income taxes, in 1992. The pre-tax gains from litigation settlements are included in litigation settlements and special charges on the income statement.
Also included in litigation settlements and special charges are provisions for special charges of $51 million, or $29 million ($0.22 per share) after income taxes, in 1993 and $128 million, or $85 million ($0.62 per share) after income taxes, in 1992. The 1993 charges were the result of implementing programs to improve productivity and reduce costs in each of Honeywell's business segments. Charges in 1992 were made to appropriately size the Space and Aviation Control business segment to current market conditions and to reposition the Home and Building Control and Industrial Control business segments to capitalize on emerging market opportunities. The special charges include provisions for work-force reductions, worldwide facilities consolidation and organizational changes in both 1993 and 1992.
Net interest expense was $51 million in 1993, $59 million in 1992 and $61 million in 1991. In 1992, Honeywell reduced total debt by $108 million, including redemption of high-coupon, long-term debt.
Earnings of companies owned 20 percent to 50 percent (primarily Yamatake-Honeywell), which are accounted for using the equity method, were $18 million in 1993, $16 million in 1992 and $15 million in 1991.
INCOME TAXES
The provision for income taxes was $156 million in 1993, compared with $235 million in 1992 and $178 million in 1991. The enactment by Congress of the Omnibus Budget Reconciliation Act of 1993, which raised the U.S. federal statutory income tax rate for corporations from 34 percent to 35 percent retroactive to January 1, 1993, did not have a material impact on the 1993 provision but did result in the recognition of a one-time gain of $9 million ($0.07 per share) in 1993 from the revaluation of deferred tax assets. Further information about income taxes is provided in Note 4 to Financial Statements on page 25.
EXTRAORDINARY ITEM
In 1992, Honeywell recorded an extraordinary loss of $14 million, or $9 million ($0.06 per share) after income taxes, as a result of early debt redemptions that required the payment of premiums and the recognition of unamortized discounts and deferred costs. These redemptions were undertaken as part of Honeywell's efforts to reduce its debt and manage its interest-rate exposure.
ACCOUNTING CHANGES
In 1992, Honeywell adopted three new Statements of Financial Accounting Standards. Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions," required recognition of the expected cost of providing postretirement benefits over the time employees earn these benefits. Before adopting SFAS 106, Honeywell recognized the costs of providing these benefits on a pay-as-you-go basis by expensing the cost in the year the benefit was provided. The cumulative effect of adopting SFAS 106 at January 1, 1992, was a charge to income of $244 million, or $151 million ($1.09 per share) after income taxes. The operating impact of adopting SFAS 106 for 1992 was additional expense of $16 million, or $11 million ($0.08 per share) after income taxes.
Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes," allowed consideration of future events in assessing the likelihood that tax benefits will be realized in future tax returns. The cumulative effect of adopting SFAS 109 at January 1, 1992, was an increase in income of $31 million ($0.23 per share) resulting from Honeywell's ability to recognize additional deferred tax assets.
Statement of Financial Accounting Standards No. 112 (SFAS 112), "Employers' Accounting for Postemployment Benefits," required that the estimated cost of providing postemployment benefits be recognized on an accrual basis. The cumulative effect of adopting SFAS 112 at January 1, 1992, was a charge to income of $40 million, or $25 million ($0.18 per share) after income taxes. The operating impact of adopting SFAS 112 for 1992 was additional expense of $4 million, or $2 million ($0.02 per share) after income taxes.
NET INCOME
Honeywell's net income was $322 million ($2.40 per share) in 1993, compared with $247 million ($1.78 per share) in 1992 and $331 million ($2.35 per share) in 1991. Net income in 1993 includes an after-tax gain from litigation settlements, after associated expenses, of $20 million ($0.15 per share); an after-tax provision for special charges of $29 million ($0.22 per share); and a gain of $9 million ($0.07 per share) from the revaluation of deferred tax assets. Net income in 1992 includes an after-tax gain from litigation settlements, after associated expenses, of $171 million ($1.24 per share); an after-tax provision for special charges of $85 million ($0.62 per share); an extraordinary loss after income taxes of $9 million ($0.06 per share) from the early redemption of long-term debt; and an after-tax reduction of $145 million ($1.04 per share) for the cumulative effect of accounting changes. Net income in 1992 also included the operating impact of SFAS 106 and SFAS 112, or an after-tax expense of $13 million ($0.10 per share).
RETURN ON EQUITY AND INVESTMENT
Return on equity was 18.4 percent in 1993, 13.8 percent in 1992 and 19.2 percent in 1991. Return on investment was 14.6 percent in 1993, 11.8 percent in 1992 and 15.4 percent in 1991. The adoption of SFAS 106 and SFAS 112 significantly reduced ROE and ROI in 1992.
CURRENCY
The U.S. dollar strengthened an average of 9 percent in 1993 compared with 1992 in relation to the principal foreign currencies in countries where Honeywell products are sold. A stronger dollar has a negative effect on international results because foreign-exchange-denominated profits translate into fewer U.S. dollars of profit; a weaker dollar has a positive translation effect.
INFLATION
Highly competitive market conditions and a relatively stagnant economy minimized inflation's impact on the selling prices of Honeywell's products and the cost of its purchased materials. Productivity improvements and cost-reduction programs largely offset the effects of inflation on other costs and expenses.
EMPLOYMENT
Honeywell employed 52,300 people worldwide at year-end 1993, compared with 55,400 people in 1992 and 58,200 people in 1991. Approximately 33,200 employees work in the United States, with 19,100 employed outside the country, primarily in Europe. Total compensation and benefits in 1993 were $2.7 billion, or 49 percent of total costs and expenses. Sales per employee were $110,900 in 1993, compared with $109,600 in 1992 and $106,100 in 1991.
ENVIRONMENTAL MATTERS
Honeywell is committed to protecting the environment, a commitment evidenced by both Honeywell's products and Honeywell's manufacturing operations. Honeywell's manufacturing sites generate both hazardous and nonhazardous wastes, the treatment, storage, transportation and disposal of which are subject to various local, state and national laws relating to protection of the environment. Honeywell is in varying stages of investigation or remediation of potential, alleged or acknowledged contamination at current or previously owned or operated sites and at off-site locations where its wastes were taken for treatment or disposal. In connection with the cleanup of various off-site locations, Honeywell, along with a large number of other entities, has been designated a potentially responsible party (PRP) by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act or by state agencies under similar state laws (Superfund), which potentially subjects PRPs to joint and several liability for the costs of such cleanup. In addition, Honeywell is incurring costs relating to environmental remediation pursuant to the federal Resource Conservation and Recovery Act. Based on Honeywell's assessment of the costs associated with its environmental responsibilities, compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and in the opinion of Honeywell management, will not have a material
effect on Honeywell's financial position, results of operations, capital expenditures or competitive position. Honeywell's opinion with regard to Superfund matters is based on its assessment of the predicted investigation, remediation and associated costs, its expected share of those costs and the availability of legal defenses. Honeywell's policy is to record environmental liabilities when loss amounts are probable and reasonably estimable.
DISCUSSION AND ANALYSIS BY SEGMENT
HOME AND BUILDING CONTROL
Sales in Home and Building Control were $2.424 billion in 1993, compared with $2.394 billion in 1992 and $2.249 billion in 1991. Sales in 1993 were up slightly as stronger U.S. sales were mostly offset by a stronger U.S. dollar and economic weakness in international markets, driven in large part by the continuing recession in Europe. Home Control gained market share in the United States through new product introductions and greater penetration of the OEM market. TotalHome-R- was introduced outside the United States in 1993. The acquisition of Enviracaire in December 1992 also contributed to the improvement in U.S. sales. Building Control experienced strong U.S. interest in its comprehensive retrofit and service solutions for schools and other institutions. The U.S. economy continues to show signs of improvement in these markets, while international market conditions have continued to deteriorate. Economic conditions may continue to impede new construction markets in 1994; however, Home and Building Control's large worldwide installed product base and market strategies should continue to support continued sales growth, given that retrofit and service revenues account for the largest portion of business.
The sales increase in 1992 reflected worldwide improvement for both Home Control and Building Control despite weak commercial construction markets and erratic housing markets. Home Control experienced increased market penetration with original equipment manufacturers and retailers, and achieved growth with new product introductions. Building Control made market share gains in small-and medium-sized commercial buildings, and there was solid growth in vertical markets such as schools and health-care facilities in the United States.
Home and Building Control operating profit was $233 million in 1993, compared with $193 million in 1992 and $229 million in 1991. Excluding the impact of special charges, operating profit increased slightly in 1993 despite the deepening European recession, a stronger U.S. dollar, unfavorable intra-European currency fluctuations, additional costs associated with streamlining the U.S. field organization, and costs associated with introducing the new EXCEL 5000TM building automation platform in the United States. Operating profit included special charges of $10 million for implementation of programs to improve productivity and competitiveness.
Operating profit in 1992 included special charges of $43 million for costs associated with worldwide facilities consolidation, organizational changes and work-force reductions incurred to capitalize on emerging market opportunities. Excluding these added costs, operating profit increased over 1991, paced by strong performance in Home Control in the United States.
Orders improved modestly in 1993 as stronger orders in the United States for both Home Control and Building Control offset international weakness and a stronger U.S. dollar. The backlog of orders showed a slight increase for 1993.
INDUSTRIAL CONTROL
Industrial Control sales were $1.692 billion in 1993, compared with $1.744 billion in 1992 and $1.627 billion in 1991. Sales declined slightly in 1993 due to negative currency translation trends and the divestiture of the Keyboard Division, which was sold to Key Tronic Corporation in the third quarter of 1993. Excluding these items, both Industrial Automation and Control and Control Components grew at moderate rates despite weak market conditions in the United States, Europe and Latin America. Industrial Automation and Control reported solid penetration gains in targeted worldwide markets despite a weak capital spending environment in the United States and Europe. Demand for
industrial systems increased in the Middle East and Asia Pacific. Sales of field instruments showed a strong increase due to broad acceptance of Industrial Automation and Control's smart field products. Control Components experienced significant growth in solid state sensors for on-board automotive and information technology and appliance market segments as demand for durable goods improved. The company expects a slight increase in 1994 Industrial Control sales despite a slow economic environment worldwide.
Industrial Control sales for 1992 increased moderately, despite the deferral of industrial automation systems purchases in the United States due to the inherent uncertainty of the economy and worldwide weakness in durable goods markets. There was modest growth in Industrial Automation and Control sales in the United States as increased sales of services and measurement and control products offset weakness in automation systems. Control Component sales increased moderately in 1992, benefiting from the trend by equipment manufacturers to increase sensor utilization for quality and productivity improvements.
Industrial Control operating profit was $190 million in 1993, $157 million in 1992 and $224 million in 1991. Excluding the impact of special charges, operating profit showed a slight increase in 1993. Profits were affected by the weak capital spending environment in the United States and Europe, strength of the U.S. dollar and aggressive investments in new technologies, with R&D spending up 26 percent over 1992. Operating profit included special charges of $9 million for implementation of programs to improve productivity and competitiveness.
Operating profit in 1992 included special charges of $39 million for costs associated with worldwide facilities consolidation, organizational changes and work-force reductions to capitalize on emerging market opportunities. Before special charges, operating profit was down in 1992 as a result of lower profit margins reflecting a changing product mix in Industrial Automation and Control.
In 1993, Industrial Control orders declined slightly, due to negative currency translation trends. Excluding this effect, Industrial Automation and Control orders increased modestly as a result of solid showings in Asia Pacific and Latin America. Control Components orders declined slightly due to the divestiture of the Keyboard Division. Micro Switch orders were strong in North America and Asia Pacific. The backlog of orders was down modestly for the year.
SPACE AND AVIATION CONTROL
Sales in Space and Aviation Control were $1.675 billion in 1993, compared with $1.933 billion in 1992 and $2.132 billion in 1991. Sales in 1993 continued to decline as anticipated as a result of the continuing cyclical decline in commercial aircraft production, weak demand in the business jet market and decreased spending in the military market. We expect these trends to continue in 1994.
Anticipated growth in 1992 did not materialize, and 1992 sales for commercial flight systems declined sharply as financial pressures caused airlines to defer, and in some instances cancel, aircraft and spare parts purchases. As expected, military markets were weak as a result of declining defense spending and flat NASA funding.
Space and Aviation Control operating profit was $148 million in 1993, compared with $176 million in 1992 and $226 million in 1991. Operating profit declined in 1993 due to the sharp volume decline in sales of commercial flight systems and significant investments in next-generation avionics. Operating profit included special charges of $7 million for implementation of programs to improve productivity and competitiveness. Because of continued weak market conditions, revenue and operating profit are expected to decline again in 1994.
Operating profit in 1992 included special charges of $35 million for costs associated with facilities consolidation, organizational changes and severance pay incurred to appropriately size operations to current and anticipated market conditions. Excluding these special charges, operating profit was down moderately in 1992 as a sharp volume decline in the commercial aviation business was partially offset by an improved cost structure and a favorable sales mix in military avionics.
Space and Aviation orders were down in 1993 as commercial flight systems and military avionics showed sharp declines. Space systems orders increased moderately. The backlog of orders declined sharply from 1992 levels.
OTHER
Sales from other operations were $172 million in 1993, $152 million in 1992 and $185 million in 1991. These sales included the activities of various business units, such as the Solid State Electronics Center and the Systems and Research Center, which do not correspond with Honeywell's primary business segments. These operations incurred operating losses of $2 million in 1993, $9 million in 1992 and $3 million in 1991. The 1993 loss included special charges of $16 million for organizational changes and work-force reductions. The 1992 loss included special charges of $3 million that were also associated with organizational changes and work-force reductions.
FINANCIAL POSITION
FINANCIAL CONDITION
At year-end 1993, Honeywell's capital structure comprised $188 million of short-term debt, $504 million of long-term debt and $1.773 billion of stockholders' equity. The ratio of debt to total capital was 28 percent and remained unchanged from year-end 1992. Honeywell's debt-to-total capital policy range is 30 to 40 percent. Honeywell managed its capital structure during 1993 at or below the low end of this range.
Total debt decreased $9 million during 1993 to $692 million. Stockholders' equity decreased $17 million in 1993. Contributing to the decrease was a $209 million increase in treasury stock. Other changes in stockholders' equity included an increase in retained earnings of $322 million from net income, offset by dividends of $122 million; a $3 million decrease in the accumulated foreign currency translation; and a $13 million decrease from the recognition of a pension liability adjustment under Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions," (see Note 16 to Financial Statements on page 33).
Several events and trends that affected Honeywell's financial position are discussed below.
CASH GENERATION
In 1993, $475 million of cash was generated from operating activities, compared with $532 million in 1992 and $489 million in 1991. Included in 1992 operating cash flow was $194 million, net of expenses and taxes, from autofocus settlements. In 1993, cash generated from investing and financing activities included $47 million of proceeds from the sale of assets, $20 million from a reduction of investment in Sperry Aerospace Group and $18 million of proceeds from employee stock plans. These funds were primarily used to support $232 million of capital expenditures, $14 million of acquisitions, $122 million of dividend payments, $241 million of share repurchases and $7 million of long-term debt repayments. Cash balances decreased $100 million in 1993.
WORKING CAPITAL
Cash used for increases in the portion of working capital consisting of trade and long-term receivables and inventories, offset by accounts payable and customer advances, was $2 million in 1993. This portion of working capital as a percentage of sales was 28 percent, compared with 26 percent in 1992. Trade receivables sold at year-end 1993 were $38 million, an increase of $22 million in 1993.
CAPITAL EXPENDITURES AND ACQUISITIONS
Capital expenditures for property, plant and equipment in 1993 were $232 million, compared with $244 million in 1992 and $240 million in 1991. The 1993 depreciation charges were $235 million. Honeywell continues to invest at levels believed to be adequate to maintain its technological position in areas providing long-term returns. During 1993, Honeywell invested $14 million in complementary business acquisitions.
SHARE REPURCHASE PLANS
In November 1990, the board of directors authorized a 4 million share repurchase program. This program was completed in 1991. In November 1991, the board of directors authorized a five-year program to purchase up to $600 million of Honeywell shares. Under terms of this authorization, which expires December 31, 1996, the program may be altered depending on economic conditions, share prices and cash-flow availability. Honeywell repurchased $3 million of shares in 1991, $189 million of shares in 1992 and $240 million of shares in 1993, and has $168 million remaining under this authorization.
At year-end 1993, Honeywell had 188 million shares issued, 132 million shares outstanding and 33,382 stockholders of record. At year-end 1992, Honeywell had 188 million shares issued, 137 million shares outstanding and 34,571 stockholders of record.
DIVIDENDS
In November 1992, the board of directors approved an 8 percent increase in the regular annual dividend to $0.89 per share, from $0.825 per share, effective in the fourth quarter 1992. In November 1993, the board of directors approved an additional 8 percent increase in the regular annual dividend to $0.96 per share effective in the fourth quarter 1993. Honeywell paid $0.9075 per share in dividends in 1993, compared with $0.84125 in 1992 and $0.76875 in 1991. Honeywell has paid a quarterly dividend since 1932 and has increased the annual payout per share in each of the last 18 years.
EMPLOYEE STOCK PROGRAM
Honeywell contributed 643,913 shares of Honeywell common stock to employees under its U.S. employee stock match savings plans in 1993. The number of shares contributed under this program depends on employee savings levels and company performance.
PENSION CONTRIBUTIONS
Cash contributions to Honeywell's Retirement Plan for U.S. non-union employees were $105 million in 1993, $79 million in 1992 and $61 million in 1991. Cash contributions to the Pension Plan for U.S. union employees were $36 million in 1993, $27 million in 1992 and $27 million in 1991.
TAXES
In 1993, taxes paid were $92 million. Accrued income taxes and related interest decreased $18 million during 1993.
FUNDING SPECIAL CHARGES
During 1993 and 1992, the company established reserves for productivity initiatives to strengthen the company's competitiveness. Future cash flows from operating activities are expected to be sufficient to fund these accrued costs.
LIQUIDITY
Short-term debt at year-end 1993 was $188 million, consisting of $181 million of commercial paper and $7 million of notes payable and current maturities of long-term debt. Short-term debt at year-end 1992 totaled $188 million, consisting of $182 million of notes payable and commercial paper and $6 million of current maturities of long-term debt.
Through its banks, Honeywell has access to various credit facilities, including committed credit lines for which Honeywell pays commitment fees and uncommitted lines provided by banks on a non-committed, best-efforts basis. Available lines of credit at year-end 1993 totaled $2.272 billion. This consists of $1.875 billion of committed credit lines to meet Honeywell's financing requirements, including support of commercial paper and bank note borrowings and an appeal bond which could be required in the Litton litigation as described in Litigation below, and $397 million of uncommitted credit lines available to certain foreign subsidiaries. This compared with $1.002 billion of available credit lines at year-end 1992, consisting of $645 million of committed credit lines and $357 million of
uncommitted credit lines available to certain foreign subsidiaries. Cash and short-term investments totaled $256 million at year-end 1993 and $346 million at year-end 1992. Honeywell believes its available cash and committed credit lines provide adequate liquidity.
LITIGATION
On August 31, 1993, a federal court jury in U.S. District Court in Los Angeles returned a verdict against Honeywell on patent infringement and intentional interference claims in the amount of $1.2 billion. These claims were part of a lawsuit brought by Litton Systems Inc. alleging, among other things, Honeywell patent infringement relating to the process used by Honeywell to coat mirrors incorporated in its ring laser gyroscopes. Honeywell believes the verdict is unsupported by the facts; that the Litton patent is invalid; and that Honeywell's process differs from Litton's. The judge in the case held a hearing November 22, 1993, on various issues including, among others, Honeywell's claims that the patent was improperly obtained due to alleged "inequitable conduct" on the part of Litton and Honeywell's other legal and equitable defenses. The court has yet to enter a judgment. The trial will conclude when the court has resolved legal issues that could alter or eliminate the jury verdict. Honeywell will evaluate the outcome of the trial, including appealing any significant judgment against the company. No trial date has been set for the antitrust claims of Litton and Honeywell.
The court has yet to rule on significant, complex and interrelated issues that could alter or eliminate the jury verdict; therefore, Honeywell and its counsel have determined that it is not possible to estimate the amount of damages, if any, that may ultimately be incurred. As a result, no provision has been made in the financial statements with respect to this contingent liability. Honeywell continues to believe the lawsuit is without merit, and its financial position, liquidity and business strategies have not been adversely affected by the jury verdict.
CREDIT RATINGS
Honeywell's credit ratings remained unchanged during 1993. Ratings for long-term and short-term debt are, respectively, A/A-1 by Standard and Poor's Corporation, A/Duff1 by Duff and Phelps Corporation and A3/P-2 by Moody's Investor Service, Inc. On August 31, 1993, Moody's Investor Service, Inc. placed Honeywell on credit watch status as a result of the jury verdict in the Litton litigation. Any lowering of Honeywell's present credit ratings could lead to higher interest costs by potentially reducing Honeywell's ability to access the commercial paper market and other unsecured borrowing sources on terms as favorable as those currently available.
STOCK PERFORMANCE
The market price of Honeywell stock ranged from $39 3/8 to $31 in 1993, and was $34 1/4 at year end. Book value at year end was $13.48 in 1993 and $13.10 in 1992.
ITEM 8. | 48305 | 1993 |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
On June 9, 1983, the Partnership commenced an offering of $260,000,000 of Limited Partnership Interests pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. On October 7, 1983, the Partnership registered an additional $140,000,000 of Limited Partnership Interests. A total of 366,177.57 Interests were sold to the public at $1,000 per interest (fractional interests are due to the Distribution Reinvestment Program) between June 9, 1983 and May 22, 1984 pursuant to a public offering.
After deducting selling expenses and other offering costs, the Partner- ship had approximately $326,000,000 with which to make investments in income-producing commercial and residential real property, to pay legal fees and other costs (including acquisition fees) related to such investments and to satisfy working capital requirements. A portion of the proceeds was utilized to acquire the properties described in Item 1 above.
At December 31, 1993, the Partnership and its consolidated ventures had cash and cash equivalents of approximately $5,362,000. Such funds and short- term investments of approximately $23,096,000 are available for distributions to partners, leasing and capital improvement costs and/or operating deficits at Long Beach Plaza and the Plaza Tower Office Building, and for the paydown of the mortgage obligation at the Marshall's Aurora Plaza and for working capital requirements and potential future operating deficits and significant leasing and tenant improvement costs at certain of the Partnership's other investment properties. The Partnership and its consolidated ventures have currently budgeted in 1994 approximately $7,203,000 for tenant improvements and other capital expenditures. The Partnership's share of such items and its share of such similar items for its unconsolidated ventures in 1994 is currently budgeted to be $5,697,000. Actual amounts expended may vary depending on a number of factors including actual leasing activity, results of property operations, liquidity considerations and other market conditions over the course of the year. The source of capital for such items and for both short-term and long-term future liquidity and distributions is expected to be through the net cash generated by the Partnership's investment properties and through the sale or refinancing of such investments. The Partnership's and its ventures' mortgage obligations are generally non-recourse and therefore the Partnership and its ventures generally are not personally obligated to pay such mortgage indebtedness.
Many of the Partnership's investment properties currently operate in overbuilt markets which are characterized by lower than normal occupancies and/or reduced rent levels. Such competitive conditions have resulted in the operating deficits described below. Based upon estimated operations of certain of the Partnership's investment properties and on the anticipated requirements of the Partnership to fund its share of potential leasing and capital improvement costs at these properties, the Partnership reduced operating cash distributions to the Limited and General Partners effective as of the third quarter of 1991 and subsequently suspended all distributions effective as of the first quarter of 1992.
As described more fully in Note 4, the Partnership has received or is negotiating mortgage note modifications (certain of which have expired and others of which expire at various dates commencing October 1996) on the Sherry Lane Place office building, Glades Apartments, Eastridge Apartments, Long Beach Plaza, Carrollwood Apartments, Marshall's Aurora Plaza and Copley Place multi-use complex. The Partnership had been unsuccessful in its efforts to obtain modifications of the loans secured by the 1001 Fourth Avenue office building, University Park office building and the Gables Corporate Plaza, as further discussed below and in Note 4. The Partnership has not remitted the required debt service payments pursuant to the loan agreements on the Gables Corporate Plaza, Long Beach Plaza, and University Park office building as discussed below. Therefore, at December 31, 1993, the corresponding balances of their respective mortgage notes and related deferred accrued interest thereon have been classified as current liabilities in the accompanying Consolidated Financial Statements (see Note 4(a)). In March 1993, the Partnership sold its interest in the Rio Cancion Apartments and the related mortgage loan was discharged out of the sales proceeds (reference is made to Notes (4)(b)(3) and 7(e)). In April 1993, the Partnership sold its interest in the Greenwood Creek II Apartments and the related mortgage loan was discharged by the lender (reference is made to Note (4)(b)(8) and Note 7(f)). In August 1993, Orchard Associates sold its interest in the Old Orchard shopping center (reference is made to Note 3(d)). In November 1993, the Partnership transferred title to the 1001 Fourth Avenue office Building to the lender and the related mortgage loan was discharged by the lender (reference is made to note 4(b)(4)). In January 1994, the Partnership transferred title to the University Park Office Building to the lender and the related mortgage loan was discharged by the lender (reference is made to note 11(b)). In January 1994, the Partnership through Gables Corporate Plaza Associates transferred title to the Gables Corporate Plaza Office Building to the lender and the related mortgage loan was discharged by the lender (reference is made to note 11(a)). For those investment properties where modifications are being sought, or with expired modifications or short-term modifications, if the Partnership is unable to secure new or additional modifications to the loans, based upon current and anticipated market conditions, the Partnership may decide not to commit any significant additional amounts to any of the properties which are incurring, or in the future do incur, operating deficits.
This would result in the Partnership no longer having an ownership interest in such property and would result in gain for financial reporting and Federal income tax purposes to the Partnership with no corresponding distributable proceeds. Such decisions would be made on a property-by-property basis.
The underlying indebtedness on certain other of the Partnership's investment properties matures and is due and payable commencing in 1994 and subsequent years (reference is made to Note 4 and to Note 3 of Notes to the Combined Financial Statements). The source of repayment is expected to be from proceeds from sale or refinancing, or extension of such indebtedness. However, there can be no assurance that any such sales, refinancings or extensions will occur.
Copley Place
Although occupancy at the property increased due to recent leasing activity, the Boston office market remains very competitive due to the large supply of available space and to the prevalence of concessions being offered to attract and retain tenants.
Commencing January 1, 1992, cash deficits and funding requirements are allocated equally between the Partnership and the joint venture partner. The joint venture has obtained a modification of the existing first mortgage note effective March 1, 1992. The modification lowered the pay rate from 12% to 9% per annum through August 1993, and at that time, further reduced it to 7-1/2% per annum through August 1998. The contract rate has been lowered to 10% per annum through August 1993 and at that time further reduced to 8-1/2% per annum through August 1998. After each monthly payment, the difference between the contract interest rate on the outstanding principal balance of the loan, including deferred interest, and interest paid at the applicable pay rate (as defined) will be added to the principal balance and will accrue interest at the contract interest rate. The outstanding principal balance, including the unpaid deferred interest, is due and payable on August 31, 1998. In return, the lender will be entitled to receive, as additional interest, a minority residual participation of 10% of net proceeds (as defined) from a sale or refinancing after the Partnership and its joint venture partner have recovered their investments (as defined). Any cash flow from the property, after all capital and leasing expenditures, will be escrowed for the purpose of paying for future capital and leasing requirements. As a result of the debt modification, the property produced cash flow in 1993, which has been escrowed for future potential leasing requirements as set forth in the current loan modification.
In 1994, the property is expected to experience a significant loss in rental income in connection with the expiration of the IBM lease (245,339 square feet in April 1994 and 34,093 square feet in October 1994) representing 23% of the leasable office space in the aggregate. Although the structure of the modification of the first mortgage loan took into account the potential downsizing of IBM, it was originally anticipated that IBM would renew approximately 80,000 square feet. However, IBM has notified the joint venture that it intends to renew only 10,000 square feet. Therefore, the property's operations will be insufficient to pay the modified debt service. The joint venture has initiated discussions with the first mortgage lender regarding an additional modification of the loan. There can be no assurances such remodification will be consummated. If the joint venture is unable to secure such remodification, the joint venture may decide not to commit any significant additional amounts to the property. This could result in the joint venture no longer having an ownership interest in the property and would result in a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds. The joint venture is aggressively marketing IBM's upcoming vacant space. In addition, the manager, an affiliate of the General Partners, has agreed to defer certain management fees.
Orchard Associates
On September 2, 1993, effective August 30, 1993, Orchard Associates (in which the Partnership and an affiliated partnership sponsored by the Corporate General Partner each have a 50% interest) sold its interest in the Old Orchard shopping center (reference is made to Note 3(d)). The Partnership is currently retaining its share of the net proceeds from the sale for working capital purposes.
JMB/NYC
At the 2 Broadway building, occupancy increased slightly to 30% during the fourth quarter 1993, up from 29% in the previous quarter. The Downtown Manhattan office leasing market remains depressed due to the significant supply of, and the relatively weak demand for, tenant space. As previously reported, Merrill Lynch, Pierce, Fenner & Smith, Incorporated's lease of approximately 497,000 square feet of space (31% of the building's total space) expired in August 1993. A majority of the remaining tenant roster at the property includes several major financial services companies whose leases expire in 1994. Most of these companies maintain back office support operations in the building which can be easily consolidated or moved. The Bear Stearns Co.'s lease of approximately 186,000 square feet of space (12% of the building's total space), which expires in April 1994, is not expected to be renewed. In addition to the competition for tenants in the Downtown Manhattan market from other buildings in the area, there is ever increasing competition from less expensive alternatives to Manhattan, such as locations in New Jersey and Brooklyn, which are also experiencing high vacancy levels. Rental rates in the Downtown market continue to be at depressed levels and this can be expected to continue while the large amount of vacant space is gradually absorbed. Little, if any, new construction is planned for Downtown over the next few years. It is expected that 2 Broadway will continue to be adversely affected by a high vacancy rate and the low effective rental rates achieved upon releasing of space under existing leases which expire over the next few years. In addition, the property is in need of a major renovation in order to compete in the office leasing market. However, there are currently no plans for a renovation because of the potential sale of the property discussed below and because the effective rents that could be obtained under current market conditions may not be sufficient to justify the costs of the renovation.
Occupancy at 1290 Avenue of the Americas increased to 98%, up from 95% in the previous quarter primarily due to Prudential Bache Securities, Inc. occupying 25,158 square feet. The Midtown Manhattan office leasing market remains very competitive. It is expected that the property will continue to be adversely affected by low effective rental rates achieved upon releasing of space covered by existing leases which expire over the next couple years and may be adversely affected by an increased vacancy rate over the next few years. Negotiations are currently being conducted with certain tenants who in the aggregate occupy in excess of 300,000 square feet for the renewal of their leases that expire in 1994 and 1995. John Blair & Co., ("Blair") a major lessee at 1290 Avenue of the Americas (leased space approximates 253,000 square feet or 13% of the building), has filed for Chapter XI bankruptcy. Because much of the Blair space is subleased, the 1290 venture is collecting approximately 70% of the monthly rent due under the leases from the subtenants. There is uncertainty regarding the collection of the balance of the monthly rents from Blair. Accordingly, a provision for doubtful accounts related to the rent and other receivables and accrued rents receivable aggregating $7,659,366 has been recorded at December 31, 1993 in the accompanying combined financial statements related to this tenant.
Occupancy at 237 Park Avenue decreased slightly to 98% in the fourth quarter 1993, down from 99% in the previous quarter. It is expected that the property will be adversely affected by the low effective rental rates achieved upon releasing of existing leases which expire over the next few years and may be adversely affected by an increased vacancy rate over the next few years.
JMB/NYC has had a dispute with the unaffiliated venture partners who are affiliates (hereinafter sometimes referred to as the "Olympia & York affiliates") of Olympia and York Developments, Ltd. (hereinafter sometimes referred to as "O & Y") over the calculation of the effective interest rate with reference to the first mortgage loan, which covers all three properties, for the purpose of determining JMB/NYC's deficit funding obligation commencing in 1992, as described more fully in Note 3(c). Under JMB/NYC's interpretation of the calculation of the effective rate of interest, 2 Broadway operated at a deficit for the year ended December 31, 1993. During the first quarter of 1993, an agreement was reached between JMB/NYC and the Olympia & York affiliates which rescinded the default notices previously received by JMB/NYC and eliminated any alleged operating deficit funding obligation of JMB/NYC for the period January 1, 1992 through June 30, 1993. Accordingly, during this period, JMB/NYC recorded interest expense at 1-3/4% over the short-term U.S. Treasury obligation rate (subject to a minimum rate of 7% per annum), which is the interest rate on the underlying first mortgage loan. Under the terms of this agreement, during this period, the amount of capital contributions that the Olympia & York affiliates and JMB/NYC would have been required to make to the Joint Ventures, as if the first mortgage loan bore interest at a rate of 12.75% per annum (the Olympia & York affiliates' interpretation), became a priority distribution level to the Olympia & York affiliates from the Joint Ventures' annual cash flow or net sale or refinancing proceeds. The agreement also entitles the Olympia & York affiliates to a 7% per annum return on such unpaid priority distribution level amount. It was also agreed that during this period, the excess available operating cash flow after the payment of the priority distribution level discussed above from any of the Three Joint Ventures will be advanced in the form of loans to pay operating deficits and/or unpaid priority distribution level amounts of any of the other Three Joint Ventures. Such loans will bear a market rate of interest, have a final maturity of ten years from the date when made and will be repayable only out of first available annual cash flow or net sale or refinancing proceeds. The agreement also provides that except as specifically agreed otherwise, the parties each reserves all rights and claims with respect to each of the Three Joint Ventures and each of the partners thereof, including, without limitation, the interpretation of or rights under each of the joint venture partnership agreements for the Three Joint Ventures. The agreement expired on June 30, 1993. Therefore, effective July 1, 1993, JMB/NYC is recording interest expense at 1-3/4% over the short-term U.S. Treasury obligation rate plus any excess operating cash flow after capital costs of the Three Joint Ventures, such sum not to be less than 7% nor exceed a 12-3/4% per annum interest rate. The Olympia & York affiliates dispute this calculation and contend that the 12-3/4% per annum fixed rate applies.
JMB/NYC continues to seek, among other things, a restructuring of the joint venture agreements or otherwise to reach an acceptable understanding regarding its long-term funding obligations. If JMB/NYC is unable to achieve this, based upon current and anticipated market conditions mentioned above, JMB/NYC may decide not to commit any additional amounts to 2 Broadway and 1290 Avenue of the Americas, which could, under certain circumstances, result in the loss of the interest in the related ventures. The loss of an interest in a particular venture could, under certain circumstances, permit an acceleration of the maturity of the related Purchase Note (each Purchase Note is secured by JMB/NYC's interest in the related venture). The failure to repay a Purchase Note could, under certain circumstances, constitute a default that would permit an immediate acceleration of the maturity of the Purchase Notes for the other ventures. In such event, JMB/NYC may decide not to repay, or may not have sufficient funds to repay, any of the Purchase Notes and accrued interest thereon. This could result in JMB/NYC no longer having an interest in any of the related ventures, which in that event would result in substantial net gain for financial reporting and Federal income tax purposes to JMB/NYC (and through JMB/NYC and the Partnership, to the Limited Partners) with no distributable proceeds. In addition, under certain circumstances as more fully discussed in Note 3(c), JMB/NYC may be required to make additional capital contributions to certain of the Joint Ventures in order to fund the deficit restoration obligation associated with a deficit balance in its capital account, and the Partnership could be required to bear a share of such capital contributions obligation.
If JMB/NYC is successful in its negotiations to restructure the Three Joint Ventures agreements and retains an interest in one or more of these investment properties, there would nevertheless need to be a significant improvement in current market and property operating conditions (including a major renovation of the 2 Broadway building) resulting in a significant increase in value of the properties before JMB/NYC would receive any share of future net sale or refinancing proceeds. The Joint Ventures that own the 2 Broadway building and land have no plans for a renovation of the property because of the potential sale of the property discussed below and because the effective rents that could be obtained under the current office market conditions may not be sufficient to justify the costs of the renovation. Given the current market and property operating conditions, it is likely that the property would sell at a price significantly lower than the allocated portion of the underlying debt. The first mortgage lender and JMB/NYC would need to approve any sale of this property.
The O&Y affiliates have informed JMB/NYC that they have now received a written proposal for the sale of 2 Broadway for a net purchase price of $15 million. The first mortgage lender has preliminarily agreed to the concept of a sale of the building but has not approved the terms of any proposed offer for purchase. Accordingly, a sale pursuant to the proposal received by the O&Y affiliates would be subject to, among other things, the approval of the first mortgage lender as well as JMB/NYC. While there can be no assurance that a sale would occur pursuant to such proposal or any other proposal, if this proposal were to be accepted by or consented to by all required parties and the sale completed pursuant thereto, and if discussions with the O&Y affiliates relating to the proposal were finalized to allocate the unpaid first mortgage indebtedness currently allocated to 2 Broadway to 237 Park and 1290 Avenue of the Americas after completion of the sale, then the 2 Broadway Joint Ventures would incur a significant loss for financial reporting purposes. Accordingly, a provision for value impairment has been recorded for financial reporting purposes for $192,627,560, net of the non-recourse portion of the Purchase Notes including related accrued interest related to the 2 Broadway Joint Venture interests that are payable by JMB/NYC to the O&Y affiliates in the amount of $46,646,810. The provision for value impairment has been allocated $136,534,366 and $56,093,194 to the O&Y affiliates and JMB/NYC, respectively. Such provision has been allocated to the partners to reflect their respective ownership percentages before the effect of the non- recourse promissory notes including related accrued interest. The provision for value impairment is not a loss recognizable for Federal income tax purposes.
There are certain risks and uncertainties associated with the Partnership's investments made through joint ventures, including the possibility that the Partnership's joint venture partners might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership. O & Y and certain of its affiliates have been involved in bankruptcy proceedings in the United States and Canada and similar proceedings in England. The Olympia & York affiliates have not been directly involved in these proceedings. During the quarter ended March 31, 1993, O & Y emerged from bankruptcy protection in the Canadian proceedings. In addition, a reorganization of the company's United States operations has been completed, and affiliates of O & Y are in the process of renegotiating or restructuring a number of loans affecting various properties in the United States in which they have an interest. The Partnership is unable to assess and cannot presently determine to what extent these events may adversely affect the willingness and ability of the Olympia & York affiliates either to meet their own obligations to the Joint Ventures and JMB/NYC or otherwise reach an understanding with JMB/NYC regarding any funding obligation of JMB/NYC. However, the financial difficulties of O&Y and its affiliates may be adversely affecting the Three Joint Ventures' efforts to restructure the mortgage loan and to re-lease vacant space in the building.
During the fourth quarter of 1992, the Joint Ventures received a notice from the first mortgage lender alleging a default for failure to meet certain reporting requirements of the Olympia & York affiliates contained in the first mortgage loan documents. No monetary default has been alleged. The Olympia & York affiliates have responded to the lender that the Joint Ventures are not in default. JMB/NYC is unable to determine if the Joint Ventures are in default. Accordingly, the balance of the first mortgage loan has been classified as a current liability in the accompanying combined financial statements at December 31, 1992 and 1993. There have not been any further notices from the first mortgage lender. However, the Olympia & York affiliates, on behalf of the Three Joint Ventures, continue to negotiate with representatives of the lender (consisting of a steering committee of holders of notes evidencing the mortgage loan) to restructure certain terms of the existing mortgage loan in order to provide for, among other things, a fixed rate of interest on the loan during the remaining loan term until maturity. In conjunction with the negotiations, the Olympia & York affiliates reached an agreement with the first mortgage lender whereby effective January 1, 1993, the Olympia & York affiliates are limited to taking distributions of $250,000 on a monthly basis from the Three Joint Ventures reserving the remaining excess cash flow in a separate interest-bearing account to be used exclusively to meet the obligations of the Three Joint Ventures as approved by the lender.
There is no assurance that a restructuring of the loan will be obtained. Interest on the first mortgage loan is calculated based upon a variable rate related to the short-term U.S. Treasury obligation rate, subject to a minimum rate on the loan of 7% per annum. A significant increase in the short-term U.S. Treasury obligation rate could result in increased interest payable on the first mortgage loan by the Three Joint Ventures.
Long Beach Plaza
In March 1993, the Partnership completed a settlement of its litigation with Australian Ventures, Inc. ("AVI") involving a long-term ground and improvement lease for approximately 144,000 square feet at the shopping center. Under the terms of the settlement, AVI paid the Partnership $550,000, and the parties terminated the ground and improvement lease. In addition, both parties dismissed their respective claims in the lawsuit with prejudice. The Partnership has paid the $550,000 received from AVI to the mortgage lender for the property as scheduled debt service due for April and part of May 1993 on the loan secured by the property. The Partnership is seeking a replacement tenant for the vacated space. In January 1994, the Partnership received an offer to lease approximately 27,200 square feet of the first floor of the vacated Buffum's building from Ross Dress for Less. In addition, Gold's Gym has offered to lease approximately 34,000 square feet of the third floor of the vacated Buffum's building and relocate from their current 9,813 square foot space on Pine Avenue. The Partnership has several prospects for the smaller Gold's Gym space. There can be no assurance these leases will be consummated. The Partnership had discussions with several other tenants regarding their requests for temporary rent relief of approximately $500,000 in the aggregate in 1992. The tenants indicated that, due to the poor sales levels of their stores at the mall, such relief was necessary if they were to continue to operate. After review of those tenants requesting relief, the Partnership decided to grant temporary relief (approximately 50% of their minimum rent) to certain tenants through December 31, 1992. The Partnership had re-evaluated each tenant's sales level and financial situation for 1993. Based on discussions with the tenants, additional relief was granted for 1993 and the tenants may be granted additional relief in 1994. As a result of the foregoing, the Partnership has initiated discussions with the first mortgage lender regarding a modification of its mortgage loan secured by the property. Due to declining retail sales at the center along with one of the center's anchor tenants vacating its space in 1991, the Partnership has not remitted all of the scheduled debt service payments since June 1993. There can be no assurance that such modification will be consummated (reference is made to Note 4(b)(13)).
Greenwood Creek II
On April 6, 1993, the Partnership transferred title to the Greenwood Creek II Apartments to the lender for a transfer price of $100,000 (before selling costs and prorations) in excess of the existing mortgage balance. The Partnership recognized a gain in 1993 for financial reporting purposes and recognized a gain for Federal income tax purposes in 1993. Reference is made to Note 7(f).
University Park
University Park office building's major tenant, California Vision Services, vacated its space of 70,697 square feet (59% of the building) upon the expiration of its lease in April 1993. The tenant's anticipated space requirements over the next several years were expected to grow over 200,000 square feet which the property is unable to accommodate. The Partnership had actively marketed the vacated space. As a result of Cal-Vision's move out, the Partnership was unable to remit the full debt service payment and has submitted cash flow from the property for April through November, 1993. In addition, the Partnership's discussions with the first mortgage lender to further modify the note had been unsuccessful. The Partnership transferred title to the property to the lender in January 1994. Given the current vacancy level of the building and the current and projected market conditions, the likelihood of recovering any additional cash investment necessary to retain ownership of the building would have been remote. This has resulted in the Partnership no longer having an ownership interest in the property and will result in net gain for financial reporting and Federal income tax purposes to the Partnership in 1994 with no corresponding distributable proceeds (reference is made to Note 4(b)(6)).
Rio Cancion
On March 31, 1993, the Partnership sold the Rio Cancion Apartments. The mortgage loan was satisfied in full from the sales proceeds (reference is made to Note 7(e)).
Carrollwood
In September 1993, the venture refinanced the mortgage loan, secured by the property, with a third party lender (reference is made to Note 4(b)(11)). The venture did not receive any significant proceeds upon refinancing.
1001 Fourth Avenue
In recent years, the Seattle, Washington office market has been very competitive due to significant overbuilding, especially in the Central Business District where 1001 Fourth Avenue Plaza is located. Current vacancy rates exceed 15%, and rental rates remain significantly depressed. In addition, a substantial amount of sublease space had become available in the immediate downtown area.
Given the current and projected market conditions, the likelihood of recovering the additional cash investment necessary to fund anticipated operating deficits would for 1001 Fourth Avenue Plaza have been remote.
As discussed more fully in Note 1, the Partnership recorded, as a matter of prudent accounting practice, a provision at June 30, 1992, for value impairment to reduce the net carrying value of the 1001 Fourth Avenue Plaza office building to the then outstanding balance of the related non-recourse financing due to the uncertainty of the Partnership's ability to recover the net carrying value of the investment property through future operations or sale.
In addition, certain disputes had arisen between the Partnership and the lender regarding a $2,000,000 letter of credit maintained by the Partnership as additional security for the lender in connection with the existing loan modification. As a result of defaults alleged by the lender, the lender attempted to draw on the $2,000,000 letter of credit prior to its expiration in November 1992. The Partnership obtained a temporary restraining order from the Supreme Court of the State of New York disallowing the lender from drawing on the letter of credit in consideration for the Partnership renewing the letter of credit for a period of ninety days to allow the parties to attempt to resolve their differences. In February 1993, the Partnership extended the letter of credit for an additional sixty days in an attempt to resolve the disputes with the lender. Subsequently, in March 1993, the temporary restraining order expired. The Supreme Court of the State of New York agreed to extend the temporary restraining order providing the Partnership post a $2,000,000 bond by April 1, 1993. The Partnership posted a $2,000,000 bond on April 1, 1993. The lender appealed this entire order. On April 29, 1993, the Partnership was notified by the Supreme Court of the State of New York that a decision was rendered in favor of the Partnership regarding the disputes surrounding the letter of credit. In late June 1993 an order was entered by the court reflecting said decision. The lender notified the Partnership that it had intended to appeal the order. As a result, the lender claimed that the release of the bond and the return of the letter of credit had been stayed pending the appeal. Negotiations with the lender for a loan modification have been unsuccessful. On November 1, 1993, the Partnership transferred title to the 1001 Fourth Avenue Plaza office building in full satisfaction of the Partnership's mortgage obligation (which had an outstanding balance, including accrued interest, of approximately $102,607,000). In exchange for the transfer of title, the lender had agreed to settle its litigation against the Partnership and return the Partnership's bond and letter of credit. This transfer has resulted in the Partnership no longer having an ownership interest in the property. Reference is made to Note 4(b)(4).
Eastridge Apartments
The Partnership reached an agreement with the lender for another modification effective May 1, 1993 on the mortgage loan secured by the property. Reference is made to Note 4(b)(5) for a description of the loan modification.
Sherry Lane Place
The Partnership reached an agreement with the lender for another modification effective November 1993 on the mortgage loan secured by the property. Reference is made to Note 4(b)(1) for a description of the loan modification.
Marshall's Aurora Plaza
In January 1994, the Partnership reached an agreement with the lender for a loan modification and extension on the mortgage loan secured by the property effective November 1993. Reference is made to Note 4(b)(12) for a description of the loan modification.
Gables Corporate Plaza
In January 1994, the venture transferred title to the property to the lender. Therefore, neither the venture nor the Partnership have an ownership interest in the property. This transfer will result in net gain for financial reporting and Federal income tax purposes in 1994 with no corresponding distributable proceeds. Reference is made to Note 4(b)(7) and 11(a).
Plaza Tower
The first mortgage loan secured by the property matures in November 1994.
The property produced cash flow in 1993 and is expected to operate at or near the break even level in 1994. This is due primarily to anticipated leasing costs associated with the rollover in tenant leases in 1994 and 1995. Currently, the Partnership is exploring its refinancing possibilities. However, there can be no assurance that the Partnership will be able to refinance the mortgage loan or obtain a loan extension.
General
An affiliate of the General Partners that acts as the property manager at a number of the Partnership's investment properties has deferred receipt of its property management and leasing fees. The cumulative amount of deferred property management and leasing fees at December 31, 1993 was approximately $13,671,000 (approximately $37 per $1,000 Interest). The amounts do not bear interest and are payable in the future.
A number of the Partnership's investments have been made through joint venture investments. There are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners might become unable or unwilling to fulfill their financial or other obligations or, that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.
Due to the market conditions and property specific factors discussed above and the general lack of buyers of real estate today, it is likely that the Partnership may hold some of its investment properties longer than originally anticipated in order to maximize the recovery of its investments and any potential return thereon. However, in light of the current severely depressed real estate markets, it currently appears that the Partnership's goal of capital appreciation will not be achieved. Although the Partnership expects to distribute from sale proceeds some portion of the Limited Partners' original capital, without a dramatic improvement in market conditions, the Limited Partners will not receive a full return of their original investment.
RESULTS OF OPERATIONS
The increase in cash and cash equivalents and short-term investments at December 31, 1993 as compared to December 31, 1992 is due primarily to the distributions of $16,978,465 from Orchard Associates as a result of its redemption (sale) of its interest in Old Orchard shopping center as more fully described in Note 3(d). In addition, the increase in cash is due to cash flow generated from property operations at the Copley Place multi-use complex being reserved to fund budgeted capital improvements pursuant to the loan modification agreement as more fully described in Note 4(b)(10) and the receipt of sales proceeds from the sales of the Rio Cancion Apartments in March 1993 and the Greenwood Creek II Apartments in April 1993. Reference is made to Notes 7(e) and 7(f).
The decrease in restricted funds at December 31, 1993 as compared to December 31, 1992 is due primarily to the Partnership being released from its letter of credit obligation as a result of the transfer of title to the 1001 Fourth Avenue office building as more fully described in Note 4(b)(4).
The increase in escrow deposits and accrued real estate taxes at December 31, 1993 as compared to December 31, 1992 is due primarily to the timing of real estate tax payments at certain of the Partnership's investment properties.
The decrease in investment in unconsolidated venture at equity at December 31, 1993 as compared to December 31, 1992 is due primarily to the distributions of $16,978,465 from Orchard Associates as a result of its redemption of interest in Old Orchard Shopping Center. In addition, the decrease was partially offset by the Partnership's share of gain on sale of interest in unconsolidated venture of $7,898,727 as a result of the above event (Note 3(d)). Also, the decrease was partially offset by the $1,200,400 investment, which represents the Partnership's paid-in capital obligation, in Carlyle Investors, Inc. (the general partner of Carlyle-XIII Associates, L.P.) and Carlyle Managers, Inc. (the general partner of JMB Office Building Associates, L.P.) of which the Partnership is a 20% shareholder (see Note 3(c)). The corresponding increase in amounts due affiliates is primarily the result of the above stated obligation.
The increase in venture partners' subordinated equity in ventures at December 31, 1993 as compared to December 31, 1992 and the corresponding decrease in venture partners' share of loss from ventures operations for the twelve months ended December 31, 1993 as compared to the twelve months ended December 31, 1992 and 1991 is due primarily to the decrease in operating losses which resulted from the lower accrual rate on the loan modification as well as higher occupancy at the Copley Place multi-use complex.
The increase in rents and other receivables at December 31, 1993 as compared to December 31, 1992 is due primarily to the timing of escalations from tenants relating to 1993 at certain of the partnership investment properties.
The decreases in prepaid expenses, land and leasehold interests, building and improvements, accumulated depreciation, deferred expenses, accrued rents receivable, current portion of long term debt, unearned rents, tenant security deposits and long term debt at December 31, 1993 as compared to December 31, 1992 and the related decreases in rental income, mortgage and other interests, depreciation property operating expenses and general and administrative expenses and the increase in amortization for the year ended December 31, 1993 as compared to the year ended December 31, 1992 are due primarily to the transfer of title to the 1001 Fourth Avenue office building in November 1993 (reference is made to Note 4(b)(4) and the sales of the Rio Cancion Apartments in March 1993 and the Greenwood Creek II Apartments in April 1993 (reference is made to Notes 7(e) and 7(f)).
The decrease in rental income, mortgage and other interest, depreciation, and general and administrative expenses for the twelve months ended December 31, 1992 as compared to the twelve months ended December 31, 1991 is due primarily to the sales of Quail Place and Heritage Park II Apartments in March 1992 and Bridgeport Apartments in April 1992 (as more fully discussed in Note 7).
The decrease in interest income for the year ended December 31, 1993 as compared to the year ended December 31, 1992 and 1991 is due primarily to lower yields and lower average balances held in interest bearing U.S. government obligations in the subsequent periods.
The increase in property operating expenses for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily due to increased repairs and maintenance and utilities expense during 1992 at the Copley Place multi-use complex. The increase is partially offset by the sales of the Quail Place and Heritage Park II Apartments in March 1992 and Bridgeport Apartments in April 1992 (as more fully discussed in Note 7).
The increase in professional services for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily attributable to legal fees associated with the litigation involving the Long Beach Plaza.
The increase in amortization of deferred expenses for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is due to increased leasing commissions recorded and amortized at certain of the investment properties during 1992.
The provision for value impairment of $6,409,039 at December 31, 1992 is due primarily to the reduction of the net carrying value of the 1001 Fourth Avenue office building as of June 30, 1992. (See Note 1.)
The increase in the Partnership's share of the loss from operations of unconsolidated ventures and the related increase in the Partnership's deficit investment in unconsolidated venture for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is due primarily to (i) a $192,627,560 provision for value impairment recorded in 1993 for 2 Broadway due to the potential sale of the property at a sales price significantly below its net carrying value, as more fully discussed above, (ii) an $11,946,285 provision for doubtful accounts recorded by JMB/NYC due to the uncertainty of collectibility of amounts due from the Olympia & York affiliates to the Three Joint Ventures, (iii) an $11,551,049 provision for doubtful accounts recorded by JMB/NYC due to the uncertainty of collectibility of amounts due from tenants at the Three Joint Ventures' real estate investment properties, and (iv) increased aggregate interest accrued with reference to the Three Joint Ventures' mortgage loan commencing July 1, 1993 as a result of the expiration of the agreement with the Olympia & York affiliates, as more fully discussed in Note 3(c).
The decrease in the Partnership's share of loss of operations of unconsolidated ventures for the year ended December 31, 1992 as compared to the year ended December 31, 1991 is primarily due to (i) the change in profit and loss allocation from 1991 to 1992 pursuant to the Three Joint Ventures' agreements, as more fully described in Note 3(c) of Notes to Financial Statements, (ii) the collection in 1992 of $6,069,444 of a total $13,340,601 bankruptcy claim against Drexel Burnham Lambert, a former tenant of the 2 Broadway Building, and (iii) the reduced aggregate interest accrued on the joint ventures' mortgage loan commencing in 1992 based upon the interest accrual determined by JMB/NYC, as more fully described above.
The net gain of $11,083,791 consists of a gain on the sale of the Rio Cancion Apartments of $2,524,958 (see Note 7(e)), a gain on the sale of the Greenwood Creek II Apartments of $1,787,073 (see Note 7(f)), a gain on the transfer of title to the 1001 Fourth Avenue office building of $6,771,760 (see Note 4(b)(4)).
The extraordinary item is the Partnership's share of prepayment penalty of $141,776 relating to the refinancing of the original mortgage note at the Carrollwood Apartments (see Note 4(b)(11)).
The net gain on sale in 1992 of $9,422,815 related to the sales of the Quail Place and Heritage Park II Apartments in March 1992, and Bridgeport Apartments in April 1992 has been reflected as a gain on sales of $2,132,879, and an extraordinary gain of forgiveness of indebtedness of $7,289,936 (as more fully discussed in Note 7). In addition, the extraordinary item includes the Partnership's share of the prepayment penalty (of $150,000) related to the refinancing of the original mortgage note at the Glades Apartments (as more fully discussed in Note 4(b)(2)).
INFLATION
Due to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.
To the extent that inflation does have an adverse impact on property operating expenses, the increased expense may be offset by amounts recovered from tenants, as many long-term leases at the Partnership's commercial properties have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, the effect on operating earnings generally will depend upon whether properties remain substantially occupied. In addition, substantially all of the leases - at the Partnership's shopping center investments contain provisions which entitle the property owner to participate in gross receipts of tenants above fixed minimum amounts.
Future inflation may also tend to cause capital appreciation of the Partnership's investment properties over a period of time as rental rates and replacement costs of properties increase.
ITEM 8. | 711604 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA.
The information required by Item 6 is included in the Registrant's Annual Report to its shareholders for the year ended December 31, 1993 on pages 22 and 42 under the headings "Selected Financial Data" and "Risk-Based and Other Capital Data", respectively, 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 Item 7 is included in the Registrant's Annual Report to its shareholders for the year ended December 31, 1993 on pages 21_51 under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations", and is incorporated herein by reference.
ITEM 8. | 9659 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain Consolidated Selected Financial Data for the periods and as of the dates indicated:
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
1993-1992
Consolidated net sales were approximately equal with 1992, whereas unit volume increased by 4%. Selling prices were generally stable, except in some European markets, but the U.S. dollar strengthened during 1993 and this had an unfavorable impact on the translated value of the Company's foreign-currency-denominated sales. The Company's seasonal sales pattern, which is closely related to trucking industry activity and shows the highest activity during the third and fourth quarters, was similar to previous years.
Because of stable selling prices, domestic unit volume and sales showed 5% and 4% improvements, respectively, over the prior year. Western Europe, while experiencing a relatively small 1% decrease in unit volume, showed a 13% decrease in sales revenue. Contributing factors were the unfavorable impact of currency rates and lower selling prices in some European markets, with the currency rate having the greater impact. Unit volume for the Company's other combined foreign operations improved 7% over the previous year, but sales did not increase accordingly. This again was due to the stronger U.S. dollar and the resulting unfavorable impact when translating foreign-currency-denominated sales at lower rates and, to a lesser extent, due to the discontinuance of sales in certain of the Company's markets.
Consolidated net earnings decreased by 5% compared to 1992. The Company's consolidated gross profit margin declined by 2.4 percentage points, but this was partially offset by a 1.5 percentage point decline in total operating expenses as a percent of sales because of generally lower spending in many categories. The Company's decrease in gross margin was primarily due to higher depreciation expense attributable to higher capital spending in recent years and higher overall manufacturing costs in line with generally higher cost levels.
Although total domestic revenues increased by 4%, domestic earnings before income taxes was the same as the previous year, with higher product costs only partially offset by decreased operating expenses.
The Company's foreign operations comprised 37% and 14% of this year's revenues and earnings before income taxes, respectively. This represented a two percentage point decline as a percent of total revenues and a three percentage point decline as a percent of total earnings before income taxes compared to the previous year.
The Western European operation's earnings before income taxes were adversely impacted again this year, decreasing by 60% from the previous year. The earnings decrease was due primarily to the lower translation rate, combined with a five percentage point drop in gross profit margin. The lower gross profit margin was due to higher raw material and manufacturing costs, which the Company absorbed because of strong competitive pressures, and non-recurring inventory valuation adjustments.
Earnings before income taxes for the combined other foreign operations decreased 12% from last year primarily due to lower gross margins in Brazil and Canada. Brazil's lower margin was primarily due to a refinement in the methodology used to determine certain manufacturing costs. Canada's lower gross margin was the result of a higher-than-usual amount of finished goods imported from the U.S. this year and the plant being shut down for an extended period in December in order to relocate its finished goods inventory to a distribution center closer to major markets in Southeastern Canada.
The Company's effective income tax rate increased from 36.5% in 1992 to 37% in 1993, reflecting the higher federal income tax rates enacted for 1993. This increase in tax rate reduced net earnings by $625,000 and earnings per share by $.02 compared to the prior year.
Earnings per share were $.10 lower in 1993, which represents a 3% decrease from the previous year. During the third quarter of 1993, the Company acquired 144,200 shares of its outstanding Common Stock and Class A Common Stock for $6,797,000 at prevailing market prices. There were fewer shares outstanding in 1993 as a result of these purchases. The cumulative current year impact of these purchases and those made in the previous year had a $.02 favorable impact on earnings per share.
1992-1991
Consolidated net sales increased 1% from 1991, which was 4 percentage points less than the unit volume increase due mainly to the impact of discontinuing the sale of custom compounding services to outside customers. Partially offsetting this decrease was the favorable impact of the higher translated value of foreign-currency-denominated sales. Domestic unit volume showed nominal improvement despite the soft North American economy, with foreign markets, in total, showing a slightly better performance than the domestic markets.
Consolidated net earnings increased 4% from 1991. The Company's selling price increases were not sufficient to offset the increases in raw material and plant costs during the year, which resulted in a slight drop in gross profit margin. This was offset by a decrease in operating expenses and higher interest income. The decrease in operating expenses resulted primarily from reduced spending for R&D and marketing programs, especially in the United States. R&D spending was lower in 1992 than the previous year because the previous year included heavy spending on the development of the Eclipse System, which is now substantially complete.
Earnings from foreign operations represented 17% and 24% of total earnings before taxes in 1992 and 1991, respectively. Net earnings from operations in Western Europe declined by 70% from 1991, even though net sales were 7% higher on a 4% increase in unit volume. The percentage differential between the net sales and volume increases was due primarily to favorable foreign translation rates into U. S. dollars. Net earnings for the year were adversely impacted by a substantial increase in operating expenses and unusually high foreign exchange losses due to devaluations of several European countries' currencies in which sales are denominated. The Company has undertaken a concerted effort to increase market share in Western Europe, and spending related to this effort is primarily responsible for the substantial increase in operating expenses.
Net sales for the other combined foreign operations increased 10% over last year, with the operations in Mexico and Brazil accounting for the majority of the increase. Net earnings were 14% higher than last year primarily due to improved gross margins in Brazil and slightly lower operating expenses, as a percentage of net sales.
The Company's effective income tax rate decreased from 38% in 1991 to 36.5% in 1992, having a positive impact on net income. Earnings per share before the cumulative effect of changes in accounting methods increased $.13, a 5% increase from 1991. During the year, the Company acquired 451,300 shares of its outstanding Common Stock and Class A Common Stock. These purchases took place during the latter half of the year and, therefore, did not significantly affect the average shares outstanding.
The Company adopted, effective January 1, 1992, Financial Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions" (FAS 106) and No. 109 "Accounting for Income Taxes" (FAS 109). The cumulative effect of adopting FAS 106 reduced net earnings by $.09 per share. The cumulative effect of adopting FAS 109 increased net earnings by $.08 per share. Adoption of FAS 106 and 109 did not significantly impact operating results for 1992. See Notes D and G for further details.
1991-1990
Consolidated net sales decreased 1% from 1990 due to a combination of lower effective selling prices and flat unit volume. Volume in the United States market was impacted by the depressed economy and the work-off of dealer inventories accumulated late in 1990 during the uncertainty surrounding the Gulf War. The effective selling price was also impacted by the Gulf War as raw material costs rose sharply in late 1990, but dropped back again to previous levels in 1991. Volume in foreign markets, in total, showed a slight increase compared to the previous year.
Consolidated net earnings increased 1% from 1990. Lower effective selling prices were offset by lower raw material costs, keeping gross profit margin stable. Operating and other expenses increased only slightly from 1990 as reduced spending on marketing programs offset higher expenses in other categories. The Company's effective income tax rate decreased from 38.5% in 1990 to 38% in 1991, having a positive impact on net income.
Earnings per share increased $.11, a 4% increase from 1990. The percentage increase in earnings per share was higher than the increase in net earnings due to fewer average shares outstanding during 1991, as a result of the full year impact of shares acquired in 1990.
Impact of Inflation and Changing Prices
Although the Company has generally been able to adjust its effective selling prices in response to changes in product costs, during the past two fiscal years the Company's gross profit margin has declined because the Company, due to competitive conditions, has elected not to increase its selling prices in response to increased product costs.
Replacement of fixed assets requires a greater investment than the original asset cost due to the impact of increases in the general price level over the useful lives of plant and equipment. This increased capital investment would result in higher depreciation charges affecting both inventories and cost of products sold.
However, for new assets, the replacement cost depreciation, calculated on a straight-line basis, is not significantly greater than historical depreciation that has principally been calculated by accelerated methods resulting in higher depreciation charges in the early years of an asset's life.
Capital Resources and Liquidity
Current assets exceeded current liabilities by $213,599,000 at the end of 1993, while cash and cash equivalents increased by $24,187,000 from December 31, 1992, and totaled $58,004,000 at year-end. The Company invests excess funds over various terms, but only instruments with an original maturity date of over 90 days are classified as investments. The increase in cash flow from operating activities was primarily from higher income taxes payable and reduced inventories.
No major changes in working capital requirements are foreseen, except for those normally faced in the growth of the business.
The Company funds its capital expenditures from the cash flow generated from operations. During 1993 the Company spent $40,472,000 for capital additions, including a major expansion at its Oxford, North Carolina plant.
As of December 31, 1993, the Company had available uncommitted lines of credit totaling $86,000,000 in the United States for working capital purposes. Also, the Company's foreign subsidiaries have approximately $31,000,000 credit and overdraft facilities available to them. From time to time during 1993, the Company's Western Europe subsidiary borrowed funds to supplement its operational cash flow needs or to repay intercompany transactions. The Company's other liabilities totaled $11,039,000, which are 2.6% of the sum of other liabilities and stockholders' equity. The Company has no plans at this time to undertake additional other liabilities of any material amount.
During the year, the Company acquired 144,200 shares of its outstanding Common Stock and Class A Common Stock for $6,797,000 at prevailing market prices and paid cash dividends amounting to $18,033,000. The Company generally funds its dividends and stock repurchases from the cash flow generated from its operations, and the Company has historically utilized excess funds to purchase its own shares, believing the acquisition of the Company's stock to be a good investment.
In 1993, the Company adopted FAS 115 and recorded the related non-cash effect to the Company's balance sheet. See Note B for further details.
ITEM 8. | 9534 | 1993 |
ITEM 6. Selected Financial Data.
"11-Year Summary of Selected Financial Data" on pages 54-56 of Exhibit (13) filed hereunder is incorporated herein by reference.
ITEM 7. | ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.
"Analysis of Operations," "Effects of Inflation" and "Liquidity, Working Capital and Capital Investment" on pages 57-64 of Exhibit (13) filed hereunder are incorporated herein by reference.
ITEM 8. | 59198 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for the five years ended December 31, 1993, appearing under "Five-Year Financial Summary" on the inside front cover page of the Intergraph Corporation 1993 Annual Report to Shareholders are incorporated 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 8 to 12 of the Intergraph Corporation 1993 Annual Report to Shareholders is incorporated by reference in this Form 10-K Annual Report.
ITEM 8. | 351145 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Intentionally omitted. See the index page to this Report for explanation.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Transportation manufactures and markets medium and heavy trucks, including school bus chassis, mid-range diesel engines and service parts in North America. These products also are sold to distributors in selected export markets. Its financial services subsidiaries provide wholesale, retail and lease financing, and commercial physical damage and liability insurance, principally to Transportation's dealers and retail customers.
As discussed in Note 1 to the Financial Statements, finance and insurance operations are materially different from the manufacturing and marketing of trucks, diesel engines and service parts. Therefore, this discussion and analysis reviews separately the operating and financial results of "Manufacturing" and "Financial Services." Manufacturing includes the consolidated financial results of Transportation's manufacturing operations with its wholly-owned financial services subsidiaries included on a one-line basis under the equity method of accounting. Financial Services includes Transportation's wholly-owned subsidiary, Navistar Financial Corporation (Navistar Financial), and other wholly-owned foreign finance and insurance companies.
Management's discussion and analysis of results of operations should be read in conjunction with the Financial Statements and the Notes to the Financial Statements.
Significant Events
During 1993, Transportation negotiated collective bargaining agreements with the United Automobile, Aerospace and Agricultural Implement Workers of America (UAW) and most of its other unions, restructured its retiree health care and life insurance plans and its Parent Company completed a public offering of common shares. These events are part of a program to reduce Transportation's operating cost structure and enable it to compete successfully.
On January 23, 1993, a new labor agreement was ratified by the members of the UAW. This agreement, which expires on October 1, 1995, permits greater productivity and efficiency, manufacturing flexibility and customer responsiveness.
On July 1, 1993, Transportation implemented a restructured retiree health care and life insurance plan (the Plan) which previously had been approved by the U.S. District Court in Dayton, Ohio on May 27, 1993, and by the Parent Company's shareowners on June 29, 1993. The Plan provides retirees with modified health care and life insurance benefits for life. The Parent Company's shareowners also approved a one-for-ten reverse stock split of its Common Stock and approved the issuance of 25.6 million shares of Class B Common Stock. The Class B shares, valued at $513 million, were purchased by Transportation from the Parent Company and contributed to a separate independent retiree Supplemental Benefit Trust as a part of the Plan.
The Plan reduced Transportation's liability for retiree health care and life insurance benefits from approximately $2.6 billion to $1.1 billion worldwide. On October 21, 1993, the Parent Company completed a public offering of 23.6 million Common shares, from which it realized net proceeds of $492 million. The net proceeds were lent to Transportation which used $300 million to pre-fund benefit liabilities under the Plan. Transportation will use the remaining proceeds for working capital purposes.
Results of Operations
Consolidated
The components of net income (loss) for the three years ended October 31 are as follows:
Millions of dollars 1993 1992 1991 - ----------------------------------------------------------------------- Income (loss) before Supplemental Trust contribution and income taxes ...................... $ 51 $ (151) $ (189) Supplemental Trust contribution: - Manufacturing ......................... (509) - - - Financial Services .................... (4) - - Income tax expense ........................ (19) (15) (22) ------- ------- ------- Income (loss) of continuing operations................. (481) (166) (211) Discontinued operations ................... - (65) - Cumulative effect of accounting changes ... (1,144) - - ------- ------- ------- Net loss ................................. $(1,625) $ (231) $ (211) ======= ======= =======
Reflecting improved operating results in both manufacturing operations and financial services, Transportation reported income of $51 million in 1993 before the Supplemental Trust contribution and income taxes compared with a pretax loss of $151 million last year and a pretax loss of $189 million in 1991. The 1993 loss of continuing operations was $481 million after the one-time charge for the Supplemental Trust contribution of $513 million and income tax expense of $19 million.
In the 1993 third quarter, Transportation adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), "Employers' Accounting for Postretirement Benefits Other Than Pensions," and Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for Income Taxes" retroactive to November 1, 1992. Prior years were not restated. As a result of Transportation's Tax Agreement with the Parent Company, substantially all of the deferred tax asset and corresponding income tax benefit resulting from adopting SFAS 106 and SFAS 109 is reflected on the financial statements of the Parent Company and, therefore, had minimal effect on Transportation's cumulative effect of changes in accounting policy. The cumulative effect of these changes resulted in a charge to income of $1,144 million.
Transportation incurred a net loss of $1,625 million for 1993. The net loss of $231 million for 1992 included a $65 million charge to discontinued operations for the settlement of suits brought by the Pension Benefit Guaranty Corporation (PBGC) related to a previously owned business.
Consolidated sales and revenues of $4,694 million in 1993 were 21% higher than the $3,871 million reported in 1992 and 36% above the $3,460 million reported in 1991 as a result of a strong cyclical recovery in the demand for trucks, diesel engines and service parts.
Manufacturing
Manufacturing reported a loss of $14 million before a one-time $509 million charge for the Supplemental Trust contribution and income taxes. Losses of $203 million and $249 million were recorded in 1992 and 1991, respectively. The 1992 results included a $47 million one-time charge for a voluntary product recall.
The components of Manufacturing loss, excluding Financial Services and before taxes, are as follows:
Millions of dollars 1993 1992 1991 - ----------------------------------------------------------------------- Pretax loss before Supplemental Trust contribution and income taxes ...................... $ (14) $ (203) $ (249) Supplemental Trust contribution ........... (509) - - ------ ------ ------ Loss before income taxes ............ $ (523) $ (203) $ (249) ====== ====== ======
The improvement in 1993 operating results is the result of increased sales volume, higher selling prices and programs implemented to improve Transportation's cost structure. Cost improvement programs included implementation of the restructured retiree benefit Plan and continued investment in new products and processes to increase efficiency and lower manufacturing hours per unit. The reduction in the loss between 1992 and 1991 was primarily the result of increased sales volume, ongoing cost improvement programs and lower financing charges offset in part by higher health care costs, reduced interest income and an increase in interest expense on obligations to the Parent Company.
Sales. Reflecting improvements in the U.S. and Canadian economies, 1993 North American industry retail sales of medium and heavy trucks totalled 288,900 units, a 19% increase over 1992 and a 26% increase from the 229,100 units sold in 1991. Compared with 1992 levels, heavy truck industry sales increased 33% to 166,400 units, led by higher demand from major leasing companies and large fleet operators. Industry sales of medium trucks, including school bus chassis, increased 4% to 123,000 units. Medium truck industry shipments were up 4% from 1992 and 11% from 1991. Industry sales of school bus chassis, about 25% of the medium truck market, increased 3% from 1992 but were 19% below 1991. The demand for school buses reflects the timing of state and local government funding of student transportation.
Transportation's sales of trucks, diesel engines and service parts during 1993 totalled $4,510 million, 22% above the $3,685 million reported for 1992 and 38% higher than the $3,259 million recorded in 1991. The sales increase principally reflects the improved demand for heavy trucks, higher shipments of mid-range diesel engines to original equipment manufacturers and improved sales of service parts. Retail deliveries of medium and heavy trucks totalled 79,800 units in 1993, an increase of 15% from 1992 and 19% higher than in 1991. Transportation maintained its position as sales leader in the North American combined medium and heavy truck market in 1993 with a 27.6% market share.
Shipments of mid-range diesel engines to original equipment manufacturers during 1993 totalled a record 118,200 units, an increase of 21% from 1992 and 58% from 1991. Higher shipments to a major automotive manufacturer to meet consumer demand for the light trucks and vans which use this engine was the primary reason for the increase.
Service parts sales of $632 million in 1993 were 11% higher than the $571 million reported in 1992 and 19% higher than the $530 million in 1991. The increase between 1993 and 1992 was the result of growth in sales to dealers and national fleets and improved price realization. The increase between 1992 and 1991 was the result of higher net selling prices, export business expansion and sales growth in dealer and national retail accounts.
Operating Costs and Expenses. Manufacturing gross margin, the relationship of sales to cost of sales, was 13.2% in 1993. Gross margin in 1992, excluding one-time product recall expenses, was 13.0%, an increase from 11.5% in 1991. Factors which led to the improvement in gross margin between 1993 and 1992 included higher sales volume, improved price realization and programs implemented to improve Transportation's cost structure. These favorable effects were partially offset by increases in purchased material and labor costs and a higher level of manufacturing start-up costs for new truck and engine products. The improvement in gross margin between 1992 and 1991 was primarily the result of higher sales volume combined with the impact of cost improvement programs.
Postretirement benefits, which include pension expense for employees and retirees and postretirement health care and life insurance coverage for employees, retirees, surviving spouses and dependents, totalled $208 million in 1993. Pension expense of $107 million in 1993 was about level with 1992 and 1991. A 30% reduction in retiree health care and life insurance expense in 1993 to $101 million was primarily the result of an $87 million year-over-year decline in expense following implementation in 1993 of the new retiree benefit plan partially offset by a $41 million increase in expense related to the adoption of SFAS 106. This statement requires the accrual of the expected cost of providing postretirement benefits during employees' active service periods. Prior to 1993, the cost of these benefits was recorded as payments were made. From 1991 to 1992, postretirement benefit expense other than pensions increased from $138 million to $146 million as cost containment programs only partially offset health care economic cost increases.
In 1993, Transportation continued its commitment to allocate resources for improvement of existing products and processes and the development of new truck and diesel engine products. Engineering expense increased to $94 million in 1993 from $92 million in 1992 and $88 million in 1991 reflecting the completion of the development and introduction of a new series of diesel engines as well as continuing development of new and existing truck products.
Marketing and administrative expense of $225 million was about equal to the amounts reported in 1992 and 1991. Interest expense of $29 million was $17 million higher than in 1992 and $12 million higher than in 1991. The increase is the result of higher interest payments on obligations to the Parent Company. The decrease in interest expense between 1992 and 1991 is the result of lower interest payments to the Parent Company and the differing levels of capitalized interest on major capital projects. Finance service charges on sold receivables increased 8% to $56 million in 1993 reflecting higher truck sales. These charges decreased 20% between 1992 and 1991 as a result of lower interest rates. The provision for losses on receivables was reduced to $5 million in 1993 from $18 million in 1992 following improvements in the economy and improved credit review procedures. Interest income declined to $9 million in 1993 from $12 million in 1992 primarily as a result of a reduction in the amount of marketable securities held by Transportation through most of the year and lower interest rates.
Discontinued Operations. A provision was recorded in the third quarter of 1992 as a loss of discontinued operations for the settlement for $65 million of the litigation commonly referred to as the Wisconsin Steel Pension Plan Cases.
Financial Services
Income of the subsidiaries comprising Financial Services is as follows:
Millions of dollars 1993 1992 1991 - ----------------------------------------------------------------------- Income before Supplemental Trust contribution and income taxes: Navistar Financial Corporation ......... $ 53 $ 46 $ 53 Foreign Subsidiaries ................... 12 6 7 ---- ---- ---- Total ................................ 65 52 60
Supplemental Trust contribution ............ (4) - - Income tax expense ......................... (22) (20) (23) ---- ---- ---- Income before cumulative effect of accounting changes ................... 39 32 37 Cumulative effect of accounting changes ... (9) - - ---- ---- ---- Net income ............................... $ 30 $ 32 $ 37 ==== ==== ====
Navistar Financial's income in 1993 before the one-time charge for the Supplemental Trust contribution and income taxes was $53 million compared with $46 million in 1992. The increase was primarily the result of increased income from sales of retail notes receivable partially offset by higher loss experience from Navistar Financial's insurance subsidiary. Earnings from the foreign subsidiaries increased $6 million as a result of lower loss reserve requirements.
During the third quarter of 1993, Navistar Financial adopted SFAS 106 and SFAS 109 retroactive to November 1, 1992. The cumulative effect of adopting these changes in accounting policy resulted in an after-tax charge to income of $9 million.
Income before income taxes for Navistar Financial decreased 13% between 1992 and 1991 as a result of lower margins earned on the finance receivables portfolio partially offset by a lower provision for credit losses. Earnings from Navistar Financial's insurance subsidiary were equal to 1991.
Total Navistar Financial revenue for 1993 was $220 million, unchanged from 1992 and 3% below 1991. During 1993, increased revenues from higher average wholesale note and account balances were offset by lower revenues from the insurance subsidiary. The decline in revenues in 1992 from 1991 reflects a decrease in retail and wholesale notes financed. These decreases were partially offset by an increase in revenues from Navistar Financial's insurance subsidiary.
Interest expense for Navistar Financial declined to $75 million in 1993 from $82 million in 1992 and $90 million in 1991. The declines in 1993 and 1992 primarily reflect the effect of lower interest rates.
The provision for losses on receivables decreased to $1 million in 1993 from $3 million in 1992 and $6 million in 1991. The decreases in the provision reflect lower losses on both retail and wholesale notes.
Liquidity and Capital Resources
Consolidated
Total cash, cash equivalents and marketable securities amounted to $493 million and $378 million at October 31, 1993 and 1992, respectively. At October 31, 1993 and 1992, approximately $160 million and $165 million, respectively, was held by Transportation's insurance subsidiaries and not available for general corporate purposes.
The following discussion has been organized to discuss separately the cash flows of Transportation's Manufacturing and Financial Services operations.
Manufacturing
Liquidity available to Manufacturing in the form of cash, cash equivalents and marketable securities totalled $316 million at October 31, 1993, $132 million at October 31, 1992, and $207 million at October 31, 1991.
Cash and cash equivalents of Manufacturing totalled $262 million at October 31, 1993, an increase from the $125 million at October 31, 1992. Summarized below is the cash flow for fiscal 1993.
Millions of dollars 1993 - ------------------------------------------------------------------------ Cash and cash equivalents provided by (used in): Operations ....................................... $ 166 Investment programs .............................. (504) Financing activities ............................. 475 ----- Increase in cash and cash equivalents .......... $ 137 =====
Operations. In 1993, operations provided $166 million in cash as follows:
Millions of dollars 1993 - ------------------------------------------------------------------------ Net loss ........................................... $(1,625) Items not affecting cash: Supplemental Trust contribution .................. 509 Cumulative effect of accounting changes .......... 1,144 Depreciation and other items ..................... 66 Change in operating assets and liabilities: Decrease in receivables ........................ $ 1 Increase in inventories ........................ (51) Increase in accounts payable ................... 122 72 ----- ------- Cash provided by continuing operations ............. $ 166 =======
The $72 million net change in operating assets and liabilities was primarily the result of higher production schedules in 1993.
Investment programs. Investment programs used $504 million in cash during 1993 including pre-funding $300 million of the retiree benefit Plan liability, capital expenditures of $110 million, a net increase of $46 million in marketable securities and $30 million for the cash collateralization of a bond related to current legal proceedings.
Financing programs. Financing activities provided $475 million in cash in 1993 primarily from $493 million in funds loaned to Transportation by the Parent Company. See Note 14 to the Financial Statements. This increase in cash was offset by an $18 million reduction in debt.
Management's discussion of the future liquidity of manufacturing operations is included in the Business Outlook section of Management's Discussion and Analysis.
Financial Services
The Financial Services subsidiaries provide product financing and insurance coverage to Transportation's dealers and retail customers. Traditionally, funds to finance Transportation's products come from a combination of commercial paper, short- and long-term bank borrowings, medium- and long-term debt issues, sales of receivables and equity capital. The lowering of Navistar Financial's debt ratings in fiscal 1992 restricted its ability to place commercial paper and term debt securities. Accordingly, Navistar Financial increased its use of bank borrowings through its revolving credit facility and sales of retail notes as funding sources. Insurance operations are funded from premiums and income from investments.
Total cash, cash equivalents and marketable securities of Financial Services were $177 million at October 31, 1993, $246 million at October 31, 1992 and $189 million at October 31, 1991.
Cash and cash equivalents of Financial Services totalled $44 million at October 31, 1993, $103 million at October 31, 1992 and $39 million at October 31, 1991. The cash flow for Financial Services for 1993 is summarized as follows:
Millions of dollars 1993 - ----------------------------------------------------------------------- Cash and cash equivalents provided by (used in): Operations ....................................... $ 63 Investment programs .............................. (65) Financing activities ............................. (57) ----- Decrease in cash and cash equivalents .......... $ (59) =====
Operations. Operations provided $63 million in cash in 1993 primarily from net income of $30 million, a $19 million decrease in working capital and non-cash expense of $9 million for the cumulative effect of the adoption of SFAS 106 and SFAS 109.
Investment Programs. The Financial Services investment programs used $65 million in 1993 as a result of a net increase of $62 million in retail and wholesale finance receivables and a $14 million increase in property and equipment leased to others, partially offset by an $11 million decrease in marketable securities.
Navistar Financial supplied 90% of the wholesale financing of new trucks to Transportation's dealers compared with 89% in 1992 and 1991. Navistar Financial's share of retail financing of new trucks sold to customers in the United States increased to 15.3% in 1993 from 13.7% in 1992 and 13.1% in 1991.
Financing Activities. Financial Services used $57 million in 1993 for financing activities consisting of $99 million for principal payments on long-term debt and $33 million of dividends paid to Transportation. Cash from financing activities was increased by $75 million of short-term borrowings.
At October 31, 1993, Navistar Financial had $1,327 million of committed credit facilities. The facilities consisted of a contractually committed bank revolving credit facility of $727 million and a contractually committed retail notes receivable purchase facility of $600 million. Unused commitments under the receivable purchase facility were $157 million, $75 million of which was used to back the short-term bank borrowings at October 31, 1993. The remaining $82 million, when combined with unrestricted cash and cash equivalents, made $105 million available to fund the general business purposes of Navistar Financial at October 31, 1993. The bank revolving credit facility was fully utilized at October 31, 1993. In addition to the committed credit facilities, Navistar Financial also utilizes a $300 million revolving wholesale note sales trust providing for the continuous sale of eligible wholesale notes on a daily basis. The sales trust is composed of three $100 million pools of notes maturing serially from 1997 to 1999.
Management's discussion of the future liquidity of financial services operations is included in the Business Outlook section of Management's Discussion and Analysis.
Environmental Matters
Transportation has been named a potentially responsible party (PRP), in conjunction with other parties, in a number of cases arising under an environmental protection law commonly known as the Superfund law. These cases involve sites which allegedly have received wastes from its current or former operations. The Superfund law requires environmental investigation and/or cleanup where waste products from various manufacturing processes and operations have been stored, treated or disposed of.
Based on information available to Transportation which in most cases includes estimates from PRPs and/or Federal or State regulatory agencies for the investigation, cleanup costs at these sites, data related to quantities and characteristics of material generated at or shipped to each site, a reasonable estimate is calculated of Transportation's share, if any, of the costs. Transportation believes that, based on these calculations, its share of the costs for each site is not material and in total the anticipated cleanup costs of current PRP actions at October 31, 1993 would not have a material impact on Transportation's financial condition, liquidity or operating results except with respect to the potential for liability discussed below. The anticipated costs associated with the current PRP actions at October 31, 1993, are reflected in Transportation's $10 million accrued liability. Transportation reviews its accruals as additional information becomes available.
The present owner of Transportation's former Wisconsin Steel facility in Chicago, Illinois has been investigating the nature and extent of any required cleanup activities at this site. In addition, the present owner of Transportation's former Solar Division in San Diego, California is conducting similar activities with respect to that site. Environmental protection agencies in each of these states are monitoring these investigations. Both of the present owners have demanded that Transportation pay for these activities. As to both sites, the eventual scope, timing and cost of such activities as well as the availability of defenses to any such claims, and possible claims against third parties and insurance companies are not known and cannot be reasonably estimated; however, substantial claims could be asserted against Transportation.
Business Outlook
Current economic trends indicate continued moderate growth in the North American economy, resulting in improved market conditions for the truck industry. Based on current order backlogs, order receipt trends and key market indicators, Transportation currently projects 1994 North American medium truck demand, including school bus chassis, to be 136,000 units, an 11% increase from 1993. Heavy truck demand is projected at 160,000 units, approximately level with 1993. Transportation's diesel engine sales to original equipment manufacturers in 1994 are expected to be about the same as in 1993. Sales of service parts by Transportation are forecast to grow 3%.
As the Federal government and private industry consider solutions to the rising cost of medical care, Transportation took decisive action with implementation of a restructured retiree health care and life insurance benefit plan on July 1, 1993 and a $300 million pre-funding of this obligation. Transportation intends to further reduce retiree health care costs by pre-funding an additional $200 million of the retiree health care and life insurance benefit liability within the next five years. Additional annual health care savings of up to $15 million are projected from managed care programs for employees and certain retirees to be implemented in 1994.
In 1994, the introduction of new truck and engine products, focused marketing programs and implementation of programs to streamline marketing, engineering and manufacturing processes are expected to further improve Transportation's competitiveness. It is management's opinion that current and forecasted cash flow will provide a basis for financing operating requirements and capital expenditures.
In addition, management believes that collections on the outstanding receivables portfolios as well as funds available from various funding sources will permit the Financial Services subsidiaries to meet the financing requirements of Transportation's dealers and customers.
ITEM 8. | 51296 | 1993 |
Item 6. Selected Financial Data.
Incorporated by reference to the information under "Historical Review 1993-1989" on page 28 of the Annual Report.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Incorporated by reference to the information under "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 12 through 14 of the Annual Report.
Item 8. | 15840 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 6 is hereby incorporated by reference from pages 44 to 45 of the Company's Annual Report to Shareholders for the year ended December 31, 1993, which is filed herewith as Exhibit 13.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The information required by Item 7 is hereby incorporated by reference from pages 16 to 21 of the Company's Annual Report to Shareholders for the year ended December 31, 1993, which are filed herewith as Exhibit 13.
ITEM 8. | 71180 | 1993 |
Item 6. SELECTED FINANCIAL DATA
The information required under this item is set forth under the caption "Selected Financial Data" on page 39 of the Company's Annual Report to Shareholders for the fiscal year ended November 5, 1993 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 under this Item is set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 30 to 38 of the Company's Annual Report to Shareholders for the fiscal year ended November 5, 1993 and is incorporated herein by reference.
Item 8. | 34501 | 1993 |
Item 6. Selected Financial Data - ---------------------------------
- -------------------------------------------------------------------------------- EIGHT - YEAR SUMMARY - --------------------------------------------------------------------------------
- 19 -
Notes: (a) After deducting preferred dividend requirements and adding the tax benefits for unallocated shares. (b) See definition of fully diluted earnings per share on page 38. (c) Total debt includes short-term debt, current installments of long-term debt, long-term debt, and ESOP loan guarantee. Total capital includes total debt and total shareholders' equity. (d) Includes one trustee who is the shareholder of record on behalf of approximately 4,300 employees in 1993, 4,500 employees in 1992, 4,600 employees in 1991, 4,500 employees in 1990, 4,700 employees in 1989, and 4,400 employees in 1988 who have beneficial ownership through the company's retirement savings plans. (e) Includes, for 1987 and 1986, a trustee who was the shareholder of record on behalf of approximately 11,000 employees who obtained beneficial ownership through the Armstrong Stock Ownership Plan, which was terminated at the end of 1987.
- 20 -
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and - ------------------------------------------------------------------------- Results of Operations ---------------------
1993 compared with 1992
Financial condition
As shown on the Consolidated Statements of Cash Flows, net cash provided by operating activities in 1993 was $291.2 million which was more than sufficient to cover investments in property, plant, and equipment and dividends. The excess cash, plus cash proceeds from the sale of assets and the decrease in cash and cash equivalents, was used to reduce debt by $124.1 million.
For 1993, the company recorded an $89.9 million charge before tax ($60.0 million after tax) for restructuring resulting from 1993 decisions associated with major process improvements and significant organizational changes recommended by the teams of project PATH (a company initiative announced in August 1993 to strengthen its global competitiveness). Approximately 80% of the before-tax losses were related to charges for severance and special retirement incentives associated with the elimination of employee positions, and approximately one-third of the before-tax loss represented future cash outlays. Most of the cash outlays are expected to occur in 1994 and to be offset by operating savings. The operating cash savings, resulting from restructuring actions taken during 1993 and 1992, more than offset the 1993 cash outlays of $39.3 million for restructuring.
During the fourth quarter of 1993, the company terminated, prior to maturity, interest rate swaps totaling $100 million, and currency swaps totaling $37.2 million.
Working capital was $204.1 million as of December 31, 1993--$37.0 million higher than the $167.1 million at year-end 1992. The primary reason for the increase in working capital was the repayment of short-term debt. Accounts receivable and inventories declined $19.1 million and $33.2 million, respectively, both reflecting reductions in most business units with half of the reductions attributed to the European building products business.
A financing arrangement of a foreign subsidiary's principal pension plan, whereby the subsidiary became self-insured for its pension obligations, resulted in recording a noncurrent asset and long-term liability of $37.7 million (see page 42).
The company's 1993 year-end ratio of current assets to current liabilities was 1.47 to 1, compared with 1.31 to 1 ratio reported in 1992. The 1993 and 1992 year-end ratio of total debt to total capital was 52.2% and 57.2%, respectively.
The company is involved in significant asbestos-related litigation which is described more fully under "Litigation" on pages 60-64 and which should be read in connection with this discussion and analysis. The company does not know how many claims will be filed against it in the future, nor the details thereof or of pending suits not fully reviewed, nor the expense and any liability that may ultimately result therefrom, nor does the company know the annual claims flow caps to be negotiated after the initial 10-year period for the settlement class action or the then compensatory levels to be negotiated for such claims or the success the company may have in addressing the Midland Insurance Company insolvency with its other insurers. Subject to the foregoing and based upon its experience and other factors, the company believes that it is probable that substantially all of the expenses and any liability payments associated therewith will be paid--in the case of the personal injury claims, by agreed-to coverage under the Wellington Agreement and supplemented by payments by non- subscribing insurers that entered into settlement agreements with the company and additional insurance coverage reasonably anticipated from the outcome of the insurance litigation and from the company's claims for non-products coverage both under certain insurance policies covered by the Wellington Agreement and under certain insurance policies not covered by the Wellington Agreement which claims have yet to be accepted by the carriers--and in the case of the asbestos- related property damage claims, under
- 21 -
an existing interim agreement, by insurance coverage settlement agreements and through additional coverage reasonably anticipated from the outcome of the insurance litigation. To the extent that costs of the property damage litigation are being paid by the company's insurance carriers under reservation of rights, the company believes that it is probable that such payments will not be subjected to recoupment. Thus, the company has not recorded any liability for any defense costs or indemnity relating to these lawsuits other than a reserve in "Other long-term liabilities" for the estimated potential liability associated with claims pending and intended to cover potential liability and settlement costs, legal and administrative costs not covered under the agreements, and certain other factors which have been involved in the litigation about which uncertainties exist. Even though uncertainties still remain as to the potential number of unasserted claims, the liability resulting therefrom, and the ultimate scope of its insurance coverage, after consideration of the factors involved, including the Wellington Agreement, the settlements with other insurance carriers, the results of the trial phase and the first level appellate stage of the California insurance litigation, the remaining reserve, the establishment of the Center for Claims Resolution, the proposed settlement class action, and its experience, the company believes that this litigation will not have a material adverse effect on its earnings, liquidity, or financial position.
The accounting treatment for the Company's asbestos-related personal injury litigation will be affected by changes in accounting practices required by the Financial Accounting Standards Board Interpretation Number 39 (FIN 39) and the Securities and Exchange Commission Staff Accounting Bulletin No. 92 (SAB 92). FIN 39, which is effective beginning in 1994, does not permit offsetting unless a right of set off exists. Historically, the Company has been following the practice of offsetting the liability for asserted claims with expected insurance coverage. The Company intends to reflect the required changes in its first quarter 1994 Form 10-Q and, therefore, will record a liability for asbestos-related personal injury claims and an asset for insurance coverage deemed probable.
Reference is made to the litigation involving The Industry Network System, Inc. (TINS), discussed on pages 64-65. The company denies all of TINS' claims and accordingly is vigorously defending the matter. In the event that a jury finds against the company, such jury verdict could entail unknown amounts which, if sustained, could have a material adverse effect on its earnings and financial position.
Reference is also made to environmental issues as discussed on pages 51, 52, and 61. The company believes any sum it may have to pay in connection with environmental matters in excess of amounts accrued would not have a material adverse effect on its financial condition, liquidity, or results of operations.
Long-term debt, excluding the company's guarantee of the ESOP loan, was reduced by $9.8 million in 1993. At year-end 1993, long-term debt represented 45% of shareholders' equity compared with 47% at the end of 1992.
Should a need develop for additional financing, it is management's opinion that the company has sufficient financial strength to warrant the required support from lending institutions and financial markets.
- 22 -
Consolidated results
Net sales in 1993 of $2.53 billion decreased 1.0% compared with 1992 sales of $2.55 billion. The weaker European exchange rates were a key factor in the sales decline. Translating foreign currency sales to U.S. dollars at 1992 exchange rates would have resulted in a year-to-year sales increase of 1.9%. Armstrong's residential markets were very positive in the U.S., but the weakness in the European economies and the lackluster commercial markets worldwide reduced the overall opportunity. While sales in the first two quarters of 1993 were lower than the comparable 1992 quarters, third and fourth quarter sales did exceed those of the prior year.
Net earnings were $63.5 million compared with a net loss in 1992 of $227.7 million. Net earnings per common share were $1.32 on a primary basis and $1.26 on a fully diluted basis. The net loss per share of common stock was $6.49 on both a primary and fully diluted basis for 1992.
The return on common shareholders' equity in 1993 was 9.0% compared with a negative 33.9% in 1992.
The 1992 loss reflects charges of $167.8 million after tax related to the company's adoption, retroactive to January 1, 1992, of SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions;" and SFAS 112, "Employers' Accounting for Postemployment Benefits." The computation of SFAS 112 was refined during 1993 with the net loss in 1992 being reduced and restated by $6.5 million or 18 cents per share. The restated 1992 net loss from continuing businesses totaled $59.9 million, or a $1.98 loss per share of common stock.
The effective tax rate for 1993 was 30.0%. This reflects the company's higher use of foreign tax credits, reductions of deferred taxes because some foreign countries reduced their statutory tax rates, and lower foreign tax rates, which more than offset the 1% increase in the U.S. statutory tax rate. The net loss from 1992 included an effective tax benefit rate of only 1.0%, primarily because some of the restructuring charges did not provide tax benefits. The company also adopted SFAS 109, "Accounting for Income Taxes," resulting in tax benefits of $5.5 million for 1992 being credited directly to retained earnings rather than to income taxes on the consolidated statement of earnings.
Restructuring charges for 1993, totaling $89.9 million before tax, were included in the earnings from continuing businesses and were associated with Armstrong initiatives to enhance its global competitiveness. These costs are primarily associated with the elimination of employee positions in the U.S. and Europe. For the full year 1992, restructuring charges totaled $165.5 million before tax and related to the closing of four major manufacturing plants; the scaling back of operations in certain other plants in the U. S. and abroad; accruals for costs associated with the elimination of positions throughout the rest of the company; as well as write-downs of the value of land, buildings, equipment, and intangible assets of the company. Cash outlays for the 1993 restructuring charges will occur primarily throughout 1994 and should be fully recovered within two to three years.
- 23 -
The cost of goods sold for 1993, when expressed as a percent of sales, was 71.4%--the lowest level for the last four years--and compares favorably with 1992's cost of goods sold of 74.1%. These lower costs reflect the positive effects of the 1992 restructuring activities, productivity gains, some pricing increases, and product mix enhancements.
Interest expense was favorably affected by lower debt levels and lower interest accruals for tax obligations. Miscellaneous income and expense in 1993 included the positive effects of lower amortization of acquired intangibles as a result of the 1992 restructuring, profits resulting from the closing out of some interest rate swaps in anticipation of interest rate increases, and gain on sale of assets. Partially offsetting these positive effects were some increased environmental expenses and a small foreign exchange loss in 1993 compared with a small foreign exchange gain in 1992.
Geographic area results (see pages 7 and 8)
United States--Sales increased by nearly 4% from 1992 levels. The 1992 net sales included five months of the building products segment's grid sales that were made prior to the formation of the Armstrong and Worthington Industries joint venture (WAVE) effective June 1, 1992. Removing these sales from 1992 would result in an additional 1% increase in the year-to-year sales comparison. Operating profits jumped 251% when comparing 1993 with those of 1992. The continuing economic recovery provided increased opportunity in our end-use markets. During 1993, single family housing starts increased 6% and the sale of existing single family homes rose nearly 8%. Nonresidential new construction appeared to be close to the bottom of its cycle.
A major source of higher sales in 1993 was the significant increase in business channeled through national home centers and mass merchandisers. These sales, coupled with the stronger resilient flooring business, were major factors in generating significantly higher operating profits. The furniture and ceramic tile businesses also generated higher sales, while sales in the building products and textile products businesses were lower. The operating profit improvements were also driven by the 1992 restructuring activities that resulted in lower manufacturing costs in most domestic businesses, by some higher sales levels, and by continuing productivity improvements.
Operating profits for both years included significant restructuring charges. The 1993 and 1992 restructuring charges total about $37 million and $98 million, respectively. The 1993 restructuring charges were primarily attributable to position eliminations. The 1992 restructuring charges included closing two plants, the write-down of fixed assets, and the elimination of employee positions.
Export sales of Armstrong products from the U.S. to trade customers increased nearly $3 million, or 11%, compared with 1992.
Europe--The 1993 European economic environment continued to be weak in both the commercial and residential markets; however, the British market offered some improvement for Armstrong products. Net sales decreased 16%, but two-thirds of the decline reflected the weakening of European currencies. Excluding the impact of the strong U.S. dollar, insulation products was the only business in Europe that recorded a year-to-year sales increase. The European building products business relies entirely on commercial construction and had the largest decline, nearly 12%. Even with lower sales, operating profits for Europe improved 41%. This improvement was primarily the result of lower costs caused by restructuring actions taken in the latter part of 1992, including the closing of the Ghlin, Belgium, ceilings manufacturing facility.
Other foreign--Sales in 1993 declined nearly 4% from those of 1992. Operating profits were recorded for 1993 compared with an operating loss in 1992. The 1992 operating loss resulted from restructuring charges associated with the closing of the Gatineau, Canada, ceilings manufacturing plant. The overall sales decline was a result of lower sales of resilient flooring in Japan and Southeast Asia that were partially offset by higher sales of flooring in Australia and Canada and of building products in the Pacific Rim. Excluding the impact of the restructuring charges in 1992, operating profit for 1993 increased in the year- to-year comparison.
Industry segment results (see pages 3 and 4)
Floor coverings--Worldwide sales were 5% higher in 1993 than in 1992, with operating profits increasing threefold from 1992 levels. The operating profit included restructuring charges in 1993 of almost $28 million compared with nearly $81 million in 1992. Almost three-fourths of the 1993 restructuring charges were related to ceramic tile with the remainder recorded in resilient flooring. Nearly all of the 1992 restructuring charges related to ceramic tile.
Sales in the resilient flooring portion increased in North America but were lower in the European and Pacific areas. The North American increase was driven by sales in the U.S. market with strong growth through national account home centers and mass merchandisers as well as modest growth through wholesalers. The U.S. resilient flooring business was also helped by higher sales of existing homes and new housing construction. Ceramic tile recorded a modest sales increase primarily because of its residential business. The commercial institutional market for ceramic tile continued to be weak, providing little sales growth in 1993 compared with 1992.
- 24 -
Operating profits, excluding the effects of restructuring charges, increased 42%. Resilient flooring operating profits improved because of the higher sales levels and because of significantly lower manufacturing costs that were achieved by process improvement and productivity gains. Ceramic tile continued to record a loss in 1993 as it did in 1992, but the losses were less in each of the 1993 quarters when compared with 1992. The ceramic tile business was adversely affected by very competitive pricing and a shift in product mix to lower margin products.
Capital investments for 1993 were higher than those of 1992 with continued concentration of these expenditures in improving and maintaining the current manufacturing processes and in generating additional capacity from existing equipment.
Building products--On a worldwide basis, market conditions did not improve in the commercial construction markets in 1993. The North American sales comparison reflects a decline because the first five months of 1992 included grid that was sold prior to the formation of the WAVE joint venture. The European markets, with the exception of the United Kingdom, were weaker in 1993. European sales declined by nearly 22%, of which half was caused by weaker European currencies.
The 1993 operating profit included restructuring charges of nearly $14 million, while the 1992 operating loss included $35 million of restructuring charges. This segment lowered its cost structure significantly as a result of restructuring actions taken in 1992 that included the closing of two manufacturing facilities and productivity improvements that were attained in 1993. Even with lower sales and competitive pricing early in 1993, the lower cost structure that was put in place, coupled with some higher sales prices in the second half of 1993, permitted this segment to increase operating profits.
Capital investments in 1993 were about the same as 1992, but both years' expenditures were lower than depreciation levels.
Furniture--Operating results for this segment were positive--1993 sales nearly 3% higher than those of 1992 and operating profits more than 150% higher than last year. Both years contained restructuring charges that were less than $1 million in 1993 and nearly $5 million in 1992. Exclusive of restructuring charges, this segment recorded operating profits that were 80% higher than last year.
With the U.S. consumer household durable goods spending increasing in 1993, modest sales increases were recorded in the Thomasville wood and upholstery business that more than offset declines in the Armstrong retail, ready-to- assemble furniture, and the contract business.
The operating profit improvement was driven by higher sales volume, lower costs resulting from the 1992 restructuring program, and improved productivity. Higher lumber costs had a negative impact on 1992 operating results and continued to increase throughout much of 1993 but were offset by increased sales prices. Capital expenditures in 1993 increased modestly over those of 1992.
Industry products--Almost three-quarters of the sales of this segment generally occur in European markets, which in 1993 remained in recession, limiting growth opportunities. Worldwide sales declined nearly 7%, with the stronger U.S. dollar accounting for 95% of the decline. Operating profits declined by slightly more than 7%, with restructuring charges of almost $13 million in each year.
The insulation business remains the most significant portion of this segment. Excluding the negative effect of currency translation, sales grew modestly while operating profits recorded a small decline. The German market remained relatively strong for this business while markets in the other European countries were adversely affected by weak economies. Sales in North America and the Pacific Rim recorded a small increase in 1993. While the insulation business restructuring programs did lower costs, they were not able to offset the impact of the lower sales and competitive pricing pressures.
The textile mill supplies business recorded significantly lower sales that were driven by the worldwide recession in the textile industry. This business, while lowering its cost structure, was unable to offset the impact of the significantly lower sales worldwide. The gasket materials business recorded slightly lower sales, with a small decline in operating profit from 1992 levels.
Capital expenditures were reduced by about one-third from 1992 levels, but were almost 40% greater than annual depreciation levels. The capital investments continue generally to support future growth of this segment.
- 25 -
1992 compared with 1991
Financial condition
As shown on the Consolidated Statements of Cash Flows, net cash provided by operating activities in 1992 was $186.8 million, more than sufficient to cover investments in property, plant, and equipment, and dividends, and an investment in a new joint venture. The balance of cash, including cash proceeds from sale of assets, was used to reduce debt and increase cash and cash equivalents.
During the first quarter of 1992, the company redeemed, for $8.8 million, all outstanding 8% sinking-fund debentures due in 1996 at face value plus accrued interest to the date of redemption.
For 1992, the company recorded a $165.5 million charge before tax ($123.8 million after tax) in connection with a restructuring plan designed to increase the overall profitability of the company by closing four major plants; scaling back of certain operations; elimination of positions throughout the company; and write-downs of land, buildings, equipment and intangible assets. Approximately two-thirds of the before-tax losses were noncash charges related to the write-down of assets. Cash outlays for restructuring charges in 1992 were approximately $9.4 million. Most of the cash outlays are expected to occur in 1993 and to be offset by operating savings resulting from the restructuring.
During the fourth quarter of 1992, the company adopted three new financial accounting statements: SFAS 106, SFAS 109 and SFAS 112. Adoption of these financial accounting statements had no current cash flow impact on the company.
Receivables declined $2.7 million and inventories declined $17.0 million. Each reflects the translation of foreign currency receivables or inventories to U.S. dollars at lower exchange rates. Higher sales volume late in the fourth quarter increased receivables and helped lower inventories. Current income tax benefits increased $8.1 million, principally because of deferred tax benefits related to restructuring charges. Other noncurrent assets decreased $53.1 million because of a $30.0 million write-off of intangible assets and a $30.0 million reduction of prepaid pension costs, both attributable to restructuring activities. Partially offsetting the decreases in noncurrent assets were investments in the WAVE grid joint venture.
- 26 -
The company's year-end ratio of current assets to current liabilities declined to approximately 1.3 to 1 from the 1.5 to 1 ratio reported in 1991. The major cause of the decline is the $47.9 million of accrued expenses associated with restructuring activities.
The company is involved in significant litigation, which is described more fully under "Litigation" on pages 60-65 and which should be read in connection with this discussion and analysis.
Although the company does not know how many claims will be filed against it in the future, nor the details thereof or of pending suits not fully reviewed, nor the expense and any liability that may ultimately result therefrom, based upon its experience and other factors, the company believes that it is probable that nearly all of the expenses and any liability payments associated therewith will be paid--in the case of the personal injury claims, by agreed-to coverage under the Wellington Agreement and supplemented by payments by nonsubscribing insurers that entered into settlement agreements with the company and additional insurance coverage reasonably anticipated from the outcome of the insurance litigation and from the company's claims for non-products coverage, both under certain insurance policies covered by the Wellington Agreement and under certain insurance policies not covered by the Wellington Agreement which claims have yet to be accepted by the carriers--and in the case of the property damage claims, under an existing interim agreement, by insurance coverage settlement agreements and through additional coverage reasonably anticipated from the outcome of the insurance litigation. To the extent that costs of the property damage litigation are being paid by the company's insurance carriers under reservation of rights, the company believes that it is probable that such payments will not be subjected to recoupment. Thus, the company has not recorded any liability for any defense costs or indemnity relating to these lawsuits other than a reserve in "Other long-term liabilities" for the estimated potential liability associated with claims pending intended to cover potential liability and settlement costs, legal and administrative costs not covered under the agreements, and certain other factors which have been involved in the litigation about which uncertainties exist. Even though uncertainties still remain as to the potential number of unasserted claims, the liability resulting therefrom, and the ultimate scope of its insurance coverage, after consideration of the factors involved, including the Wellington Agreement, the settlements with other insurance carriers, the remaining reserve, the establishment of the Center for Claims Resolution, the proposed settlement class action, and its experience, the company believes that this litigation will not have a material adverse effect on its earnings, liquidity, or financial position.
Reference is made to the litigation involving The Industry Network System, Inc. (TINS), discussed on pages 64-65. The company denies all of TINS' claims and accordingly is vigorously defending the matter. In the event that a jury finds against the company, such jury verdict could entail unknown amounts which, if sustained, could have a material adverse effect on its earnings and financial position.
Long-term debt, excluding the company's guarantee of the ESOP loan, was reduced by $34.8 million in 1992. At year-end 1992, long-term debt represented 47% of shareholders' equity compared with 34% at the end of 1991. The increase is the result of shareholder equity reductions caused primarily by the cumulative-effect charges from adoption of accounting statements and restructuring charges previously discussed.
Should a need develop for additional financing, it is management's opinion that the company has sufficient financial strength to warrant the required support from lending institutions and financial markets. In June 1992, the company's registration statement for $250 million of debt securities was declared effective.
Consolidated results
Record net sales in 1992 of $2.55 billion increased 4.5% from $2.44 billion in 1991. Increased sales opportunity was provided by the residential, do-it- yourself, and industrial markets, while for the fifth consecutive year, commercial markets remained depressed. European economies continued
- 27 -
to reflect a recessionary environment, which resulted in reduced demands for the company's products. Sales in each of the 1992 quarters were above those of 1991. The rate of growth was highest in the first quarter, but was lower during the last three quarters of the year.
Net losses in 1992 were $227.7 million, compared with net earnings of $48.2 million in 1991. Net losses per share of common stock for 1992 were $6.49 on both a primary and fully diluted basis compared with 1991 net earnings of 77 cents per share.
The return on common shareholders' equity in 1992 was a negative 33.9% compared with a positive return of 3.3% in 1991.
The 1992 losses reflect charges of $167.8 million after tax related to the company's adoption, retroactive to January 1, 1992, of SFAS 106 and SFAS 112. The 1991 net earnings included a $12.4 million after-tax provision related to discontinued businesses.
Losses from continuing businesses in 1992 totaled $59.9 million, compared with earnings from continuing businesses of $60.6 million in 1991. The loss per share of common stock from continuing businesses was $1.98 on both a primary and fully diluted basis compared with 1991 earnings per share of $1.11.
The net loss for 1992 included an effective tax benefit rate of 1.0% compared with 1991's effective tax rate of 39.6%. The reduced 1992 tax benefit rate is generally because some of the restructuring charges do not provide tax benefits. In addition, a lower share of foreign countries' earnings resulted in lower tax rates. The company also adopted SFAS 109 resulting in tax benefits of $5.5 million for 1992 being credited directly to retained earnings rather than to income taxes on the consolidated statement of earnings. The 1991 effective tax rate included an increased share of the company's earnings coming from foreign countries with higher tax rates and a $3.7 million deferred income tax charge reflecting increases in state income tax rates.
The loss from continuing businesses before income taxes was $60.4 million, compared to earnings from continuing businesses before income taxes in 1991 of $100.3 million.
Included in the loss from continuing businesses for the full year 1992 were restructuring charges of $165.5 million before tax. These restructuring charges related to the closing of four major manufacturing plants--two in the U.S., one in Canada, one in Belgium--and to the scaling back of operations in certain other plants in the U.S. and abroad. Also included were accruals for costs associated with elimination of positions throughout the company, as well as write-downs of the value of land, buildings, equipment, and intangible assets of the company. The cash outlays for the restructuring charges will occur primarily in 1993 and are expected to be recovered by the savings resulting from the restructuring. Restructuring charges for 1991 amounted to $8.4 million after tax.
Lower short-term interest rates favorably affected interest expense. Miscellaneous income and expense in 1992 included the positive effects of an insurance reimbursement for certain costs associated with the 1990 takeover threat, foreign exchange gains, lower amortization of intangibles, and a gain from the early retirement of certain debt; the 1991 results included foreign exchange gains of $5.9 million.
The cost of goods sold for 1992, when expressed as a percent of sales, was 74.1% compared with 1991's 73.8%. This higher cost relationship is the result of the previously mentioned expense accruals required by SFAS 106 and SFAS 112. Operating results were affected by competitive pricing pressures and higher fixed costs concurrent with slow sales growth.
- 28 -
Geographic area results (see pages 7 and 8)
United States--Sales increased more than 4% while operating profits declined 61% when compared with 1991. Residential end-use markets improved significantly in 1992 when compared with 1991. Single family housing starts increased at a double digit rate while the sales of existing single family homes provided a more modest increase. New construction put in place for private nonresidential buildings was significantly lower in 1992 than in 1991.
The 1992 net sales included only five months of the building products segment's grid sales compared with a full year's sales in 1991 as a result of the grid joint venture with Worthington Industries effective June 1, 1992. Results after that date have been recorded on an equity-accounting basis. The major contributor to increased sales in 1992 was the resilient flooring business which benefited from significant new product introductions and year-to-year improvements in the previously mentioned single family housing starts and sales of existing homes. Most domestic businesses were affected by competitive and promotional pricing and less favorable product mix. Costs associated with the expansion of the residential ceramic tile program adversely impacted profit performance.
The largest decline in operating profit is attributable to the major restructuring charges recorded during 1992, including the closing of the Pleasant Garden, N.C., furniture plant, the closing of the Quakertown, Pa., quarry-tile ceramic plant, and related accruals for the write-downs of land, buildings, and equipment, as well as elimination of employee positions.
Export sales of Armstrong products from the U.S. to trade customers declined $5 million or 17% during 1992 when compared with 1991.
Europe--The 1992 economic environment in Europe continued to weaken in both the commercial and residential markets. Net sales increased 7%, but more than half of the increase was the result of translating foreign currency sales to
- 29 -
U.S. dollars at higher exchange rates. Operating profits declined 56%. Nearly 60% of this decline was due to restructuring charges related to the closing of the Ghlin, Belgium, plant and to accruals for the elimination of employee positions. The European insulation business continued its sales and operating profit improvement, primarily as a result of a strong German insulation market. This business's operating profit was reduced by start-up costs related to new facilities in Spain and Germany during 1992. The European ceilings business was affected by the depressed commercial markets coupled with competitive pricing and a less favorable product mix.
Other foreign--Sales in 1992 declined 3% from those of 1991 while an operating loss was recorded for the year. The operating loss included restructuring charges associated with the closing of the Gatineau, Canada, ceilings manufacturing plant. Sales improvement was recorded in the Southeast Asian area, but operating profits declined in this area as a result of increased costs that are designed to obtain future growth.
Industry segment results (see pages 3 and 4)
Floor coverings--Sales were 7% higher in 1992 than in 1991, with operating profits declining by 64%. Operating profits include restructuring charges in 1992 of nearly $81 million compared with $3 million in 1991. Nearly all of the restructuring charges relate to ceramic tile.
Sales in the resilient flooring portion increased significantly, paced by sales in North America, where a new annual sales record was set with the help of the introduction of the largest-ever assortment of new flooring products during the second quarter of 1992. Ceramic tile recorded a small increase in sales primarily because of the developments in the residential ceramic tile markets through American Olean and Armstrong distribution channels. The ceramic tile portion continues to be adversely affected by the depressed commercial institutional market and recorded losses in both 1992 and 1991.
Operating profits during 1992, while positively affected by the sales growth, were adversely affected by competitive pricing, movement towards a lower margin sales mix, small increases in raw material costs in the second half of the year, and continuing costs related to the new residential ceramic tile businesses.
Capital investments for 1992 were lower than 1991 but continued to be directed toward product development, cycle-time reduction, and manufacturing process improvements.
Building products--On a worldwide basis, market conditions remained depressed in the commercial construction markets, resulting in lower opportunity and declining product prices. Sales declined nearly 3% year to year while recording an operating loss that included restructuring charges of $35 million in 1992 compared with $4.3 million in 1991.
The year-to-year sales decline was caused by the transfer of grid sales for the last seven months of 1992 to the WAVE joint venture.
The continued decline of nonresidential construction in the U.S. and abroad significantly affected the operating results. Worldwide competitive pricing pressures and lack of sales growth eroded operating profit faster than the company's ability to lower costs.
- 30 -
Capital investments in 1992 were reduced significantly from prior year levels and were directed towards manufacturing process improvement and consolidations.
During 1992, the company closed its Gatineau, Canada, and Ghlin, Belgium, ceilings plants and scaled back other operations. In 1991, Armstrong exited certain wall businesses and its Forms + Surfaces architectural products business.
Furniture--The 1992 sales increased 5%, while operating profits declined 43%, including restructuring charges of $4.8 million.
The contract furniture, ready-to-assemble furniture, and upholstered furniture businesses reflected sales increases that were partially offset by lower sales in the Thomasville wood business. Operating results were adversely affected by promotional pricing efforts, higher lumber costs, and increased costs for employee medical benefits.
Actions were taken in 1992 to monitor customer satisfaction, increase square footage of the Thomasville Home Furnishings Stores, reengineer upholstery operations to improve service, and develop a computerized order service system for expediting shipments. Investments in these areas increased capital expenditures modestly for 1992 compared with 1991. Restructuring actions included closing the Pleasant Garden manufacturing facility and elimination of salaried employee positions.
Industry products--Worldwide sales increased 11% while operating profits declined $7.7 million, or 18%. Restructuring charges were $12.5 million in 1992 and $2.2 million in 1991.
The insulation business remained strong in 1992 because of the European markets, particularly in Germany. New product introductions and improved technical values through new formulations aided the success of this business. Profitability was slowed somewhat by start-up costs for new facilities in Spain and Germany that increased capacity. The gasket materials business recorded strong sales and operating profit increases when compared with 1991. The textile mill supplies business recorded small sales increases, but operating results declined because of cost and pricing pressures.
- 31 -
Item 8. | 7431 | 1993 |
Item 6.Selected Financial Data
The Six-Year Selected Financial and Statistical Data as set forth in the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
Item 7. | Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Operations and Financial Condition as set forth in the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
Item 8. | 310158 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
FIVE-YEAR SELECTED FINANCIAL AND STATISTICAL DATA (in millions, except per share data)
A27
A28
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EARNINGS: The Company reported net earnings for the year ended December 31, 1993 of $15.6 million, or $.38 per share, compared with a net loss of $83.1 million, or $2.01 per share in 1992 and net earnings of $46.0 million, or $1.12 per share, in 1991. Net earnings in 1993 include $104.5 million of previously unrecognized results of the Company's investments in Peru. In the fourth quarter of 1993, the Company resumed equity accounting for its 52.3% interest in Southern Peru Copper Corporation (SPCC) and recorded the results of its 80% owned subsidiary Corporacion Minera Nor Peru, S.A. (Nor Peru). The change in accounting for Asarco's investments in Peru resulted from the improvements in the political, economic and operating conditions in Peru, which included the ratification of a new constitution and the successful completion of SPCC's capital program financing, which restored management's influence over its Peruvian operations. To reflect this change, the Company recorded $18.2 million of previously unrecognized earnings relating to the period 1988 through 1993 from its investments in Peru and $86.3 million, or $2.08 per share, for the cumulative effect of a change in accounting principle resulting from SPCC's adoption of SFAS 109, "Accounting for Income Taxes". The Company also recorded an after-tax charge of $16.7 million ($25.6 million pre-tax) related to the valuation of certain inventories and additions to reserves, principally for assets planned for disposition. Also included in 1993 earnings are LIFO profits of $5.9 million after-tax ($9.2 million pre-tax) resulting from the reduction of inventories accounted for on a LIFO basis due principally to the completion of the integration of the Company's copper business.
Results were adversely impacted beginning in late 1992 and into early 1993 by unusually heavy rains in Arizona which affected operations at two of the Company's principal copper properties. While the most severe effect of the rains was overcome by the second quarter of 1993, the limitations imposed on mining operations at the Ray mine by the substantial amount of water retained in the pit continued to affect operations through the balance of the year. As a result, copper production was reduced from expected levels, costs were higher and net earnings were reduced by $22 million. Completion of the major expansions at the Company's Mission and Ray mines in Arizona resulted in increased copper mine production in 1993 and 1992 compared with 1991, but principally because of the heavy rains in Arizona, copper mine production did not meet expectations.
Asarco earnings are heavily influenced by the metals markets. The economic recovery in the United States created increasingly strong demand for the Company's products domestically but economic weakness in continental Europe and in Japan offset most of the growth in the U.S., Southeast Asia and Latin America. As a result of the imbalance in supply and demand, prices for all of the Company's principal base metal products, copper, lead and zinc, reached new lows for this economic cycle in 1993. Silver prices however, increased in 1993 compared to 1992 and 1991 as speculative buying and concern over inflation renewed investor demand for precious metals. Compared with 1992, the Company's 1993 earnings were lowered by $96 million due to these price declines.
The net loss of $83.1 million in 1992 includes an after-tax charge of $122.1 million consisting of $56 million for the adoption of SFAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions", $44 million for environmental costs, and $21.1 million for the reduction in carrying value of certain facilities.
Net earnings of $46 million in 1991 were reduced by a charge of $6.6 million after-tax, to establish a reserve for a receivable from a copper customer which filed for bankruptcy protection and were benefited by an after-tax profit of $5.4 million from the sale of the Company's direct interest in Highlands Gold Limited.
In August 1993, the Company sold a 9.9% interest in Asarco Australia Limited (Asarco Australia), its gold mining subsidiary for $13.8 million. The sale resulted in a pre-tax gain of approximately $10.3 million ($5.4 million after- tax). Owning less than 50% of Asarco Australia following the sale, the Company began to account for this investment by the equity method. In September 1993, Asarco Australia offered 13.3 million shares of previously unissued common stock to the public, resulting in net cash proceeds of A$16.4 million. As a result of this share issuance, the Company's ownership was reduced to 45.3% and a $3.3 million pre-tax gain ($2.1 million after-tax) was recognized as the shares were sold at a price exceeding the book value per share of the Company's investment. In January 1994, the Company sold its remaining 45.3% interest (66.5 million shares) for $79.5 million. The sale resulted in a pre-tax gain of $58.5 million which will be reported in the first quarter of 1994.
A29
PRICES: Prices for the Company's metals are established principally on the New York Commodity Exchange (COMEX) or the London Metal Exchange (LME). Thus, it is not possible to predict prices for future metal sales.
Price volume analysis: The following prices and volumes were realized.
SALES: Sales in 1993 were $1,736.4 million, compared with $1,908.5 million in 1992 and $1,911.8 million for 1991. The decline in sales dollars caused by lower prices for copper and lead in 1993 was partially offset by increased volumes for both metals. Accounting for the Company's investment in Asarco Australia as an equity investment rather than as a consolidated subsidiary reduced 1993 sales by approximately $25 million.
COST OF PRODUCTS AND SERVICES: Cost of products and services in 1993 were $1,638.0 million, compared with $1,647.3 million in 1992 and $1,634.2 million in 1991. The decrease in 1993 was caused principally by the elimination of operating costs at operations on standby status. In April 1993, the Company put its Troy, Montana, copper-silver mine on standby due to low silver prices. The Troy shutdown followed the suspension of production at the Galena mine in 1992 and the Coeur mine in 1991. LIFO profits of $9.2 million, the deconsolidation of Asarco Australia and other operating cost reductions, $8.2 million of previously unrecognized losses of Nor Peru and higher purchases of refined copper also affected cost of products and services. The Company's cost for purchased refined copper approximates the market price at which it is sold. Cost of products and services were negatively impacted by the heavy rains in Arizona in late 1992 and early 1993. The increase in 1992 was from increases in copper sales volumes, net of the impact of lower lead and silver sales volumes and lower purchases of refined copper. In 1991, equipment availability problems, higher reagent usage, pump repairs and train derailments at the Ray mine, resulted in reduced production and higher operating costs.
OTHER EXPENSES: Selling and administrative costs decreased by $1.8 million in 1993 and $7.1 million in 1992, principally as a result of cost reduction programs. The 1991 provision for doubtful accounts includes a $10.6 million bad debt reserve for receivables from Laribee Wire Manufacturing Company, Inc. and its affiliated companies. Depreciation and depletion expense decreased by $6 million in 1993 as a result of the temporary closure of the Troy mine, the deconsolidation of Asarco Australia and lower production at the Ray mine due to heavy rains. Depreciation and depletion expense increased by $11.8 million in 1992 primarily as a result of higher production following the completion of the expansion programs at Mission in October 1991 and Ray in February 1992. Increases in ore reserves at Ray extended the economic life of the mine, reducing depreciation and depletion expense. Research and exploration expense declined by $5.0 million in 1992 as a result of reduced levels of exploration activity, and that level was maintained in 1993.
A30
NONOPERATING ITEMS: Interest expense increased a further $6.1 million in 1993 after increasing by $5.0 million in 1992 as compared to 1991 as a result of higher borrowings. The amount of interest capitalized has been declining as a result of the completion of portions of the copper expansion program. Interest expense has been reduced by lower interest rates paid on floating rate debt. The weighted average interest rate on this debt was 3.7% in 1993 compared to 4.2% in 1992 and 6.5% in 1991. Other income was $30.2 million in 1993, $23.9 million in 1992 and $22.9 million in 1991. Other income in 1993 includes a $10.3 million gain on the sale of a 9.9% interest in Asarco Australia and $9.4 million of dividends from SPCC, recorded prior to resuming equity accounting. Other income in 1992 includes $7.8 million of dividends from SPCC and in 1991 an $8.7 million gain on the sale of Highlands Gold Limited shares. Dividends from M.I.M. Holdings Limited included in other income were $8.3 million in 1993, $8.8 million in 1992 and $9.5 million in 1991.
TAXES ON INCOME: The tax benefits in 1993 and 1992 result principally from operating losses and, in 1992, from the settlement of a Canadian tax assessment. Taxes in 1993 include $2.8 million for additional deferred Federal Income taxes as a result of the increase in the statutory tax rate to 35% and higher taxes on the gain realized on the sale of 9.9% of the shares of Asarco Australia, as a result of providing taxes on earnings previously treated as permanently reinvested while Asarco Australia was a consolidated subsidiary. Taxes on income were reduced for 1991 as a result of percentage depletion, partially offset by the tax effect of the pro rata repurchase of outstanding shares by SPCC. Net operating loss carryforwards have reduced the Company's deferred tax liability by $127.6 million at December 31, 1993. The Company believes that these carryforwards, which expire in 2006, 2007 and 2008, will reduce future federal income taxes otherwise payable and, if necessary, the Company could implement available tax planning strategies, including the sale of certain assets, to realize the tax benefit of the carryforwards.
EQUITY IN EARNINGS OF NONCONSOLIDATED ASSOCIATED COMPANIES: Equity earnings in 1993 are principally from the previously unrecognized results of SPCC. In the second quarter of 1991, the Company discontinued equity accounting for its investment in Mexico Desarrollo Industrial Minero, S.A. de C.V. (MEDIMSA), after announcing that it was considering the sale or other form of disposition of some or all of its investment. In light of this and other factors, the Company's equity earnings from MEDIMSA include earnings for the first quarter of 1991 only. In January 1994, the Company signed an agreement with Grupo Industrial Minera Mexico, S.A. de C.V. (Grupo Mexico) for combining MEDIMSA with Grupo Mexico, its publicly traded parent. The agreement is subject to a number of approvals. Under the terms of the agreement with Grupo Mexico, the Company will hold a 23.6% stake in the new Grupo Mexico upon completion of the transaction. This transaction will ultimately provide greater liquidity for the Company as its holdings will be in a publicly traded entity.
CASH FLOWS - OPERATING ACTIVITIES: Net cash provided from operating activities was $38.9 million in 1993, compared with $105.7 million in 1992 and $67.5 million in 1991. The $66.8 million decrease in 1993 from 1992, was from lower earnings due to a decline in metals prices and other items noted above, net of $101.5 million of operating cash provided from inventory and receivable reductions and higher accounts payable. Setting aside the effect of the $122.1 million provision, which is a noncash charge, and other noncash items, the $38.2 million increase in 1992 from 1991 results from $13.9 million from operating activities and $24.3 million from a reduction in operating assets net of liabilities.
CASH FLOWS - INVESTING ACTIVITIES: Capital expenditures were $112.3 million in 1993, of which $23.8 million was spent on the completion of the El Paso copper smelter modernization. Capital expenditures in 1992 were $134.6 million, including $70.3 million for the copper expansion and modernization program at the Ray mine and El Paso smelter and $9.5 million for participation payments on previously acquired properties. Capital expenditures in 1991 were $282.9 million, of which $207.5 million was spent on the expansion and modernization program at the Mission and Ray mines and the El Paso smelter. The expansion and modernization at Mission was completed in the fourth quarter of 1991 and at Ray in the first quarter of 1992. The Company's planned capital expenditures in 1994 are estimated to be about $90 million.
The proceeds from sale of securities and property represents, principally, the investment portfolio of Geominerals Insurance Company, Ltd. which for the most part is reinvested by purchasing additional securities. Proceeds of $13.8 million from the sale of a 9.9% interest in Asarco Australia are included in proceeds from sale of securities in 1993. In 1992, the Company did not exercise a $40 million option to purchase 16,705,527 shares of MEDIMSA which it held under a 1989 agreement, effectively lowering its ownership interest to 28.3%. Included in purchases of investments in 1991 is $24.9 million for a stock subscription of MEDIMSA by a wholly owned subsidiary of the Company. The Company received
A31
proceeds of $25.8 million in 1991 from the sale of shares of Highlands Gold Limited and received $31.4 million from a SPCC pro rata repurchase of outstanding shares which is included in proceeds from sale of securities. The Company reduced its carrying value in SPCC by the amount of these proceeds. In 1991, Asarco Australia, previously a 60% owned subsidiary of the Company, acquired the remaining 50% interest in the Wiluna gold mine owned by its former partner for $17.4 million.
LIQUIDITY AND CAPITAL RESOURCES: Debt securities in the amount of $250 million were issued in 1993 including $100 million of 7 3/8% Notes due in 2003, $100 million of 7 7/8% Debentures due in 2013 and $50 million of 7% Notes due in 2001. Proceeds of these debt issues were used to reduce borrowings under revolving credit loan agreements. In addition, after year-end, the Company prepaid its 9 3/4% Sinking Fund Debentures at par value plus a premium of .9%. In 1993, the Company also entered into a new five-year $320 million revolving credit agreement to replace a $260 million revolving credit agreement which expired. At December 31, 1993, the Company's debt as a percentage of total capitalization was 38.0%, compared with 39.0% at the end of 1992 and 35.2% at the end of 1991. Debt at the end of 1993 was $900.5 million, compared with $868.8 million in 1992 and $801.6 million at the end of 1991. Additional available credit under existing loan agreements totaled $339 million at the end of 1993. The Company adopted SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities" in the fourth quarter of 1993, which increased stockholders equity by an after-tax credit of $112.7 million ($173.4 million pre-tax) to reflect the increased net value of its cost investments, principally M.I.M. Holdings Limited. Earnings were not affected by this accounting change.
The Company expects that it will meet its cash requirements in 1994 and beyond from internally generated funds, from proceeds of the sale of its remaining interest in Asarco Australia in January 1994 and from borrowings, if necessary, under its revolving credit agreements, or from additional debt financing.
DIVIDENDS AND CAPITAL STOCK: The Company paid dividends of $20.8 million, or 50 cents per share, in 1993 and $33.0 million, or 80 cents per share, in 1992. In 1991, the Company purchased 67,314 shares of common stock at a cost of $1.8 million and paid dividends of $65.8 million, or $1.60 per share. At the end of 1993, the Company had 41,718,000 common shares issued and outstanding, compared with 41,467,000 at the end of 1992 and 41,249,000 at the end of 1991.
CLOSED FACILITIES AND ENVIRONMENTAL MATTERS: During 1993, the reserve for environmental matters was increased by $6.2 million for ongoing evaluations of environmental costs. As a result of developments during 1992, at a number of the Company's properties where it was probable that an environmental liability had been incurred, the Company was able to further refine previous estimates with requisite certainty for a substantial portion of the anticipated costs at those sites. Accordingly, in 1992, the Company recorded a pre-tax charge of $72.4 million to provide additional reserves for these environmental costs. At the end of 1993, reserves for closed plant and environmental matters totaled $116.1 million. Cash expenditures charged to these reserves were $44 million in 1993, $36 million in 1992 and $32 million in 1991. The increased level of expenditures in 1993 are due to settlement of litigation concerning past operations at the Company's Globe plant in Denver. Future environmentally related expenditures cannot be reliably determined in many circumstances due to the early stages of investigation, the uncertainties relating to specific remediation and clean-up methods and therefore the related costs, the possible participation of other potentially responsible parties, insurance coverage issues and changing environmental laws and interpretations. It is the opinion of Management that the outcome of these environmental matters will not materially adversely affect the financial position of Asarco and its consolidated subsidiaries. However, it is possible that future environmental contingencies could have a material effect on quarterly or annual operating results, when they are resolved in future periods. This opinion is based on considerations including experience related to previous court judgments and settlements and remediation costs and terms. The financial viability of other potentially responsible parties has been considered when relevant and no credit has been assumed for any potential insurance recoveries when the availability of insurance has not been determined.
In 1992, the Company concluded that certain facilities, primarily at the El Paso, Texas, smelter, were unlikely to be used following completion of its modernization and expansion program in 1993. Accordingly, the Company recorded a pre-tax charge of $31.9 million to reduce the carrying value of these facilities.
ACCOUNTING MATTERS: In 1993, the Company adopted SFAS 112, "Employers' Accounting for Post Employment Benefits", which had no net effect on earnings.
A32
ITEM 8 | 7649 | 1993 |
Item 6. Selected Financial Data.
The following selected financial data are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.
Selected Financial Data
Years Ended December 31, 1993(a) 1992 1991 1990 1989 (dollars in thousands)
Total revenues $1,288,777 $1,170,371 $1,141,662 $1,114,068 $1,072,817
Net income (b) 195,741 161,908 135,020 121,925 86,107
December 31, 1993(a) 1992 1991 1990 1989 (dollars in thousands)
Total assets $7,658,775 $7,210,763 $6,906,025 $6,802,524 $6,534,341
Long-term debt 4,018,797 3,604,371 2,819,045 2,239,448 2,348,158
Item 6. Continued
(a) The Company adopted three new accounting standards through cumulative adjustments as of January 1, 1993, resulting in a one-time reduction of net income of $12.7 million. See Note 2. of the Notes to Consolidated Financial Statements in Item 8. herein for information on the adoption of new accounting standards.
(b) Per share information is not included because all of the common stock of AGFI is owned by American General.
Item 7. | Item 7. Continued
Factors which specifically affected the Company's operating results are as follows:
Finance Charges. Changes in finance charge revenues, the principal component of total revenues, are a function of period to period changes in the levels of ANR, the yield, and the number of days in the periods compared. ANR for 1993 and 1992 increased when compared to the respective previous year. The increases resulted from receivables originated or renewed by the Company due to business development efforts and the continuance of the Company's historical practice of purchasing portfolios of receivables. The yield for 1993 and 1992 increased when compared to the respective previous year primarily due to increased emphasis on higher-rate non-real estate secured loans during 1993 and 1992 and higher yield on retail sales contracts for 1992. The additional day in 1992 also increased finance charge revenues for 1992 when compared to 1993 and 1991.
Insurance Revenues. There was an increase in insurance premiums earned for 1993 when compared to 1992 primarily due to the increase in premiums written in 1992 when compared to 1991. Insurance premiums written also increased for 1993 when compared to 1992 primarily due to an increase in the sale of the core credit and credit-related insurance products that resulted from increased loan volume, insurance product roll-outs, and the assumption of additional reinsurance business. Insurance premiums earned increased in 1992 when compared to 1991 primarily due to the increase in premiums written in 1991 when compared to 1990.
Other Revenues. Other revenues increased for 1993 and 1992 when compared to the respective previous year primarily due to an increase in investment revenue. The increase in investment revenue is due to the increased amount of investments in marketable securities and realized investment gains partially offset by a decline in investment yields. The decline in investment yields is primarily due to the low interest rate environment which caused some higher-yielding investments to be called. The proceeds of the called investments were reinvested at then current rates.
Interest Expense. Changes in interest expense are a function of period to period changes in the borrowing cost, average borrowings, and the number of days in the periods compared. The borrowing cost for 1993 and 1992 decreased when compared to the respective previous year due to the decline in short-term interest rates and the issuance of long-term debt at rates lower than the rates on fixed-rate obligations maturing, redeemed or that remain outstanding. Average borrowings for 1993 and 1992 increased when compared to the respective previous year primarily to fund asset growth.
Operating Expenses. Operating expenses increased for 1993 and 1992 when compared to the respective previous period. The increases were primarily due to increases in salaries, benefits, and occupancy costs. These expenses increased primarily due to an increase in the number of consumer finance offices in the third quarter of 1992 and the additional employees required to operate such offices. The increase in operating expenses for 1993 and 1992 when compared to the respective previous year was partially offset by the increase in deferral of finance receivable origination costs. Operating expenses also increased for 1993 when compared to 1992 due to a major branch office automation program.
Item 7. Continued
Provision for Finance Receivable Losses. Provision for finance receivable losses for 1993 increased when compared to 1992 due to an increase in net charge-offs and amounts provided for the allowance for finance receivable losses. Provision for finance receivable losses for 1992 decreased when compared to 1991 due to a decrease in net charge-offs partially offset by an increase in the amounts provided for the allowance for finance receivable losses. Net charge-offs for 1993 increased when compared to 1992 primarily due to the increase in ANR. The allowance for finance receivable losses for 1993 and 1992 increased when compared to the respective previous year primarily due to the increase in net finance receivables and to bring the balance to appropriate levels based upon the economic climate, portfolio mix, levels of delinquency, and net charge- offs.
Insurance Losses and Loss Adjustment Expenses. Insurance losses and loss adjustment expenses for 1993 increased when compared to 1992 primarily due to an increase in premiums written and the assumption of additional reinsurance business, slightly offset by a decrease in loss ratios. Insurance losses and loss adjustment expenses for 1992 also increased when compared to 1991. This increase was primarily due to an increase in premiums written and annuity payments that were made beginning in 1992 on annuity business which was acquired in 1991.
Cumulative Effect of Accounting Changes. The adoption of three new accounting standards resulted in a cumulative adjustment effective January 1, 1993 consisting of a one-time charge to earnings of $12.7 million. Other than the cumulative effect, adoption of these new accounting standards did not have a material effect on 1993 net income and is not expected to have a material impact in the future. See Note 2. of the Notes to Consolidated Financial Statements in Item 8. | 25600 | 1993 |
Item 6. Selected Financial Data.
The following table sets out certain selected financial data for the years indicated: Years Ended December 31, ------------------------------------ 1993 1992 1991 1990 1989 ------ ------ ------ ------ ------ (In thousands, except per share data)
Revenues $27,022 $31,413 $29,612 $34,311 $38,073 Costs and expenses: Operating costs 24,269 32,587 32,617 38,499 37,693 Provision for restructuring 288 1,392 1,000 - - Interest expense (income), net 43 125 83 78 (21) ------ ------ ------ ------ ------ Total costs and expenses 24,600 34,104 33,700 38,577 37,672 ------ ------ ------ ------ ------ Income (loss) before income taxes 2,422 (2,691) (4,088) (4,266) 401 Provision (benefit) for income taxes 53 (46) 101 (543) 309 ------ ------ ------ ------ ------ Net income (loss) (1) $ 2,369 $(2,645) $(4,189) $(3,723) $ 92 ====== ====== ====== ====== ====== Average shares outstanding 4,243 4,243 4,242 4,213 4,211 ====== ====== ====== ====== ====== Net income (loss) per share (1) $ .56 $ (.62) $ (.99) $ (.88) $ .02 ====== ====== ====== ====== ====== Dividends per share $ .00 $ .00 $ .00 $ .00 $ .00 ====== ====== ====== ====== ====== Total assets $11,018 $14,693 $13,615 $17,320 $23,696 Long-term debt - - - - 600 Working capital 5,846 2,413 4,298 6,661 9,561 Property and equipment, net 2,257 3,312 3,758 5,810 7,474 Stockholders' equity 8,114 5,745 8,390 12,564 16,276
- ----- (1) The net loss and net loss per share for 1992 originally reflected the tax benefit of a net operating loss carryforward as an extraordinary item. The tax benefit of the net operating loss carryforward has been reclassified and netted against the income tax provision, as explained in Note 5 to the Consolidated Financial Statements.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
FINANCIAL CONDITION.
Management considers cash provided by operations and retained earnings to be primary sources of capital. The Company maintains lines of credit to supplement these primary sources of capital and has leased its major facilities, reducing the need to expend capital on such items. Changes in the Company's financial condition, liquidity, and capital requirements during the three year period ended December 31, 1993 are attributable to significant operating losses through the first quarter of 1993 and a return to profitability in the periods subsequent to the March 1993 quarter. The return to profitability resulted in a significant improvement in the Company's financial condition. The losses resulted from a general decline in demand for products sold by the Company, significant expenses to maintain certain foreign subsidiaries, costs associated with excess capacity and costs related to restructuring of operations. The reduction in expenses resulting from the restructuring of operations, which was completed in the first quarter of 1993, resulted in the Company returning to profitability in 1993.
Certain ratios and amounts monitored by management in evaluating the Company's financial resources and performance are presented in the following chart:
1993 1992 1991 -------- -------- -------- Working capital: Working capital (thousands of dollars) $ 5,846 $ 2,413 $ 4,298 Current ratio 3.1 to 1 1.3 to 1 1.9 to 1 Profitability ratios: Gross profit 43 % 42 % 39 % Return on revenues 9 % ( 8)% (14)% Return on assets 22 % (18)% (31)% Return on equity 29 % (46)% (50)% Equity ratios: Total liabilities to equity 0.4 1.6 0.6 Assets to equity 1.4 2.6 1.6
The Company's financial condition improved significantly during 1993. Working capital increased to $5.8 million at December 31, 1993 from $2.4 million at December 31, 1992, and the ratio of current assets to current liabilities increased to 3.1 at the end of 1993, compared to 1.3 at the end of 1992. The improvement is attributable to a return to profitability resulting from expense reductions which included reductions in personnel levels and restructuring of operations, reduction in excess leased space and a general reduction in most expense items.
Net cash provided by operating activities was $5.2 million in 1993, contrasted with $1.5 million used by operations in 1992. The principal items contributing to the cash provided by operations in 1993 are net income
of $2.4 million, depreciation and amortization of $1.3 million, and decreases in accounts receivable and inventories. Cash provided by operations was used to reduce debt under financing agreements by $2.4 million in the 1993 period.
Cash flows from operations were also used to reduce accounts payable and accrued liabilities by a total of $2.3 million and provided cash of $1.7 million which was used to substantially complete restructuring of operations. Accounts receivable were unusually high at December 31, 1992 due to shipment of conditioning products during the latter part of the fourth quarter of 1992. The decrease in inventories in 1993 resulted from shipment of conditioning products in the first quarter of 1993 that were partially completed at December 31, 1992 and a decrease in raw materials inventory resulting from a decrease in demand for products sold by the Company. The decrease in the current ratio and working capital in 1992 compared to 1991 resulted principally from the $2.6 million loss reported in 1992 and an increase in inventories and accounts receivable. The inventory increase resulted from an increase in work-in-progress inventory related to products that were shipped in 1993. Short-term borrowing and an increase in accounts payable were used to support cash used by operations and to purchase $1.4 million of capital equipment in 1992.
Capital expenditures during 1993 totaled $492,000, a decrease from expenditures of $1.4 million in 1992. A change in product mix and volume increases at the Company's Service facilities will require additional equipment during 1994. Management currently projects that 1994 expenditures may exceed $1.0 million. The lease on the Company's corporate headquarters expires in 1995. The Company will decide during the first half of 1994 whether to continue to lease or purchase the existing facility, or to relocate to a different facility.
The Company maintains bank lines of credit to provide funds to support periodic changes in liquidity. Bank debt decreased $2.4 million in 1993 after increasing $2.0 million in 1992. Cash flow from operations was used to pay off all bank debt in 1993. Borrowings under loan agreements during 1992 were used to support cash used by operations and to finance capital expenditures. The U.S. Company's working capital line of credit is evidenced by demand notes and credit availability is limited to 80% of eligible accounts receivable. The Company's Singapore subsidiary has an overdraft facility; continuation of the facility is at the discretion of the bank. The Company could borrow an additional $1.4 million under its lines of credit at December 31, 1993. Current projections indicate that cash generated by operations supplemented by incidental bank borrowing under existing agreements will be sufficient to meet the cash requirements of the Company during 1994.
Effective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The adoption of this standard did not have a material effect on the Company's Financial Statements.
Reliability's revenue is dependent on conditions within the semiconductor industry and profitability is dependent on revenues and controlling expenses. Semiconductor manufacturers experienced good sales
growth during 1992 and 1993 and current forecasts indicate an increase in revenues for the industry in 1994. The Company has net operating loss carryforwards available to reduce income taxes on a portion of future taxable income.
RESULTS OF OPERATIONS.
OVERVIEW. Revenues from products sold by the Company declined during the three year period ending in 1993 except that an increase in revenues in the Conditioning Products segment in 1992 was attributable to revenues from the sale of INTERSECT 30 systems. Delivery of these high unit price systems began in the second quarter of 1992 and continued throughout 1993. A decline in revenues during the three year period in the Power Sources segment resulted from price competition, resulting in a significant decrease in unit prices and a decrease in unit volume. Customer requirements for conditioning Services decreased slightly in 1993. A small decrease in Services revenues in 1992 resulted from a revenue decrease at one of the Company's services facilities.
REVENUES. Revenues decreased 14% in 1993 to $27 million, reflecting decreases in all business segments. Revenues in the Central America geographical segment increased while the U.S., Asia and Pacific and Western Europe segments declined. The increase in the Central America segment is attributable to shifting Power Sources manufacturing to Costa Rica from Ireland and Singapore. The overall decrease in the U.S. segment is related to volume and unit price decreases. A substantial portion of the decrease in the Asia Pacific segment is related to shifting Power Sources manufacturing from Singapore to Costa Rica and to shut-down of the Japanese operation. In 1992, revenues were $31.4 million, an increase of 6% over 1991, reflecting an increase in the Conditioning Products segment, a decrease in the Power Sources segment and a small decrease in the Services segment.
Conditioning Products revenues decreased 16% in 1993 to $14.2 million after increasing 27% in 1992. A decrease in the unit volume of older models of burn-in chambers and loader and unloader products and lower average unit prices contributed to the decline. The increase in 1992 is attributable to a significant increase in revenues from the sale of INTERSECT 30 products. Revenues in the Conditioning Products segment overall, excluding INTERSECT products, declined during the three year period due to changes in requirements by the semiconductor industry for burn-in and other conditioning products and to product mix changes. Domestic conditioning and testing product shipments increased due to shipment of INTERSECT 30 systems beginning in the second quarter of 1992. Revenues from the sale of conditioning and testing products in Japan decreased significantly in 1992 due to a reduction in capital spending by Japanese semiconductor manufacturers.
Revenues in the Power Sources segment decreased in 1993 to $5.4 million after decreasing 20% to $7.0 million in 1992. The decrease, in both years, resulted principally from price competition resulting in average unit sale price and volume decreases. The decline in revenues appeared to be stabilizing during the latter part of 1993.
Revenues in the Services segment decreased 3% in 1993 to $7.4 million after decreasing only $6,000 in 1992. The 1993 decrease in revenues is attributable to product mix changes and unit price decreases resulting from lower operating costs being passed through to customers. Average unit prices increased during the latter part of 1993 due to a shift in product mix. Revenues included in the Services segment from the sale of conditioning products to Services customers increased during 1993 due to a change in product mix. Revenues at the Durham services facility decreased in 1992 due to volume decreases caused by product mix changes. Revenues at the Singapore facility increased in 1992 due to volume increases and increases in average unit sales prices due to product mix changes.
INFLATION. The overall impact of inflation on revenues has been minimal. Salaries and wages have increased at rates less than the general inflation rate during the three year period due to salary reductions and wages freezes during 1991 and 1992. The cost of raw materials and purchased parts increased at rates somewhat greater than the general inflation rate due to general increases in demand.
COSTS AND EXPENSES. Changes in costs and expenses during the three year period are primarily related to various cost reduction and restructuring measures, changes in revenue levels and the changes in research and development expenditures.
Total costs and expenses, excluding the provision for restructuring, decreased $8.3 million in 1993 compared to the revenue decrease of $4.4 million. Cost of revenues decreased $2.7 million; marketing, general and administrative expenses decreased $3.8 million; and research and development expenses decreased $1.8 million. The overall decrease in expenses, in 1993, related to restructuring of operations, expense reduction programs and a decrease in revenue and volume related expenses. Total costs and expenses, excluding the provision for restructuring, decreased $30,000 in 1992 to $32.6 million, compared to a revenue increase of $1.8 million. In general, costs and expenses decreased in 1992 due to a reduction in personnel levels and various cost reduction programs. The decreases were offset in some instances by volume related expenses associated with revenues from the sale of the INTERSECT 30 products. Costs and expenses were also affected by certain operations operating below levels necessary to absorb fixed overhead costs.
The Company's gross profit, as a percent of revenues, was 43%, 42% and 39% in 1993, 1992 and 1991, respectively. The 1993 increase is related to an increase in the Conditioning Products segment. The increase in the Conditioning Products segment resulted from a decrease in both fixed and variable manufacturing costs and changes in product mix. The increase also resulted from a reduction in expenses due to shut-down of the Japanese operation. A small decline in the gross profit in the Services segment is due principally to an increase in revenues from the sale of conditioning products to Services customers, because the gross profit on these products is traditionally low due to price competition. Revenues in the Power Sources segment declined 22% in 1993, but the gross profit in the segment was basically unchanged compared to 1992. Total manufacturing costs declined significantly due to the restructuring of operations and shifting
of all production capacity for this segment to Costa Rica. A significant portion of the benefit of the change took effect in the third quarter of 1993. The overall 1992 gross profit increase is principally related to an increase in the Conditioning Products segment and to a lesser extent to an increase in the Service segment, reduced by a decrease in the Power Sources segment. The increase in the Conditioning Products segment resulted from a reduction in overhead expenses, including personnel and expense reductions, and a higher absorption of fixed overhead by certain operations. The increase in the Services segment in 1992 results from product mix changes and a reduction in overhead expense. Expense controls at both of the Company's services facilities and a reduction in overhead expense also contributed to the increase. The 1992 decrease in the Power Sources segment relates to volume and price decreases and the cost of carrying excess production capacity.
Marketing, general, and administrative expenses decreased $3.8 million in 1993 in comparison to a $4.4 million decrease in revenues. Expenses were reduced throughout 1993 by stringent expense reduction programs, reductions in personnel levels and discontinuation of operations at two foreign facilities. Approximately 45% of the decrease is due to shut-down of the UK and Japanese operations in late 1992 and consolidation of Power Sources manufacturing in Costa Rica. In addition, expenses decreased in the Conditioning Products segment due to a decrease in revenue related expenses such as commissions and warranty and installation costs. The increase of $459,000 in 1992 is related to an increase in revenue related expenses, such as commissions, royalties and similar expenses, in the Conditioning Products segment resulting from shipment of INTERSECT systems. Expenses in the Power Sources and Services segments decreased in 1992. The decrease in expenses in the Services segment resulted from stringent expense control measures. Expenses in the Power Sources segment decreased in 1992 due to volume decreases and the shut-down of the Irish power sources facility in 1991. Expenses at the Costa Rica and Singapore power sources operations increased, but at rates less than the decrease related to the Irish operation. Expense controls and personnel reductions at most facilities during 1992 resulted in a decrease in marketing, general and administrative expenses. The expense reductions were offset by the revenue related expenses associated with the increase in INTERSECT revenues, but expenses in the Conditioning Products segment increased only 16% while revenues increased 27%.
Research and development expenditures totaled $889,000 in 1993, compared to $2.6 and $3.1 million in 1992 and 1991, respectively. A significant portion of expenditures in each of the three years related to development of conditioning and testing products, with a substantial portion of these expenditures being related to development of the INTERSECT 30 line of burn- in and test systems. The decrease in 1992 and 1993 results from completion of the INTERSECT 30 development project in 1992. Costs associated with development of conditioning products increased in 1993 after declining in 1992. Development costs in the Power Sources segment declined in 1993 and also in 1992.
The Company recorded in 1993 a provision for restructuring of operations totaling $288,000. The provision was composed of $319,000 related to retirement and severance pay for U.S. employees who were terminated in March 1993 and a $31,000 reduction of the 1992 restructuring provision related to
downsizing power sources production capacity in Singapore. The Company recorded a $1.4 million provision for restructuring of operations in 1992. The provision was composed of $1.0 million for curtailment of operations in Japan, $216,000 related to closing of the U.K. facility, $325,000 related to reduction of power sources manufacturing capacity in Singapore and a $149,000 reduction of the 1991 provision for closing of the Irish power sources facility. The Company recorded a $1.0 million provision for shut- down of its Irish power sources facility in the third quarter of 1991. The shut-down was completed during 1992 at a cost which was $149,000 less than the original estimate.
Net interest expense decreased significantly in 1993 due to a reduction in debt balances during the last half of 1993. Interest expense increased in 1992 compared to 1991 due to an increase in debt balances, reduced somewhat by a decline in interest rates. Interest income declined in 1993 and 1992 due to a decrease in investable cash balances and a decrease in interest rates in 1992.
INCOME TAX EXPENSE (BENEFIT). The Company's income tax expense (benefit) was $53,000, $(46,000) and $101,000, in 1993, 1992 and 1991, respectively. This equated to an effective tax rate of 2% in 1993 and a negative 2% in 1992. The 1991 provision of $101,000 was recorded on a loss of $4.1 million. The Company's effective tax rates differed from the U.S. tax rate of 34% due to tax benefits of net operating loss carryforwards in 1993 and 1992; tax provided on a dividend from a foreign subsidiary in 1992; tax benefits, in 1993, related to expenses incurred in shutting down a foreign subsidiary; expenses of foreign subsidiaries for which tax benefits were not available in 1992 and 1991; and in 1991 tax benefits were not available to the U.S. Company due to net operating loss carryback limitations.
Item 8. | 34285 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
ALZA incorporates by reference the selected consolidated financial data set forth at page 37 in the Annual Report.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ALZA incorporates by reference Management's Discussion and Analysis of Financial Condition and Results of Operations set forth at pages 20 to 22 in the Annual Report.
ITEM 8. | 4310 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data shown below should be read in conjunction with the consolidated financial statements and related notes.
(1) Beginning in 1990, shortline expenses were reported as a reduction of revenues. Prior to 1990, these expenses had been included in purchased services expense. The reclassification had no effect on net income. Previously issued consolidated financial statements were not restated to reflect the reclassification.
(2) The 1991 pre-tax special charge relates to: (i) restructuring costs for reducing surplus crew positions and a management separation pay program, (ii) increases in estimated personal injury costs and (iii) increases in estimated environmental clean-up costs.
(3) During 1991, BN extinguished debt through an early redemption resulting in an extraordinary loss, net of income taxes, of $14 million, or $.18 per common share. During 1990, BN extinguished debt through
note exchange agreements and the purchase of certain debentures. The net income for the year ended December 31, 1990 includes a resulting extraordinary gain, net of income taxes, of $14 million, or $.18 per common share.
(4) Results for 1992 reflect the cumulative effect of the change in accounting method for revenue recognition, and the cumulative effect of the implementation of the accounting standard for postretirement benefits (Statement of Financial Accounting Standards (SFAS) No. 106). The cumulative effect of the change in accounting method for revenue recognition decreased 1992 net income by $11 million, or $.13 per common share. The cumulative effect of the change in accounting method for postretirement benefits decreased 1992 net income by $10 million, or $.11 per common share, and had no immediate effect on cash flows.
(5) Results for 1993 include the effects of the Omnibus Budget Reconciliation Act of 1993 (the Act) which was signed into law on August 10, 1993. The Act increased the corporate federal income tax rate by one percent, effective January 1, 1993, which reduced net income by $29 million, or $.32 per common share, through the date of enactment.
(6) Beginning in November 1991, shares used in computation of earnings (loss) per common share reflect a November 1991 public offering of 10,350,000 shares.
(7) During 1993, BN adopted SFAS No. 109, "Accounting for Income Taxes." The effect of the adoption was to increase the current portion of the deferred income tax asset with a corresponding increase in the noncurrent deferred income tax liability of $26 million at January 1, 1993. Certain 1992 balance sheet data was reclassified to conform to the 1993 presentation. These reclassifications had no effect on previously reported net income, stockholders' equity or cash flows.
(8) The 1991 operating ratio excludes the special charge discussed in note (2) above.
(9) Net income used to calculate return on average stockholders' equity excludes, in the year of occurrence, the special charge, extraordinary items and the cumulative effect of accounting changes.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis relates to the financial condition and results of operations of Burlington Northern Inc. (BNI) and its majority-owned subsidiaries (collectively BN). The principal subsidiary is Burlington Northern Railroad Company (Railroad).
CAPITAL RESOURCES AND LIQUIDITY
Cash from operations and other resources
Cash generated from operations is BN's principal source of liquidity and is primarily used for dividends and capital expenditures. Operating activities provided cash of $578 million in 1993, compared with $680 million in 1992 and $368 million in 1991. The decrease in cash from operations in 1993 compared with 1992 was primarily attributable to an $81 million increase in labor-related payments, a decline in the level of accounts receivables sold and a one-time settlement agreement payment received in 1992. These items were partially offset by a decrease in interest paid during 1993. The increase in cash from operations in 1992 over 1991 was primarily due to increased profitability, a smaller decline in the level of accounts receivable sold and the one-time settlement agreement payment received in 1992. While operating cash flows for 1993 and 1991 were sufficient to fund dividends, such cash flows were not sufficient to completely fund capital expenditures. In 1992, operating cash flows were sufficient to fund both dividends and capital expenditures. Cash shortfalls as a result of these cash outlays are generally financed with debt. Sources available for such financing are discussed below.
During the first quarter of 1993, BN entered into an agreement to acquire 350 new-technology alternating current traction motor locomotives. BN accepted delivery of one locomotive during 1993 and anticipates delivery of between approximately 60 and 100 each year from 1994 through 1997. Future cash from operations during this strategic investment period may not, at times, be sufficient to completely fund dividends as well as capital expenditures and strategic investments. Therefore, these requirements will likely be financed using a
combination of sources including, but not limited to, cash from operations, operating leases, debt issuances and other miscellaneous sources. Each financing decision will be based upon the most appropriate alternative available.
During December 1993, BNI filed a registration statement with the Securities and Exchange Commission for the issuance, from time to time, of up to $500 million aggregate principal amount of debt securities. Net proceeds from the sale of the debt securities, if any are offered and sold, will be used to pay down debt or for other general corporate purposes.
BNI acquired equipment which was financed in December 1993 through the issuance of $78 million of 6.32 percent notes due 1994 to 2012.
In July 1993, BNI issued $150 million of 7 1/2 percent senior unsecured debentures due 2023 and used the proceeds for general corporate purposes, including working capital. These debentures were the final borrowing under the registration statement filed on September 24, 1991 covering the issuance, from time to time, of up to $500 million aggregate principal amount of debt securities.
Railroad maintains an effective program for the issuance, from time to time, of commercial paper. These borrowings are supported by Railroad's bank credit agreement, thus outstanding commercial paper balances reduce available borrowings under this agreement. The bank credit agreement allows borrowings of up to $500 million on a short-term basis. The agreement is currently scheduled to expire in November 1994. At Railroad's option, borrowing rates are based on prime, certificate of deposit or London Interbank Offered rates. Annual facility fees are 0.25 percent. The maturity value of commercial paper outstanding at December 31, 1993 was $27 million, leaving a total of $473 million of the credit agreement available, while no commercial paper was outstanding at December 31, 1992.
Railroad has an agreement to sell, on a revolving basis, an undivided percentage ownership interest in a designated pool of accounts receivable with limited recourse. As of December 31, 1993, the agreement allowed for the sale of accounts receivable up to a maximum of $175 million. The agreement expires not later than December 1994. At December 31, 1993 and 1992, accounts receivable were net of $100 million and $189 million, respectively, representing receivables sold.
In November 1992, BNI completed a public offering of 6,900,000 shares of 6 1/4 percent cumulative convertible preferred stock at $50 per share. Most of the $337 million net proceeds from the offering were placed in trust to fund the redemption of BNI's $300 million 9 5/8 percent notes due 1996. Under the terms of the indenture, the 9 5/8 percent notes were redeemable at par, commencing February 1, 1993. The notification for redemption of the 9 5/8 percent notes was issued to holders of the notes in December 1992 with a redemption date of February 1, 1993. The debt was considered to be extinguished as of December 31, 1992, because BNI had irrevocably placed assets in trust, prior to such date, to be used solely to satisfy scheduled payments of both the interest on and principal of the $300 million 9 5/8 percent notes. The difference between BNI's redemption price and the net carrying value resulted in an immaterial loss which was recorded in other income (expense), net in 1992.
In July 1992, BNI issued $150 million of 7 percent senior unsecured notes due 2002. The proceeds were used to retire $100 million of 14 3/4 percent notes due August 15, 1992 and to reduce outstanding commercial paper balances. In February 1992, BNI issued $200 million of 8 3/4 percent senior unsecured debentures due 2022 and used the proceeds to reduce outstanding commercial paper balances. These debt instruments provided favorable long-term interest rates and matched long-term borrowing to the long-lived assets of BN's capital program.
In November 1991, BNI completed a public offering of 10,350,000 shares of common stock. The transaction resulted in net proceeds of $359 million which were used primarily to retire $250 million of 11 5/8 percent subordinated debentures.
Capital expenditures and resources
A breakdown of capital expenditures is set forth in the following table (in millions):
Equipment expenditures for 1993 increased primarily as a result of acquiring freight cars through purchases rather than through operating leases and increased information system purchases. Capital roadway expenditures for 1993 increased compared with 1992 primarily due to spending related to the severe flooding in the Midwest. Spending for signal and communication projects and new strategic initiatives for transportation network management further contributed to this increase. The average age of locomotives and freight cars at year-end 1993 was 14.5 years and 18.6 years compared to 13.5 years and 18.4 years at year-end 1992.
Capital roadway spending in 1992 reflects an increase in track programs in the Powder River Basin to support BN's coal unit train service, as well as additional signal and communication projects. Equipment expenditures were lower in 1992 primarily due to the 1991 purchase of 50 high horsepower locomotives at a cost of $76 million.
BN projects capital spending for the next few years to be higher than in previous years partially as a result of certain strategic investments, with a projection for 1994 of approximately $650 million. As discussed in "Cash from operations and other resources," BN has a commitment to acquire 350 new-technology alternating current traction motor locomotives through 1997. Also, BN will continue its implementation of several strategic initiatives for transportation network management using information systems technology.
In addition to capital expenditures, BN continues to utilize operating leases to fulfill certain equipment requirements. In 1994, BN anticipates financing approximately $200 million of equipment through operating leases. The method used to finance this equipment will depend upon current market conditions and other factors. During 1993, BN renewed leases primarily for intermodal doublestack cars and containers, and locomotives. In 1992, renewals were primarily for covered hoppers, locomotives and coal cars.
Dividends
Common stock dividends declared have remained constant at $1.20 per common share for 1993, 1992 and 1991. Dividends paid on common and preferred stock during these periods were $125 million, $106 million and $92 million, respectively. The increase in 1993 dividends was primarily attributable to the issuance of 6,900,000 shares of 6 1/4 percent cumulative convertible preferred stock in November 1992. The increase in 1992 was due in large part to the issuance of 10,350,000 shares of common stock in November 1991. BNI expects to continue its current policy of paying regular quarterly dividends on its common and preferred stock, however, dividends are declared by the Board of Directors based on profitability, capital expenditure requirements, debt service and other factors.
Capital structure
BN's ratio of total debt to total capital, excluding redeemable preferred stock, was 48 percent at the end of both 1993 and 1992 and 62 percent at the end of 1991. In 1992, the total debt to total capital ratio improved from 1991 because debt was reduced, the 6 1/4 percent cumulative convertible preferred stock was issued and net income exceeded dividend requirements.
RESULTS OF OPERATIONS
Year ended December 31, 1993 compared with year ended December 31, 1992
BN had net income of $296 million, or $3.06 per common share, on 89.7 million shares for 1993 compared with net income of $278 million, or $3.11 per common share, on 88.6 million shares for 1992.
Results for 1993 included the effects of severe flooding in the Midwest, most notably in the third quarter. The floods slowed and often halted operations, forced extensive detours, increased car, locomotive and crew costs and resulted in extensive rebuilding of damaged track and bridges. BN estimated that the third quarter flooding reduced revenues during 1993 by $44 million and increased operating expenses by $35 million, for a combined reduction of $79 million or $.55 per common share. Net income for 1993 included the retroactive effects of the Omnibus Budget Reconciliation Act of 1993 (the Act), which was passed into law during August 1993. The Act increased the corporate federal income tax rate by one percent, effective January 1, 1993, which reduced net income by $29 million, or $.32 per common share, through the date of enactment. BN recognized a one-time, non-cash charge of $28 million to income tax expense to adjust deferred taxes as of the enactment date and a charge of $1 million to current income tax expense. Net income for 1992 included settlement payments received for the reimbursement of attorneys' fees and costs incurred by BN in connection with litigation filed by Energy Transportation Systems, Inc., and others, and reimbursement of a portion of the amount paid by BN in settlement of that action. The pre-tax amount recorded in other income (expense), net was approximately $47 million. Also during 1992, BN's net income included a $21 million, or $.24 per common share, cumulative effect of changes in accounting methods and a $17 million, or $.19 per common share, favorable tax settlement with the Internal Revenue Service (IRS).
Revenues
During 1993, BN refined Railroad's customer oriented business units by creating smaller, more focused business units. The following table presents BN's revenue information by Railroad business unit, and includes reclassification of prior-year information to conform to current year presentation:
Coal revenues improved $12 million compared with 1992, primarily as a result of increased traffic caused by a rise in the demand for electricity. Higher revenues resulting from volume increases were partially offset by lower yields arising from competitive pricing pressures in contract renegotiations, traffic mix and other factors. Additionally, BN estimated lost coal revenues of approximately $35 million for the third quarter of 1993 as a result of flood-related problems in July and August which interrupted service to several utilities.
Agricultural Commodities revenues were $7 million higher than 1992 as stronger yields were partially offset by lower volumes. Improved yields resulted from a traffic mix with a greater portion of wheat traffic in 1993. Stronger export demand, for high-quality wheat grown in regions served by BN, contributed to a $74 million improvement in wheat revenues. Reduced crop quality and production problems, stemming from poor planting and growing conditions, resulted in lower corn volumes and produced a year-over-year decline in corn revenues of $45 million.
Intermodal revenues were $19 million higher in 1993 compared with 1992. BN AMERICA (BNA) revenues in 1993 surpassed revenues in 1992 as a result of continued escalating demand for containerized transportation and an increased demand for intermodal service due generally to a shortage in truck capacity. As import traffic expanded and shifted from ports in California to ports served by BN in the Pacific Northwest, intermodal-international revenues increased. Domestic trailer revenues declined as trailer traffic continued to convert to containers, partially offsetting other Intermodal increases.
Chemicals revenues for 1993 were $17 million greater than in 1992. Increased plastics shipments for existing customers led improvements in overall Chemicals revenues. Environmental logistics and fertilizer traffic in 1993 surpassed 1992 levels, also contributing to the higher revenues for Chemicals.
Revenues for Minerals Processors increased $15 million compared with 1992. As drilling activity increased, export traffic for clays and aggregates expanded, contributing to greater revenues in 1993 than in 1992. Glass minerals and cement revenues exceeded 1992 levels. This increase was due to expanded sand traffic, which also benefited from increased drilling activity, and increased cement traffic, related to certain highway and airport construction projects.
Vehicles & Machinery revenues were $21 million greater than in 1992. This improvement was due in part to growth in production and sales of light vehicles which increased domestic traffic volumes. A rise in demand for heavy machinery also contributed to greater revenues. Yields increased in 1993 primarily as a result of a decline in the average length of haul.
Forest Products, Iron & Steel and Aluminum, Non-Ferrous Metals & Ores had lower revenues in 1993 compared with 1992. Current year Forest Products revenues were $6 million less than in 1992 because of reduced lumber traffic, resulting from a weak timber industry market, which was partially offset by increased particle and construction board traffic. Iron & Steel revenues declined $6 million compared with 1992, primarily due to lower taconite traffic caused by labor strikes at two large customers. Aluminum, Non-Ferrous Metals & Ores revenues decreased by $5 million as aluminum production declined. Revenues for Consumer Products were relatively flat compared with 1992.
Expenses
Total operating expenses for 1993 were $4,038 million compared with $4,033 million for 1992. Despite the adverse effects of the Midwest flooding on operating expenses during the third quarter of 1993, BN's year-to-date operating ratio improved one percentage point, to 86 percent, compared with 87 percent for 1992.
Overall compensation and benefits expenses for 1993 remained constant with 1992. Cost of living allowances (COLAs) for union employees were $24 million lower during 1993 compared with 1992 due to timing differences of vesting periods. Work force reductions and a decrease in railroad unemployment taxes lowered expenses in 1993. These savings were offset by increases in incentive compensation, wages and salaries, and higher costs for union health, welfare and life insurance benefits. Increased wages were partially caused by a scheduled three percent basic wage increase effective July 1993 and inefficiencies associated with the Midwest flooding during 1993.
Fuel expenses were $14 million higher during 1993 compared with 1992, primarily due to weather-related reductions in fuel efficiency. Increased fuel consumption due to higher traffic volume was substantially offset by the decrease in the average price paid for diesel fuel, 61.5 cents per gallon in 1993 compared with 62.2 cents per gallon in 1992. Included in the 1993 average price per gallon is a 4.3 cents per gallon increase in the federal fuel tax effective October 1, 1993, as part of the Omnibus Budget Reconciliation Act of 1993. This increased tax added approximately $7 million to expense in the fourth quarter.
Materials expenses for 1993 increased $5 million compared with 1992. The combination of flood-related problems and a larger fleet size increased materials costs for locomotive repairs. Also, safety and protective equipment expenditures were higher due to continued emphasis of BN's safety programs. Offsetting these increases were lower car materials expenses.
Equipment rents expenses were $6 million higher in 1993 compared with 1992 due to increases in both car-hire expenses and locomotive rentals. A reduction in car-hire expenses during the first half of 1993, due to improved utilization of equipment, was more than offset by flood-related inefficiencies which increased car-hire expenses during the second half of 1993.
Purchased services expenses for 1993 were $8 million higher than in 1992. Contributing to this increase were cost increases for intermodal logistics, training, moving and derailments. Lower trackage rights credits, which reduces purchased services expenses, were received from the Southern Pacific Transportation Company (SPTC) as the floods reduced SPTC volumes over BN track. These increases were partially offset by decreases in contracted locomotive repairs and consultant fees.
Depreciation expense for 1993 was $14 million higher compared with 1992 primarily due to an increase in the asset base.
The $42 million decrease in other operating expenses compared with 1992 was primarily due to a $35 million decline in costs associated with personal injury claims. BN has introduced a number of programs to improve worker safety and counter increasing personal injury costs. Reductions in bad debt expense and various other costs were partially offset by losses on property retired due to flood damages and increased moving expenses.
Interest expense declined $41 million in 1993 compared with 1992. This decline was mainly due to a lower average long-term debt balance outstanding during 1993 and the refinancing of higher interest rate debt throughout 1992.
Other income (expense), net was $36 million lower in 1993 than in 1992. The higher 1992 income was due to a first quarter net gain of $47 million for payments and reimbursements received for the settlement of prior litigation. This decline was partially offset by an increase in the net gain on property dispositions in 1993 compared with 1992.
The effective tax rate was 43.2 percent for 1993 compared with 33.8 percent for 1992. This increase resulted primarily from the retroactive increase, effective January 1, 1993, in tax rates as part of the Omnibus Budget Reconciliation Act of 1993. Excluding the retroactive effect of the tax rate change on deferred tax balances at January 1, 1993, BN's effective tax rate was 38.2 percent for 1993. Additionally, a favorable tax settlement with the IRS reduced the 1992 effective tax rate by 3.8 percent.
Year ended December 31, 1992 compared with year ended December 31, 1991
BN had net income of $278 million, or $3.11 per common share, on 88.6 million shares for 1992 compared with a net loss of $320 million, or $4.14 per common share, on 77.5 million shares for 1991. Results for 1992 were reduced by $11 million, or $.13 per common share, net of tax, cumulative effect of an accounting change in revenue recognition method and $10 million, or $.11 per common share, net of tax, cumulative effect of an accounting change for postretirement benefits. Results for 1991 included an after-tax special charge of $442 million, or $5.79 per common share, related to railroad restructuring costs and increases in liabilities for casualty and environmental clean-up costs, and an extraordinary loss of $14 million, or $.18 per common share, net of tax benefits, as a result of early retirement of debt.
The 1991 special charge included the following pre-tax components (in millions):
Revenues
During 1993, BN refined Railroad's customer oriented business units by creating smaller, more focused business units. The following table presents BN's revenue information by Railroad business unit, and includes reclassification of prior-year information to conform to current year presentation:
Coal revenues in 1992 were $34 million below 1991. The decrease included the effects of a two-day work stoppage during the second quarter. The effects of the work stoppage were not recovered later in 1992 because of continued weak demand. Mild weather during the first three quarters of 1992 decreased demand for coal and slowed traffic compared with the prior year. In addition, competitive pricing pressures in contract renegotiations and declining cost indices, on which many coal contract rates are based, also contributed to lower 1992 revenues.
Revenues for Agricultural Commodities were $1 million less in 1992 than in 1991. The decrease was primarily due to weak export demand for corn in the latter three quarters of 1992 which contributed to a $36 million reduction compared with 1991. This decrease was substantially offset by a $34 million increase in wheat that resulted from strong export shipments during 1992.
The $24 million increase in Intermodal revenues was driven by a $59 million increase in BNA traffic that was attributable to increased demand for containerized transportation. A portion of the increase in containerized transportation was due to a conversion from trailer transportation which decreased by $24 million compared with 1991.
Forest Products revenues increased $20 million compared with 1991. The increase reflects an improvement in lumber revenues that resulted from good spring building conditions, favorable movements because of product pricing pressures and increased demand caused by Hurricane Andrew's destruction. Pulpmill feedstock revenues also increased because of higher demand for woodchips. These increases were slightly offset by a decreased demand for paper and paper products during 1992, partly due to excess supplies of newsprint.
Revenues for Chemicals were $42 million greater in 1992 than in 1991. The increase was primarily due to increased plastics shipments from new contracts. Higher fertilizer and petroleum products revenues were also contributing factors. Fertilizer traffic improved due to a strong spring application season and increased shipments at the beginning of the year to replenish low inventory levels from the fall of 1991. Petroleum products benefited from a stronger economy in 1992 than in 1991.
Revenues in 1992 for Consumer Products and Iron & Steel both improved by $8 million compared with 1991. The improvement for Consumer Products resulted from higher bulk food products revenues, due largely from an increased movement of sugar, and higher frozen foods revenues. Frozen foods revenues improved over
the prior year due largely to increased french fry traffic resulting from favorable product prices. Iron & Steel revenues improved due to increased traffic because of two new pipe projects.
Revenues for Minerals Processors, Vehicles & Machinery and Aluminum, Non-Ferrous Metals & Ores were relatively flat in 1992 compared with 1991. While Vehicles & Machinery revenues were flat overall, automotive revenues increased as higher traffic volume more than offset lower yields. Declining yields reflect the rates used in late 1991 and 1992 long-term contract renewals, which were influenced by competitive pricing pressures. This increase in automotive revenues was offset by declines in heavy machinery and government traffic revenues. The slight decrease in Minerals Processors revenues was attributable to a weaker demand for glass minerals and cement products related to the construction and automobile industries. Aluminum, Non-Ferrous Metals & Ores benefited from a stronger economy in 1992 than in 1991.
Expenses
Total operating expenses for 1992 were $4,033 million compared with expenses of $4,090 million, excluding a $708 million special charge, in 1991. The operating ratio for 1992 was 87 percent compared with the 1991 ratio, excluding the special charge, of 90 percent. The improvement in operating expenses was primarily attributable to savings in compensation and benefits and fuel costs.
Compensation and benefits expenses decreased by $47 million compared with 1991. During 1991, BN recorded a $77 million accrual for union employees' signing bonuses and for COLAs. The 1992 COLA accruals were $58 million. Current-year savings of $22 million were also noted in health, welfare and life insurance benefits due to union contract modifications. Smaller crew sizes and a full year of reduced pay rates for employees on reserve boards, which were established in the second half of 1991, also contributed to lower wages and salaries in 1992. These combined savings were somewhat offset by increases in mechanical, maintenance crew and other wages. Also, increasing use of the wage continuation program for injured employees, which was phased in during 1991, served to further offset the savings.
Fuel expenses were $20 million lower than in 1991. In 1992, BN paid 62.2 cents per gallon compared with 65.5 cents in 1991. This lower average fuel price per gallon resulted in approximately $19 million of the overall savings. Reduced consumption also contributed slightly to the overall decrease.
Materials expenses for 1992 were $12 million higher than in 1991. Materials costs were higher due to increased locomotive repairs during 1992. Increasing track repair cost and related work equipment repair cost also contributed to the overall increase.
The $12 million decrease in equipment rents expenses compared with 1991 was largely due to a decline in locomotive related expenses. Locomotive cost savings resulted from a renegotiated purchased power agreement and the expiration, during 1992, of several locomotive leases which were not renewed. These cost savings were somewhat offset by an increase in car-hire expenses due to lower 1992 than 1991 recoveries for prior period car-hire overpayments, which offset car-hire expenses in the period recovered.
Purchased services expenses increased $7 million in 1992 compared with 1991. The increases over 1991 were a result of higher expenses related to computer programming costs associated with the implementation of several strategic initiatives, the expansion of a BNA customer service center due to increased BNA traffic, payments for car repairs and intermodal logistics costs. These increases were somewhat offset by lower environmental clean-up expenses, decreased relocation costs, fewer locomotive overhauls and increased payments from SPTC for trackage rights.
Depreciation expense for 1992 was $9 million lower than in 1991. The decrease was primarily attributable to reduced depreciation for rail subsequent to the current-year implementation of an Interstate Commerce Commission required service life study for rail. The effect of the study on rail depreciation was to reduce 1992 expense by $28 million. This decrease was partially offset by increased depreciation, due to a larger asset base.
Other expenses for 1992 was $12 million greater than in 1991. Although reported injury claims decreased, personal injury expense, excluding wage continuation costs discussed in compensation and benefits, increased by approximately $18 million as settlement costs for claims settled increased, and hearing loss claims
continued to develop. Bad debt accruals also contributed to this increase. Lower derailment expenses and a decline in moving expenses partially offset this increase.
Interest expense decreased $40 million in 1992 compared with 1991. Lower market interest rates and reduced commercial paper balances were significant contributors to this decrease. The reduction of long-term debt and the refinancing of high interest rate debt, during 1992 and late 1991, added to the current-year savings. Also, 1991 interest expense included an interest accrual related to a rate litigation case.
In 1992, BN recorded other income, net of expense, of $41 million versus other expense, net of income, of $25 million in 1991. The 1992 income is due primarily to a first quarter net gain of $47 million for payments and reimbursements received for the settlement of prior litigation. Loss on investment and loss on sale of receivables were also lower in 1992 than in 1991.
The effective tax rate was 33.8 percent and 37.6 percent in 1992 and 1991, respectively. The lower 1992 rate was the result of a fourth quarter Appeals Division settlement of IRS audits for the years 1981 through 1985. The total tax benefit recorded in 1992 was $17 million which reduced the effective tax rate by 3.8 percent.
OTHER MATTERS
In October 1991, Railroad entered into an agreement (Crew Consist Agreement No. 1) with the United Transportation Union (UTU) covering the southern portion of Railroad's system. Crew Consist Agreement No. 1 provided for crews on most through-freight trains to consist of one conductor and one engineer and for crews on all other trains to consist of one brakeman, one conductor and one engineer.
Under the terms of Crew Consist Agreement No. 1, Railroad offered the opportunity for voluntary separation from employment in return for severance payments of up to $60,000 per employee. Remaining conductors or brakemen who, as a result of Crew Consist Agreement No. 1, were unable to hold a position in active service, due to relative seniority, were placed on a reserve board. Employees in reserve status received compensation at a rate equal to either 75 percent of their previous 12-month earnings, or 75 percent of the basic five-day yard helper rate of pay, whichever is greater, and are required to be available for return to active service on 15 days' notice. Each UTU member on the southern portion of Railroad's system received a lump-sum payment of $1,000 upon ratification of Crew Consist Agreement No. 1.
In May 1993, Railroad entered into an agreement (Crew Consist Agreement No. 2) with the UTU covering approximately 3,400 UTU members in the northern portion of Railroad's system. Crew Consist Agreement No. 2 provides for crews on most through-freight trains to consist of one conductor and one engineer and for crews on all other trains to consist of one brakeman, one conductor and one engineer. It is similar to Crew Consist Agreement No. 1, covering the southern portion of Railroad's system. Each UTU member on the northern portion of Railroad's system received a one-time lump-sum payment of $5,000, pursuant to Crew Consist Agreement No. 2.
Under the terms of Crew Consist Agreement No. 2, Railroad offered the opportunity for voluntary separation from employment in return for severance payments of up to $80,000 per employee. Conductors and brakemen who choose not to accept the voluntary separation offer can elect volunteer surplus status pursuant to which they will receive $60,000 to be paid out over a period of 18 to 48 months, as each selects. If such employee has not been recalled to active service by the time such payments cease upon expiration of the selected period, such employee will remain in volunteer surplus status, without further compensation or benefits, until recalled to active service. Employees in volunteer surplus status may be called back to service only after the individuals in reserve status, within their own subdivided seniority district, have been recalled. Remaining conductors and brakemen who, as a result of Crew Consist Agreement No. 2, are not needed in train service, and who do not elect one of the above severance options, will be placed on a reserve board.
Employees in reserve status will receive compensation equal to either 75 percent of their previous 12-month earnings, or 75 percent of the basic five-day yard helper rate of pay, whichever is greater, and are required to be available for return to active service on 15 days' notice.
In October 1993, the UTU elected to adopt Crew Consist Agreement No. 2 for those southern portion UTU members who were previously covered by Crew Consist Agreement No. 1. Crew Consist Agreement No. 2 was implemented on the southern portion of the Railroad's system during the fourth quarter of 1993. Upon implementation, each of the approximately 3,300 UTU members on the southern portion of Railroad's system received a one-time lump-sum payment of $4,000, which was the incremental difference between the $1,000 lump-sum payment received following ratification of Crew Consist Agreement No. 1 and the amount received by UTU members following adoption of Crew Consist Agreement No. 2.
Railroad will continue to remove excess positions from train service through the implementation of Crew Consist Agreement No. 2. Approximately 1,350 excess positions have been removed as a result of employees accepting severance or voluntary surplus payments. Other excess positions have been eliminated and personnel formerly in those positions have been assigned to reserve boards, absorbed through additional train starts and/or utilized in quality and safety initiatives. Based upon its experience under Crew Consist Agreement No. 1, Railroad anticipates that the number of employees on reserve status will decline over time.
In July 1993, the American Train Dispatchers Association ratified an April agreement which will facilitate the consolidation of all dispatching functions into a centralized train dispatching office in Fort Worth, Texas by the end of 1995.
Since 1935, BN has participated in the national railroad retirement system which is separate from the national social security system. Under this system, an independent Railroad Retirement Board administers the determination and payment of benefits to all railroad workers. Both BN and its employees are subject to a tax on employee earnings which is above the normal social security rate assessed to those who are employed outside the railroad industry.
Personal injury claims, including work-related injuries to employees, are a significant expense for the railroad industry. Employees of BN are compensated for work-related injuries according to the provisions of the Federal Employers' Liability Act (FELA). FELA's system of requiring finding of fault, coupled with unscheduled awards and reliance on the jury system, has resulted in significant increases in expense. The result has been a trend during the last several years of significant increases in BN's personal injury expense which reflects the combined effects of increasing medical expenses, legal judgments and settlements. To improve worker safety and counter increasing costs, BN has introduced a number of programs to reduce the number of personal injury claims and the dollar amount of claims settlements which helped reduce cost in 1993. If these efforts continue to be successful, future expenses could be further reduced. The total amount of personal injury expenses (including wage continuation payments) were $216 million, $253 million and $224 million in 1993, 1992 and 1991, respectively. BN is also working with others through the Association of American Railroads to seek changes in legislation to provide a more equitable program for injury compensation in the railroad industry.
BN's operations, as well as those of its competitors, are subject to extensive federal, state and local environmental regulation. In order to comply with such regulation and to be consistent with BN's corporate environmental policy, BN's operating procedures include practices to protect the environment. Amounts expended relating to such practices are inextricably contained in the normal day-to-day costs of BN's business operations.
Under the requirements of the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (Superfund) and certain other laws, BN is potentially liable for the cost of clean-up of various contaminated sites identified by the U.S. Environmental Protection Agency and other agencies. BN has been notified that it is a potentially responsible party (PRP) for study and clean-up costs at a number of sites and, in many instances, is one of several PRPs. BN generally participates in the clean-up of these sites through cost-sharing agreements with terms that vary from site to site. Costs are typically allocated based on relative volumetric contribution of material, the amount of time the site was owned or operated, and/or the portion of the total site owned or operated by each PRP. However, under Superfund and certain other laws, as a PRP, BN can be held jointly and severally liable for all environmental costs associated with a site.
Environmental costs include initial site surveys and environmental studies of potentially contaminated sites as well as costs for remediation and restoration of sites determined to be contaminated. Liabilities for environmental clean-up costs are initially recorded when BN's liability for environmental clean-up is both probable and a reasonable estimate of associated costs can be made. Adjustments to initial estimates are recorded as necessary based upon additional information developed in subsequent periods. BN conducts an ongoing environmental contingency analysis, which considers a combination of factors, including independent consulting reports, site visits, legal reviews, analysis of the likelihood of participation in and ability to pay for clean-up by other PRPs, and historical trend analysis.
BN is involved in a number of administrative and judicial proceedings in which it is being asked to participate in the clean-up of sites contaminated by material discharged into the environment. BN paid $27 million, $20 million and $21 million during 1993, 1992 and 1991, respectively, relating to mandatory clean-up efforts, including amounts expended under federal and state voluntary clean-up programs. At this time, BN expects to spend approximately $120 million in future years to remediate and restore these sites.
Liabilities for environmental costs represent BN's best estimates for remediation and restoration of these sites and include asserted and unasserted claims. BN's best estimate of unasserted claims was approximately $5 million as of the end of 1993. Although recorded liabilities include BN's best estimates of all costs, without reduction for anticipated recovery from insurance, BN's total clean-up costs at these sites cannot be predicted with certainty due to various factors such as the extent of corrective actions that may be required, evolving environmental laws and regulations, advances in environmental technology, the extent of other PRPs participation in clean-up efforts, developments in ongoing environmental analyses related to sites determined to be contaminated, and developments in environmental surveys and studies of potentially contaminated sites. As a result, charges to income for environmental liabilities could possibly have a significant effect on results of operations in a particular quarter or fiscal year as individual site studies and remediation and restoration efforts proceed or as new sites arise. However, expenditures associated with such liabilities are typically paid out over a long period, in some cases up to 40 years, and are therefore not expected to have a material adverse effect on BN's consolidated financial position, cash flow or liquidity.
In November 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 112, "Employers' Accounting for Postemployment Benefits." This standard requires employers to recognize benefits provided to former or inactive employees after employment but before retirement, if certain conditions are met. In the first quarter of 1994, BN will adopt SFAS No. 112. The principal effect of adopting this standard will be to establish liabilities for long-term and short-term disability plans. The effect upon earnings to adopt this standard is expected to be approximately $15 to $20 million. The initial effect of applying this standard will be reported as the effect of a change in accounting method and previously issued financial statements will not be restated.
In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 addresses the accounting and reporting requirements for investments in equity securities that have readily determinable fair values and for all investments in debt securities, and is effective for fiscal years beginning after December 15, 1993. The initial effect of applying this standard is to be reported as the effect of a change in accounting method and previously issued financial statements may not be restated. No material effect on BN's financial condition or results of operations is anticipated from the adoption of SFAS No. 115.
ITEM 8. | 351979 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
- ------------
(a) Earnings per share of common stock is based on 37,212,192 weighted average shares of common stock outstanding for 1993, 36,049,135 weighted average shares of common stock outstanding for 1992 and 31,421,731 shares of common stock outstanding for the years 1989 through 1991.
(b) Represents dividends declared subsequent to the Offering.
(c) In May 1991, EPG declared and paid a dividend of $175 million to its then parent company, The El Paso Company ("TEPCO"). In September 1991, EPG declared a dividend of all its Oil and Gas Operations Segment to TEPCO. The total amount of that dividend was $925 million. In addition, EPG declared and paid dividends to BR totaling $55 million in 1991 and $274 million prior to the Offering in 1992.
(d) Excludes current maturities.
(e) MPC has been consolidated for the months of May 1993 through December 1993.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION AND LIQUIDITY
Cash provided by operating activities was $236 million for 1993 compared with $334 million for 1992. The decrease from the previous year was primarily due to proceeds received in 1992 from the sale of the direct bill portion of the take-or-pay receivables, lower take-or-pay collections in 1993, rate refund payments resulting from the settlement agreement and costs incurred to repair flood damaged pipelines (see Other of this section), partially offset by decreased tax payments in 1993.
Cash provided by continuing operating activities was $334 million for 1992 compared with $249 million for 1991. The increase was primarily due to proceeds from the sale of the direct bill portion of the take-or-pay receivables, the 1991 net cash payments made in connection with the August 14, 1991 FERC order (see Rates and Regulatory Matters of this section), the decrease in take-or-pay expenditures and a decrease in interest payments. The increase was partially offset by a reduction in volumetric take-or-pay receivable collections and a decrease in accruals for regulatory issues.
Acquisition
On June 1, 1993, the Company acquired from a wholly owned subsidiary of Enron Corp., that subsidiary's 50 percent interest in MPC, for approximately $40 million in cash, representing the approximate book value of the investment. The acquisition, which was funded by internally generated cash flow, gives the Company 100 percent ownership of MPC. The acquisition was accounted for using the purchase method.
In conjunction with the acquisition, the following liabilities were assumed:
The following MPC balances are included in the December 31, 1993 Consolidated Balance Sheet of the Company:
The operating results of MPC are included in the Company's consolidated results of operations for the months of May 1993 through December 1993. The Company's previously owned 50 percent equity interest in MPC is included in other-net in the accompanying Consolidated Statement of Income.
The following pro forma summary presents the consolidated results of operations of the Company as if the acquisition had occurred as of January 1, 1993 and January 1, 1992. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what may have resulted had the acquisition occurred as of those dates or of results which may occur in the future.
Gathering and Production Area Facilities
On January 14, 1994, EPG filed an application with FERC seeking an order which would terminate, effective January 1, 1996, certificates applicable to certain gathering and production area facilities owned by EPG on the basis that such facilities are not subject to FERC jurisdiction.
EPG intends, effective January 1, 1996, to transfer all of its nonjurisdictional gathering and production area facilities to a wholly owned subsidiary of EPG. Such facilities are used for gathering and other nonjurisdictional functions and are an inherent part of EPG's current gathering operations. The facilities to be transferred consist of approximately 6,700 miles of various sized pipelines, compressors with horsepower of 40,600 and various treating and processing plants. These nonjurisdictional facilities, together with the facilities included in the January 14, 1994 FERC application, constitute all of EPG's gathering and production area facilities.
Rates and Regulatory Matters
On July 1, 1991, EPG filed for FERC approval of new system rates and placed the proposed new rates into effect on January 1, 1992, subject to refund. On July 31, 1992, EPG again filed for new system rates to recover increased costs and return on rate base associated with EPG's expansion and modernization projects. These rates became effective on February 1, 1993, subject to refund. In the July 1992 filing, EPG's rate base increased from $752 million to approximately $1.2 billion. EPG made its compliance filing on December 31, 1992 in accordance with the Restructuring Rules.
In January 1993, EPG, certain of its customers and FERC staff reached a settlement agreement which led to the resolution of the above mentioned rate and restructuring proceedings. The settlement agreement was filed in January 1993 to supersede EPG's December 31, 1992 compliance filing. As required by FERC order, EPG filed revised rates on September 14, 1993, which implemented the settlement agreement effective October 1, 1993. Under the settlement agreement, EPG refunded a total of approximately $56 million, inclusive of interest, in the fourth quarter of 1993. EPG had provided for these rate refunds as revenues were collected.
The settlement agreement provides for the accelerated recovery of a substantial portion of EPG's investment in its underground storage facility. This is being recovered by a demand charge mechanism over the period from October 1, 1993 through December 31, 1996. The amount to be recovered was approximately $56.7 million plus interest accruing beginning February 1, 1993 at the FERC allowed rate, which approximates the prime rate. The amount recovered through December 31, 1993 was $19 million. The outstanding balance at December 31, 1993 was $37 million, of which $12 million is included in other current assets and $25 million is included in other assets in the accompanying Consolidated Balance Sheet. The settlement agreement also established new depreciation rates for certain of EPG's facilities effective January 1, 1992.
On August 14, 1991, FERC approved an order resolving all of the issues in EPG's December 1987 rate case filing and certain other pending matters which became effective on September 1, 1991. The order provided for: (i) the establishment of revised rate levels for the period July 1, 1988 through the effective date of EPG's next rate change, which occurred on January 1, 1992; and (ii) payment of certain refunds for the
period July 1, 1988 through August 31, 1991. EPG disbursed to its customers $252 million in October 1991 in accordance with the order. The total refund obligation at September 1, 1991 was $369 million before certain offsets, including an unbilled portion of the $169 million of recoverable excess gas costs. The net refund obligation and the remaining balance of the recoverable excess gas costs, $25 million, were recorded against previously established accruals.
Pursuant to the Restructuring Rules, MPC filed its restructuring plan on November 3, 1992. On March 2, 1993, FERC issued an order essentially approving MPC's compliance filing, subject to changes, which were made in an amended restructuring plan on March 29, 1993. Several of MPC's customers filed protests and requests for rehearing of the March 2, 1993 FERC order. The rehearing requests were denied, and FERC approved the amended restructuring plan on July 9, 1993, with an effective date of August 1, 1993. On October 15, 1993, FERC issued an order which denied requests for rehearing of the July 9, 1993 order. Several of MPC's customers have filed petitions for review of the March 2, 1993, July 9, 1993 and October 15, 1993 orders with the United States Court of Appeals which are currently pending.
The primary issues on appeal pertain to FERC's requirement that MPC's rates for firm transportation service be based upon SFV rate design rather than MFV rate design. The application of SFV rates requires MPC's existing firm shippers to pay a higher proportion of their total transportation rate in the reservation component of the rate, and this increases aggregate transportation charges for low load factor shippers. Such shippers have contended that FERC's application of SFV rate design to MPC unlawfully abrogates the rate provisions of MPC's service agreements and constitutes an unlawful rate increase. MPC believes the United States Court of Appeals will uphold SFV rates as applied to MPC.
Take-or-Pay Settlements
Since 1987, EPG has made, or has committed to make, buy-out and buy-down payments totaling $1.5 billion to resolve past and future take-or-pay exposure, to terminate and reform gas purchase contracts, to amend pricing and take provisions of gas purchase contracts and to settle related litigation. In certain cases, EPG resolved claims by making recoupable prepayments. At December 31, 1993 and December 31, 1992, the recoupable prepayment balances were $9 million and $19 million, respectively. These payments resolved virtually all the outstanding producer claims asserted against EPG and terminated or prospectively reformed substantially all of EPG's remaining gas purchase contracts, with the result that EPG no longer has any material take-or-pay exposure.
EPG has filed to recover $1.1 billion of its buy-out and buy-down costs under FERC cost recovery procedures. The collection period for the direct bill portion of the take-or-pay buy-out and buy-down costs extends through May 1994. The collection period for the volumetric surcharge portion of such costs extends through March 1996. Through December 31, 1993, EPG had recovered approximately $1.0 billion; of that recovery, $361 million was collected by direct bill and $682 million by volumetric surcharge. EPG has established a reserve for that portion of the volumetric surcharge receivables balance which is unlikely to be collected over the period through March 1996, based on current throughput projections. The balance of this reserve was $19 million at December 31, 1993.
Under FERC procedures, take-or-pay cost recovery filings may be challenged by pipeline customers on prudence and certain other grounds. In October 1992, FERC approved an order, subject to rehearing, resolving all but one of the outstanding issues regarding EPG's take-or-pay proceedings. The remaining issue involves the claim by several customers that EPG has sought to recover an excessive amount for the value of certain production properties which were transferred to a producer as part of a 1989 take-or-pay settlement. On March 8, 1993, an initial decision from the presiding ALJ was rendered which, if adopted without changes by FERC, would require EPG to refund to or forgo collection from its customers of up to $30 million, plus interest. Exceptions to this initial decision were filed with FERC by both parties on April 7, 1993. On April 27, 1993, briefs opposing exceptions were filed by the same parties as well as by FERC staff. EPG has established adequate reserves for this issue and does not believe that the ultimate outcome will have a materially adverse effect on the Company's financial condition or results of operations.
On January 14, 1992, EPG completed a sale of substantially all of its remaining take-or-pay buy-out and buy-down receivables. The sale totaled $325 million, including $305 million of cash received at closing, which was used to repay $300 million of a payable to BR. The receivables sold in this transaction included $104 million which was recovered through direct bill and $221 million to be recovered through volumetric surcharge. The volumetric surcharge portion of the sale has been accounted for as a financing transaction because EPG is subject to certain recourse provisions related to such receivables. At December 31, 1993 and December 31, 1992, $87 million and $125 million, respectively, of the volumetric surcharge portion of the receivables sold remained outstanding. Amounts collected related to the take-or-pay receivables sold are remitted to the purchasers of the receivables.
Restructuring and Financing Transactions
In February 1992, EPG established a $300 million revolving credit facility with a group of banks which expires in March 1996. As of December 31, 1993, there were no borrowings outstanding under this facility. Approximately $1 million of commercial paper was outstanding as of December 31, 1993.
During 1992 and 1991, EPG completed several transactions in preparation for its separation from BR. Among these transactions was the transfer of the net assets of El Paso Production Company ("EPPC") and Meridian Oil Hydrocarbons Inc. ("Hydrocarbons"), collectively, the Company's Oil and Gas Operations Segment, which is reported as discontinued operations.
In December 1991, EPG declared and paid a dividend to BR of $55 million. In January and February 1992, EPG declared and paid dividends totaling $274 million to BR. These dividends were paid from the balance owed to EPG under an intercorporate cash management arrangement.
In March 1992, EPG completed the Offering. The proceeds from the Offering, net of related costs, totaled approximately $96 million. On June 30, 1992, BR distributed its 31.4 million shares of EPG's common stock to BR shareholders, which represented approximately 85 percent of EPG's outstanding common stock. As a result, BR no longer retains an ownership interest in EPG.
EPG had a Commitment Agreement with BR under which it could borrow up to $300 million and Loan Agreements for borrowings up to $500 million. At December 31, 1991, outstanding borrowings under the Commitment and Loan Agreements were $300 million and $325 million, respectively. In January 1992, additional borrowings of $109 million were made under the Loan Agreements to purchase the notes and debentures described below.
EPG also undertook certain transactions to establish an appropriate capital structure for its post-separation operations. In December 1991 and January 1992, EPG purchased notes and debentures totaling $253 million and $134 million, respectively. Funds were provided by proceeds from borrowings under the BR Loan Agreements. In addition, all of the outstanding 9 5/8% debentures were called for redemption at 106.84 percent of their principal amount. In January 1992, EPG received net proceeds of $569 million from the issuance of new debt securities. The proceeds were used for repayment of borrowings under the Loan Agreements with BR, redemption of debentures and payment of general corporate costs.
EPG repaid its outstanding commercial paper in December 1991 with borrowings under the Commitment Agreement with BR. The proceeds from the sale of the take-or-pay receivables, previously discussed herein, were used to repay the borrowings under the Commitment Agreement with BR.
The Commitment Agreement and the Loan Agreements with BR were terminated prior to the completion of the Offering.
Competition
Currently, EPG faces competition from other companies which transport natural gas to the California market. Competition generally occurs on the basis of price, quality and reliability of service.
The total present interstate pipeline capacity for delivering natural gas to the California border is approximately 6.9 Bcf/d. In addition to EPG, three other major interstate pipelines presently deliver natural
gas to California. Transwestern has the capacity to deliver approximately 1.1 Bcf/d from Permian, Anadarko and San Juan Basin supply sources; PGT has the capacity to deliver about 1.8 Bcf/d of Canadian gas; and Kern River has the capacity to deliver approximately 700 MMcf/d from Rocky Mountain supply sources. PGT completed a 755 MMcf/d expansion of its California capacity on November 1, 1993. In 1992, Kern River held an open season to determine interest in expanding capacity to California by 200 MMcf; however, no planned expansions have since been announced.
Demand for natural gas in the California market is projected to be less than capacity for some time to come. EPG maintains a strong competitive position in the market by virtue of the fact that its pipeline is, and expects to remain, the lowest-cost transporter of natural gas to California and the principal means of moving gas from the San Juan Basin to the California border. EPG's pipeline capacity to California is fully subscribed under long-term contracts which provide for the payment of fixed reservation charges.
EPG's largest single contract for interstate capacity to California is its 1,450 MMcf/d contract with SoCal, which has a primary term ending August 31, 2006. In 1992, SoCal relinquished 300 MMcf/d pursuant to this contract (out of an original contract demand quantity of 1,750 MMcf/d), all of which was subsequently subscribed by new firm shippers under long-term contracts. Pursuant to this contract, SoCal has the option to relinquish an additional 300 MMcf/d of capacity during the first quarter of 1996. PG&E has a contract for 1,140 MMcf/d of firm capacity rights on EPG's system. This contract has a primary term ending December 31, 1997. CPUC has directed PG&E to maintain 600 MMcf/d of capacity on EPG's system to service PG&E's core and core subscription service customers. EPG expects to offset potential future reductions in capacity commitments through new contracts with various natural gas users in California which are now served indirectly through SoCal and PG&E, as well as through the development of additional East-of-California and northern Mexico markets.
In general, natural gas faces varying degrees of competition from electricity, coal and oil. Competitive pressure from alternative fuels is less prevalent in EPG's market area due to strict environmental regulations in California.
Environmental
Accruals for environmental compliance costs are established when environmental assessments and/or remediation are probable, and when costs can be reasonably estimated. As of December 31, 1993, EPG had a reserve of $38 million for the following environmental contingencies with income statement impact:
1 -- EPG has been conducting remediation of PCB contamination at its facilities. The majority of the required PCB remediation has been completed. Future PCB remediation costs are estimated to range between $8 million and $11 million over the next five years.
2 -- EPG executed an Administrative Order on Consent with EPA on June 25, 1993 to conduct a RI/FS for a BI site located in Statesville, North Carolina, that has been identified for cleanup. BI and EPG have entered into an agreement to jointly fund the RI/FS for the site. EPG's share of the potential remediation costs is estimated to be between $17 million and $20 million over a 30 year period.
3 -- On November 2, 1993, in accordance with an EPA order, EPG and ARCO submitted work plans for remediation of the subsurface at the Prewitt Refinery in McKinley County, New Mexico. EPG and ARCO have a cost sharing agreement to each pay one-half of any remediation costs at this site. EPG's share of the remediation costs is estimated to be between $10 million and $20 million over a 30 year period.
4 -- EPG is involved in other environmental assessment and remediation activities which include two additional CERCLA sites (Fountain Inn, South Carolina and Odessa, Texas) and one state Superfund site (Etowah, Tennessee). The amount reserved as of December 31, 1993 will cover these and other small environmental assessments and other remediation projects.
EPG also has potential expenditures, of a capital nature, for the following environmental projects:
1 -- EPG has analyzed CAAA, and believes that these rules will impact the Company's operations primarily in the following areas: (i) potential required reductions in the emissions of NOx in non-attainment areas; (ii) the requirement for air emissions permitting of existing facilities; and (iii) enhanced monitoring of air emissions. The Company anticipates capitalizing the equipment costs associated with complying with CAAA and estimates that approximately $5 million to $27 million will be spent during the 1995 through 1997 time frame. However, EPA's proposed enhanced monitoring rules, when finalized, could potentially impose greater costs to the Company.
2 -- EPG has been conducting remediation of mercury contamination at certain facilities and is replacing mercury containing meters with dry flow devices. The remaining remediation costs are estimated to be between $8 million and $12 million, most of which will be incurred over the next two years. EPG will close and retire about 5,400 earthen siphon/dehydration pits in the San Juan Basin as recently required by certain environmental regulations. EPG estimates costs of approximately $17 million to $25 million to retire these pits over the next two years. The mercury remediation and pit closure costs, which are associated with the retirement of equipment, will be recorded as adjustments to accumulated depreciation, as required by regulatory accounting.
On December 21, 1993, EPA issued EPG a Notice of Liability for the CSMRI site in Golden, Colorado. Because EPA has not yet determined the volume of hazardous substances sent to the site by all parties, there is no way to estimate EPG's potential share of remediation costs. However, based on the volumes EPA presently lists as contributed by EPG and other potentially responsible parties, it appears that EPG is a minor contributor.
It is possible that new information or future developments could require the Company to reassess its potential exposure related to environmental matters. As such information or developments occur, contingency amounts will be adjusted accordingly.
Common Stock Transactions Subsequent to the Offering
For the year ended December 31, 1993, EPG paid approximately $40 million in dividends. On January 14, 1994, EPG's Board of Directors declared a quarterly dividend of $0.3025 per share on EPG's common stock, payable on April 4, 1994 to shareholders of record on March 11, 1994.
On October 22, 1992, EPG's Board of Directors authorized the repurchase of up to two million shares of EPG's outstanding common stock from time to time in the open market. Shares repurchased are held in EPG's treasury and are expected to be used in connection with employee stock option plans to minimize dilution to existing shareholders. During 1992, EPG acquired 812,773 shares of its common stock for an aggregate value of $24 million and in the fourth quarter reissued, in connection with employee stock option plans, 628,258 shares of common stock out of treasury stock for an aggregate value of $11 million. The 184,515 remaining shares were reissued through April 1993, in connection with employee stock option plans, for an aggregate value of $5 million.
During 1993, EPG acquired 509,095 shares of its common stock for an aggregate value of $18 million and subsequently reissued, in connection with employee stock option plans, 22,734 shares of its common stock out of treasury stock for an aggregate value of $0.5 million. As of December 31, 1993, EPG had 486,361 shares of treasury stock. In addition, from April 1993 through December 1993, EPG issued 43,394 shares of common stock in connection with employee stock option plans.
A total of 2,300 and 132,700 restricted shares of EPG's common stock were granted to certain employees for 1993 and 1992, respectively. The market value of such shares awarded was approximately $0.1 million and $2.8 million in 1993 and 1992, respectively.
Capital Expenditures
The Company's planned capital expenditures for 1994 of approximately $210 million are primarily for maintenance of business, system expansion and system enhancement. These expenditures are expected to be
financed through internally generated funds. Capital expenditures for 1993 were $164 million compared to $246 million for 1992. The decrease was due primarily to the 1992 completion of system expansion and enhancement projects.
On July 7, 1992, EPG filed an application with FERC, which was amended on November 27, 1992, to expand the delivery capacity of its system in the vicinity of Yuma, Arizona and, through an extension of its system south to San Luis Rio Colorado, Sonora, Mexico, to serve northern Mexican markets. The proposed expansion would provide shippers the opportunity to deliver natural gas to Mexican markets in northern Baja California via new pipeline capacity of 348 MMcf/d. This project is expected to cost approximately $71 million and will be financed through internally generated funds or through short-term borrowings. On November 29, 1993, FERC issued an order which approved the siting, construction and operation of facilities necessary for a border crossing facility in Yuma, Arizona which would connect the proposed extension with pipeline facilities in Mexico. The order also made a preliminary determination on environmental issues. FERC is deferring action on the remainder of the July 7, 1992 filing until EPG demonstrates that it has long-term executed contracts or binding precedent agreements for a substantial amount of the firm capacity of the proposed facilities.
EPG is a member of a five-company consortium that plans to build the proposed Samalayuca II Power Plant near Ciudad Juarez, Mexico. On December 17, 1992, an award for construction was granted to the consortium by the Comision Federal de Electricidad, the Mexican government-owned utility. On March 16, 1993, EPG filed an application with FERC to expand its system in order to provide natural gas service to the proposed Samalayuca II Power Plant and to an existing power plant in the same location. The proposed expansion would provide an additional 300 MMcf/d of capacity at a cost of approximately $57 million and will be financed through internally generated funds or through short-term borrowings. In the November 29, 1993 order, FERC also approved the proposed border crossing facility south of Clint, Texas which would connect EPG's facilities with facilities in Mexico. FERC is deferring action on the remainder of the March 16, 1993 filing until EPG demonstrates that it has long-term executed contracts or binding precedent agreements for a substantial amount of the firm capacity of the proposed facilities.
On December 29, 1993, PG&E, SoCal and the CPUC jointly filed a motion with FERC seeking clarification or rehearing of the November 29, 1993 FERC order for both the Yuma, Arizona and the Samalayuca II Power Plant projects discussed above.
On March 17, 1993, MPC filed an application, which was amended on November 8, 1993, for a certificate of public convenience and necessity to build and operate a 475 MMcf/d expansion of its existing system. The proposed expansion will extend from MPC's existing east lateral located near Bakersfield, California approximately 352 miles northward to the vicinity of Sacramento and the East Bay area near San Francisco. The expansion will also include 56 miles of looping of the existing pipeline along with 207 miles of laterals. The estimated cost of the entire system is $467 million which is expected to be funded primarily through project financing. MPC expects to receive its FERC certificate in early 1994 and put the expansion into service in January 1996.
On December 16, 1993, FERC held a public conference to examine a jurisdictional question raised by CPUC and PG&E regarding MPC's system expansion. The primary issue is whether FERC or CPUC should have jurisdiction over the proposed expansion. Written comments were filed by interested parties on January 10, 1994, with a final decision by FERC expected in early 1994.
Other
In January 1993, EPG experienced flood damage to its pipeline system in the Gila, Arizona area due to heavy rain. Since that time, EPG has been incurring costs for repairs and expects to be reimbursed through its property insurance policies once all repairs have been completed.
RESULTS OF OPERATIONS
Year Ended December 31, 1993 Compared to Year Ended December 31, 1992
Operating revenues for the year ended December 31, 1993 were $106 million higher than for the same period of 1992. New system rates and a new rate design placed into effect February 1, 1993, resulted in a $41 million increase in revenues which was comprised of an increase in reservation revenues of $111 million
offset by a decrease in transportation revenues of $70 million. The consolidation of MPC contributed $27 million to the increase. Higher production area rates and volumes increased revenues by $3 million and $7 million, respectively. Higher sales rates increased revenues by $34 million; however, lower sales volumes offset that increase by $5 million. In addition, the sale of gas in storage contributed $18 million to the increase in revenues; this increase is offset in operating charges. Offsetting the increase in operating revenues was a decrease of $13 million due to lower transportation volumes, a decrease in return on take-or-pay receivables of $4 million and a decrease in liquid revenues of $2 million.
Operating charges were $62 million higher for the year ended December 31, 1993 compared to the same period for 1992. Higher average cost of gas contributed $39 million to the increase. In addition, the sale of gas in storage contributed $18 million to the increase in operating charges; this increase is offset in operating revenues. Higher operation and maintenance costs of $26 million were due primarily to an accrual for estimated take-or-pay undercollections, the consolidation of MPC and increases in employee benefit costs and outside contractors fees, primarily related to environmental clean-up. This increase is partially offset by lower stock related benefit costs. An increase of $3 million in other taxes is primarily due to the consolidation of MPC and an increase in ad valorem taxes. The increase in operating charges was partially offset by lower depreciation rates after giving effect to the rate settlement. Additionally, lower gas sales volumes resulted in a decrease in operating charges of $4 million.
EPG's throughput for 1993 was 1,306 Bcf compared to 1,357 Bcf in 1992. This decrease is due to lower deliveries to the utility electric generation market resulting from the availability of excess hydroelectric power in the California markets. The lower deliveries to California were partially offset by higher throughput to off-system markets.
Interest and debt expense for the year ended December 31, 1993 was $7 million higher than for the same period of 1992 due primarily to the consolidation of MPC.
Allowance for funds used during construction ("AFUDC") was $2 million lower for the year ended December 31, 1993 than for the same period in 1992 due to a decrease in expansion project expenditures during 1993.
Other-net was $6 million higher for the year ended December 31, 1993 compared to the same period for 1992. Contributing to the higher expense was a $6 million increase related to environmental accruals; a $4 million reduction in direct bill interest income; and a $4 million reduction in partnership earnings due to the consolidation of MPC. The increase was offset by lower interest expense of $4 million on tax adjustments and $3 million of interest income related to the recovery of EPG's investment in its underground storage facility.
Year Ended December 31, 1992 Compared to Year Ended December 31, 1991
Operating revenues for 1992 were $68 million higher than 1991. The overall increase in revenues was due primarily to new rates placed into effect on January 1, 1992. The new rates resulted in a $156 million increase in reservation revenues, which reflects the shift from firm sales service to firm transportation service. By unbundling its sales service, the Company's sales occur at the mainline receipt point as opposed to the delivery point. Lower accruals for regulatory issues resulted in an increase in revenues of $42 million. Higher sales volumes resulted in increased revenues of $88 million; however, lower sales rates offset that increase by $23 million. Also offsetting the increases were lower transportation rates which resulted in decreased revenues of $113 million. Other decreases affecting the improved 1992 results were a $30 million decrease in production area revenues resulting from the sale of certain gathering and processing facilities and lower rates, a $28 million decrease in return on take-or-pay receivables, an $11 million decrease in liquid revenues and a $6 million decrease in interest on receivables from customers.
Operating charges were $68 million higher for 1992 compared to 1991. The increase was primarily due to higher purchased gas costs. Higher sales volumes resulted in a $72 million increase in purchased gas costs; however, this increase was partially offset by a $15 million decrease due to lower gas purchase prices. A $12 million increase in depreciation and a $7 million increase in taxes, other than income taxes, both resulting from system expansions, also contributed to the increase in operating charges. An $8 million decrease in operation and maintenance costs was principally due to reductions in fees paid to outside operators and
contractors, partially offset by additional costs allocated to the Company from BR resulting from the separation of the two companies.
Throughput for 1992 was 1,357 Bcf compared to 1,409 Bcf in 1991. The decrease in throughput was principally due to increased competition in the California markets. Lower deliveries to California were partially offset by higher throughput to the East-of-California and off-system markets.
Interest and debt expense was $68 million for 1992 compared with $98 million for 1991. The decrease was primarily due to a $18 million reduction in interest on commercial paper, which balance was repaid in December 1991, and a $17 million reduction in interest on rate refund, which refund was made in October 1991. These decreases were partially offset by an $8 million increase resulting from the cost of the take-or-pay receivables sale.
Interest income from BR was $2 million for 1992 compared with $38 million for 1991. This decrease was due to the dividends declared and paid to BR in December 1991 and in January and February 1992, from the balance owed by BR to EPG under the intercorporate cash management arrangement.
Reported as other-net was $2 million expense for 1992 compared with $12 million income for 1991. Contributing to lower income in 1992 was a $5 million decrease in net gains on dispositions of facilities; a $7 million reduction in MPC partnership earnings resulting from a non-recurring income adjustment in 1991; and a $6 million increase in other interest. A $6 million increase in income from temporary investments and other interest income partially offset the lower income.
OTHER
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106 ("SFAS 106") requiring companies to account for other post-retirement employee benefits ("OPEBs") (principally retiree medical costs) on an accrual basis versus the pay-as-you-go basis traditionally followed by most United States companies. The Company adopted SFAS 106 effective January 1, 1993.
The Company provides a non-contributory defined benefit postretirement medical plan that covers employees who retired on or before March 1, 1986 and limited postretirement life insurance for employees who retire after January 1, 1985. As such, the Company's obligation to accrue for OPEBs is primarily limited to the fixed population of retirees who retired on or before March 1, 1986. The medical plan is funded to the extent employer contributions are recoverable through rates.
EPG began recovering through its rates the OPEB costs included in the settlement agreement. To the extent actual OPEB costs exceed the amounts reflected in the settlement agreement, a regulatory asset has been recorded. Management expects such amounts to be fully recovered through its rates.
The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112 ("SFAS 112") which requires companies to account for benefits to former or inactive employees after employment but before retirement (referred to in SFAS 112 as "postemployment benefits"). SFAS 112 is effective for the fiscal years beginning after December 15, 1993. Postemployment benefits include every form of benefit provided to former or inactive employees, their beneficiaries and covered dependents. Benefits include, but are not limited to salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits (including workers' compensation), job training and counseling and continuation of benefits such as health care benefits and life insurance coverage. The cumulative effect at January 1, 1994 of adopting SFAS 112 is estimated to be approximately $8 million. Management expects to fully recover its postemployment benefit costs through rates.
The Revenue Reconciliation Act of 1993, enacted in August 1993, changed the corporate income tax rate from 34 to 35 percent effective January 1, 1993. As a result, the Company's current year provision for income tax expense was adjusted in the third quarter of 1993 by approximately $1 million, of which $0.5 million is related to the balance of deferred income taxes at December 31, 1992. In addition, the balance of accumulated deferred income taxes at January 1, 1993 was increased $5 million in accordance with Statement of Financial Accounting Standards No. 109 ("SFAS 109"), and a corresponding regulatory asset was recorded. Management expects such amounts to be fully recovered through its rates.
Deferred credits, in the accompanying Consolidated Balance Sheet, include excess deferrals resulting from the reduction of the statutory federal tax rate from 46 to 34 percent on July 1, 1987.
ITEM 8. | 31986 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
Information with respect to selected financial data contained in Terra Industries' 1993 Annual Report to Stockholders under the caption "Financial Summary" is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Information with respect to management's discussion and analysis of financial condition and results of operations contained in Terra Industries' 1993 Annual Report to Stockholders under the caption "Financial Review" is incorporated herein by reference.
ITEM 8. | 722079 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth for the indicated periods selected historical financial information for ICH and its consolidated subsidiaries. Such information should be read in conjunction with the consolidated financial statements of ICH, and the related notes and schedules, included elsewhere herein. Factors affecting the comparability of certain indicated periods are discussed under "Management's Discussion and Analysis of Financial Condition and Results of Operations" in ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following is an analysis of the results of operations and financial condition of ICH and its consolidated subsidiaries. The consolidated financial statements and related notes and schedules included elsewhere in this Form 10-K should be read in conjunction with this analysis.
RECENT EVENTS AND OTHER FACTORS
During 1993, ICH successfully completed the sale for cash of its interest in Bankers Life Holding Corporation ("BLHC"), completed an exchange offer for a substantial portion of its debt scheduled to mature over the next several years, significantly reduced its and its subsidiaries' exposure to the risks associated with highly volatile mortgage-backed securities, and realized significant gains from the sale of investments in CCP Insurance, Inc. ("CCP Insurance"). These transactions resulted in a significant improvement in ICH's financial position, and the sale of the interest in BLHC provided ICH with substantial liquidity with which to meet its financial obligations. In addition, ICH completed the restructuring of its insurance holding company system, reduced its subsidiaries' dependence on
financial reinsurance by in excess of 40%, and began the process of terminating significant reinsurance arrangements with an affiliated company. ICH utilized a portion of the proceeds from its sale of BLHC and cash remaining from its sale of Bankers Life and Casualty Company ("Bankers") in 1992 to further reduce some of the more expensive components of its capital structure. In management's opinion, ICH made significant progress in improving its relationship with regulatory authorities, and continued progress in consolidating the operations of its Texas-based insurance subsidiaries and in further reducing operating expenses. The successes in 1993 were offset, in part, by lower than anticipated earnings from continuing operations and additional losses and writedowns in the Company's investment portfolio. Subsequent to year-end, in February 1994, ICH purchased and retired its Class B Common Stock which had given its previous holders the ability to elect 75% of the members of ICH's Board of Directors. Following is an analysis of these various events and factors, including management's assessment of their impact on the financial position and liquidity of ICH, as well as management's future expectations.
SALE OF INVESTMENT IN BANKERS LIFE HOLDING CORPORATION
At year-end 1992, ICH's subsidiaries held direct and indirect common equity interests in BLHC totaling approximately 39.9%. Such interests had been acquired in conjunction with the sale of ICH's subsidiary, Bankers, in November 1992. During the first quarter of 1993, ICH acquired such interests from its subsidiaries. Effective March 31, 1993, BLHC completed an initial public offering of 19.55 million shares of its common stock, or an aggregate 35.8% interest in BLHC, at $22 per share. Proceeds of the offering, after underwriting expenses, approximated $405 million. Effective the same day, Conseco Capital Partners, L.P. ("CCP") announced a plan of dissolution and BLHC common shares held by CCP were subsequently distributed to the respective partners. ICH received 2,917,318 shares of BLHC common stock as a result of such distribution, increasing its direct ownership in BLHC common stock to 13,316,168 shares, or approximately 24.4% of BLHC's outstanding common shares following the offering. ICH reflected a pre-tax gain on the BLHC offering totaling approximately $99.4 million, primarily representing ICH's equity in the net proceeds of such offering. BLHC utilized a portion of the offering proceeds to redeem certain of its outstanding securities, including $50 million stated value of BLHC preferred stock and $34.7 million principal amount of BLHC junior subordinated notes held by ICH's subsidiaries. Because a portion of the purchase price paid for such investments had been allocated to ICH's common equity investments in BLHC, such redemptions resulted in additional pre-tax gains totaling approximately $8.3 million.
On September 30, 1993, ICH sold its investment in BLHC to Conseco, Inc. ("Conseco") and one of Conseco's subsidiaries for $287.6 million cash. ICH utilized $50 million of the proceeds to redeem $50 million stated value of its Series 1987-A Preferred Stock held by a Conseco subsidiary. The sale of the BLHC shares resulted in a pre-tax gain totaling approximately $197.6 million. For financial reporting purposes, the gains resulting from BLHC's offering and the sale of ICH's remaining interest in BLHC totaling approximately $297.0 million have been reflected as a single line item in the 1993 statement of earnings. ICH continued to reflect its equity in the operating results of BLHC through the date of sale.
Effective March 31, 1993, Bankers and an ICH subsidiary terminated a reinsurance agreement under which Bankers had previously ceded substantially all of its directly underwritten participating life insurance business to ICH's subsidiary. Assets, primarily fixed maturities and cash, with a fair value of approximately $163.6 million were transferred to Bankers and Bankers assumed policy liabilities on the reinsured business totaling approximately $186.2 million. ICH realized a gain on the termination of the reinsurance agreement totaling approximately $22.6 million which has been reflected in other income in the 1993 statement of earnings.
CHANGES IN CAPITAL STRUCTURE
During 1993, ICH completed an exchange offer for a portion of its outstanding debt and significantly reduced some of the more expensive components of its debt and equity structure. Subsequent to year-end, a significant transaction occurred affecting control of the Company.
As discussed above, $50 million stated value of ICH's Series 1987-A Preferred Stock was redeemed in conjunction with the sale of the interest in BLHC. In addition, on December 2, 1993, ICH redeemed for $50 million cash all of its Series 1987-C Preferred Stock at its stated value. These redemptions reduced ICH's annual preferred dividend requirements by $13.5 million.
Utilizing a portion of the proceeds from the sale of BLHC and cash remaining from the sale of Bankers in 1992, ICH retired all of the remaining $124.9 million principal amount of its 16 1/2% Senior Subordinated Debentures due 1994 ("Debentures") during 1993. Approximately $37.5 million of the Debentures were redeemed through a scheduled sinking fund payment in January 1993, an additional $37.5 million were called in March 1993 at a price of 101.84% of the amount redeemed, approximately $4.1 million were exchanged for new debt of the Company in November 1993, and the remaining Debentures were redeemed at par effective for financial reporting purposes as of December 30, 1993. Interest savings on the retired Debentures, excluding the exchanged debt, will approximate $20.2 million annually.
In November 1993, ICH completed an exchange offer whereby $4.1 million of the Debentures and $87.1 million of its 11 1/4% Senior Subordinated Notes due 1996 ("Old Notes") were exchanged for $91.2 million of 11 1/4% Senior Subordinated Notes due 2003 ("New Notes"). See Note 3 of the Notes to Financial Statements for additional information regarding terms of the New Notes. Prior to the exchange offer, ICH and its subsidiaries held $46.8 million of the Old Notes which can, at ICH's option and upon repurchase of the $34.1 million of such Old Notes held by its subsidiaries, be utilized to partially satisfy its first $100 million sinking fund obligation relative to the Old Notes on December 1, 1994. The results of the exchange offer provided ICH additional flexibility in meeting such sinking fund obligation, since the amount of the Old Notes exchanged for New Notes can, also at ICH's option, be taken into consideration in determining what portion, if any, of the Old Notes it wishes to redeem through operation of the sinking fund. Assuming ICH utilizes its available Old Notes and defers sinking fund payments by an amount equivalent to the Old Notes which were exchanged, ICH would not have any sinking fund obligation in 1994 and its obligation in 1995 would total $66.1 million. Alternatively, and assuming its ability to generate the required liquidity, ICH may, at its option, determine to retire up to $100 million of the Old Notes at their par value through operation of the sinking fund in each of 1994 and 1995. ICH also has the option of calling any portion of the Old Notes at a 3% premium through November 30, 1994, and at a 2% premium during the following twelve month period. Thereafter, the Old Notes may be called at their par value.
On February 11, 1994, ICH purchased all of the 100,000 shares of its Class B Common Stock from Consolidated National Corporation ("CNC") for total cash consideration of $500,000. The Class B Common Stock had entitled CNC to elect 75% of ICH's Board of Directors and, by virtue of such voting power, CNC was considered to be ICH's controlling shareholder. The Class B Common Stock was immediately cancelled and retired following ICH's purchase. Concurrently, Stephens Inc. ("Stephens") and Torchmark Corporation ("Torchmark") purchased 4,457,000 shares and 4,667,000 shares, respectively, of ICH Common Stock from CNC. Stephens is an investment banking firm with its principal offices located in Little Rock, Arkansas, and Torchmark is a diversified insurance and financial services company headquartered in Birmingham, Alabama. One officer each from Stephens and Torchmark was elected to fill vacancies on the ICH Board of Directors. In addition, a management and services agreement between ICH and CNC was cancelled, and new ten-year services agreements were entered into with the two principal shareholders of CNC. As a result of these transactions and the transactions with Consolidated Fidelity Life Insurance Company as described below, CNC's ownership in ICH will be reduced to approximately one million shares, or 2%, of ICH's outstanding Common Stock. Management believes these transactions are significant for various reasons. Most importantly, management believes that ICH's access to both debt and equity capital markets has previously been limited because of the control position held by CNC through the Class B stock, and that the retirement of the Class B stock and considerable reduction in CNC's holdings of ICH Common Stock could ultimately enhance ICH's ability to refinance its currently outstanding debt.
TRANSACTIONS WITH CONSOLIDATED FIDELITY LIFE INSURANCE COMPANY
Effective June 15, 1993, ICH entered into an agreement (the "Agreement") which initiated the process of terminating certain reinsurance arrangements involving Consolidated Fidelity Life Insurance Company ("CFLIC"), a subsidiary of CNC. The reinsurance arrangements involve certain annuity business with reserves totaling approximately $330.0 million as of December 31, 1993, which was transferred by a subsidiary of ICH, Southwestern Life Insurance Company ("Southwestern"), to an unaffiliated reinsurer in 1990. The unaffiliated reinsurer, in turn, transferred the business to another CNC subsidiary, Marquette National Life Insurance Company ("Marquette"). In 1991, Marquette transferred the annuity business to CFLIC.
The reinsurance arrangements have been under review by the Texas Department of Insurance ("Texas Department") and, in March 1993, ICH and Southwestern agreed with the Texas Department that they would, among other things, develop a plan to enhance and diversify the assets supporting the liabilities reinsured by CFLIC, including possibly recapturing the reinsured annuity business. The recapture is subject to negotiations with the unaffiliated reinsurer and approval by the Texas Department.
CNC and CFLIC agreed to structure the proposed recapture in a manner that will permit ICH to redeem or retire certain of its outstanding securities, provided that CFLIC would be allowed to retain certain assets following the recapture. CFLIC holds ICH's senior secured debt, with a current balance of $30 million, which it acquired in 1992 from ICH's bank lenders. In addition, CFLIC holds approximately $22.2 million stated value of ICH's Series 1984-A Preferred Stock, $7 million stated value of Series 1987-B Preferred Stock, and 620,423 shares of ICH's Common Stock.
CFLIC also intends to terminate another reinsurance arrangement under which business written by Bankers is reinsured by CFLIC. Under terms of the Agreement, ICH is responsible for the negotiation on CFLIC's behalf of both the Southwestern and Bankers recaptures and the management of the affairs of CFLIC and Marquette, including management of their investments, until the recaptures are effected. Upon completion of the recaptures, CFLIC will have no remaining insurance business.
To facilitate the recaptures of the reinsured business, ICH acquired $63 million of CFLIC preferred stock in exchange for its ownership interest in certain investments with an estimated fair value as of June 15, 1993, of $63 million, including its ownership in a limited partnership (HMC/Life Partners, L.P.) and 83% of ICH's ownership interest in I.C.H. Funding Corporation ("ICH Funding"). ICH Funding is a special purpose entity that was formed in 1992 to hold ICH's residual interest in a pool of mortgage-backed securities acquired from Bankers. The CFLIC preferred stock is non-redeemable and non-voting with cumulative 6% annual dividends that are payable "in-kind" until the recaptures are completed. ICH and CFLIC anticipate that the assets received by CFLIC from ICH in consideration for the preferred stock, along with other assets held by CFLIC, including its ownership in Marquette, will be transferred to Southwestern upon recapture of the annuity business. Following the recaptures, CFLIC is obligated to repurchase its preferred stock by transferring its ownership interest in the ICH debt and preferred securities and additional assets to ICH. Upon their receipt, ICH intends to retire the ICH securities.
For financial reporting purposes, no gain or loss was recognized on the transfer of assets to CFLIC. The Agreement identifies the specific assets and liabilities plus, subject to certain conditions, an amount of cash that will be retained by CFLIC following the recaptures. All remaining assets held by CFLIC, including the ICH securities, will revert to ICH in redemption of CFLIC's preferred stock. As a consequence, ICH will benefit or suffer the consequences to the extent of any appreciation or depreciation in the value of the assets transferred to CFLIC. At December 31, 1993, ICH has reflected its investment in the CFLIC preferred stock at its approximate fair value of $54 million, or $9 million less than the value assigned to such preferred stock at June 15, 1993. The reduction in fair value between the two dates was primarily attributable to a decline in the fair value of the 83% interest in ICH Funding transferred to CFLIC.
Management believes the transactions with CFLIC will be beneficial for several reasons. In addition to eliminating $30 million in scheduled debt principal requirements, the redemption or retirement of the ICH securities will reduce ICH's interest and preferred dividend requirements by approximately $5.4 million annually. Further, the recapture of the Southwestern annuity business will substantially eliminate the possibility for conflicts of interest between CNC and its subsidiaries and ICH. Management's present goal is to complete the transactions with CFLIC as soon as possible.
RESTRUCTURING OF ICH HOLDING COMPANY SYSTEM
In September 1993, ICH completed the restructuring of its insurance holding company system, from a vertical to a substantially horizontal structure. The restructuring was designed to increase the financial independence of ICH's subsidiary insurance companies and reduce the effect of multi-jurisdictional regulation that results when such subsidiaries are held indirectly, through other insurance subsidiaries. In the process of such restructuring, a surplus debenture due to ICH from a subsidiary with an outstanding principal balance of $105.8 million was retired and added to ICH's investment in its subsidiaries. As a consequence, there are no remaining surplus debentures due to ICH from its subsidiaries. The restructuring is expected to facilitate more accurate analysis and understanding of the Company by ratings agencies, securities analysts, and regulators, and will permit the direct payment of dividends from subsidiaries to ICH in future periods. Following such restructuring, ICH's subsidiaries affected by the restructuring have maintained risk-based capital levels substantially in excess of those required by applicable regulatory authorities.
RATINGS
ICH's subordinated debt and preferred stock are rated by various nationally recognized statistical rating organizations, such as Moody's Investors Service, Inc. ("Moody's") and Standard and Poor's Corporation ("S&P"). These agencies, along with Duff & Phelps Credit Rating Company ("Duff & Phelps"), have also rated the claims paying ability of certain of ICH's insurance subsidiaries. In addition, A.M. Best, an agency specializing in the rating of insurance companies, has assigned ratings to each of ICH's insurance subsidiaries. Over the last two years, substantially all of the ratings issued by these agencies have reflected ratings downgrades. Virtually all ratings downgrades experienced by ICH and its subsidiaries were attributed to high or continuing leverage at the parent company level.
Moody's has rated ICH's subordinated debt at "B3" and its preferred stock at "Caa," both of which are below investment grade. S&P has rated ICH's debt at "B-" and its preferred stock at "CCC+," both of which are also below investment grade. Southwestern has been assigned claims paying ratings of "Ba2" by Moody's (questionable financial security), "BBB-" by S&P (adequate financial security, but capacity to meet policyholder obligations susceptible to adverse economic and underwriting conditions) and "A" by Duff & Phelps (high claims paying ability). A.M. Best has assigned "B++" ratings (very good) to all of ICH's significant insurance subsidiaries.
The ratings assigned to ICH by ratings agencies have a significant effect on ICH's ability to borrow funds, as well as the interest rates that ICH must pay in order to borrow funds. The claims paying ratings assigned to ICH's subsidiaries could have a significant effect on a given subsidiary's ability to market its products, as well as its ability to retain its presently existing insurance in force. Except for an increase in the level of withdrawals of guaranteed investment contracts ("GICs") as discussed in "Liquidity and Capital Resources -Insurance Operations," management does not believe that ICH's insurance subsidiaries have experienced more than normal policy surrenders and withdrawals as a result of the ratings downgrades received in 1992 and 1993. In addition and notwithstanding such ratings downgrades, total new business produced by ICH's insurance subsidiaries, excluding GIC business, increased in 1993 as compared to 1992.
Substantially all of ICH's and its subsidiaries' present ratings were issued prior to ICH's sale of its investment in BLHC, the restructuring of its insurance holding company system, the completion of its debt exchange offer, the retirement of its remaining Debentures, and the redemptions of $100 million in preferred stocks and the Class B Common Stock. Management believes, as a result of these
previously discussed events, that the financial condition of ICH and its insurance subsidiaries has significantly improved and that, as a result, the possibility exists for upgrades in such financial and claims paying ratings. ICH has arranged for meetings with all applicable rating agencies in March 1994, but there can be no assurance that ICH's or its subsidiaries' ratings will be upgraded following such meetings.
REGULATORY ENVIRONMENT
ICH's insurance subsidiaries are subject to comprehensive regulation in the various states in which they are authorized to do business. The laws of these states establish supervisory agencies with broad administrative powers, among other things, to grant and revoke licenses for transacting business, to regulate trade practices, reserve requirements, the form and content of policies, and the type and amount of investments, and to review premium rates for fairness and adequacy. These supervisory agencies periodically examine the business and accounts of ICH's insurance subsidiaries and require them to file detailed annual financial statements and reports prepared in accordance with statutory accounting practices. In addition, as an insurance holding company, ICH is also subject to regulatory oversight in the states in which its insurance subsidiaries are domiciled.
Primarily as a result of the failures of several large insurance holding companies during the past few years, increased scrutiny has been placed upon the insurance regulatory framework, and a number of state legislatures have enacted legislation that has altered, and in many cases increased, state authority to regulate insurance companies and their holding company systems. Further, some Congressional leaders have proposed legislation which could result in the federal government's assuming some role in the regulation of the insurance industry. In light of these developments, the National Association of Insurance Commissioners (the "NAIC") and state insurance regulators have also become involved in the process of re-examining existing laws and regulations and their application to insurance companies. In particular, this re-examination has focused on insurance company investment and solvency issues and, in some instances, has resulted in new interpretations of existing law, the development of new laws and the implementation of non-statutory guidelines. The NAIC has formed committees and appointed advisory groups to study and formulate regulatory proposals on such diverse issues as the use of surplus debentures, the accounting for reinsurance transactions, uniform investment laws and the adoption of risk-based capital requirements. In addition, in connection with its accreditation of states to conduct periodic examinations, the NAIC has encouraged and persuaded states to adopt model NAIC laws on specific topics, such as holding company regulations, the structure of reinsurance transactions, and the definition of extraordinary dividends. During 1992 and continuing in 1993, in part as a result of these activities, ICH's insurance subsidiaries became subject to substantially more oversight by insurance regulators, and such increased oversight will likely continue in 1994 and future periods.
During 1992, a special working group (the "Group") of the NAIC, which included the representatives of seven states, conducted an extensive review of the operations and financial condition of ICH and CNC and their respective insurance subsidiaries. Retaining the services of an independent accounting firm, other than ICH's public accountants, the Group placed particular emphasis on reviewing transactions between related parties and major transactions with certain other unaffiliated companies, differences between GAAP and statutory reporting practices, cash flow projections, off-balance sheet risks and non-traditional investments, and the insurance subsidiaries' risk-based capital requirements. In December 1992, based on their review of the findings, the Group advised ICH they had material concerns about asset quality and the cash flow position of ICH. The asset quality concerns were discussed in detail in ICH's 1992 Annual Report on Form 10-K and, as indicated in such discussion, substantially all of the Group's concerns had already been addressed by ICH. Management believes that the Group's concerns regarding ICH's cash flow position were effectively overcome in 1993 by the sale of ICH's investment in BLHC and the successful completion of ICH's debt exchange offer. As a result of these events and the resolution of remaining asset quality concerns, the Group's utilization of other independent accountants to review the affairs of ICH and its subsidiaries has been effectively eliminated and management believes that regulators from the states in which ICH's
insurance subsidiaries are domiciled were significantly more cooperative in granting the required approvals for ICH to accomplish the restructuring of its insurance holding company system. The Group has nevertheless indicated that it will likely continue to monitor, to the extent it deems appropriate, the activities and the operations of ICH and CNC and their respective insurance subsidiaries. However, based on the progress made to date in resolving concerns expressed by the Group, management does not anticipate that ICH will encounter any regulatory difficulty in proceeding with its corporate objective to grow its insurance operations through strategic acquisitions or other means.
Life insurance companies are generally required under statutory accounting rules to maintain an asset valuation reserve ("AVR") which consists of two components: a "default component" to provide for future credit-related losses on fixed income investments and an "equity component" to provide for losses on all types of equity investments, including real estate. Life insurance companies are also required to maintain an interest maintenance reserve ("IMR"), which is credited with the portion of realized capital gains and losses from the sale of fixed maturity investments attributable to changes in interest rates. The IMR is required to be amortized against statutory earnings on a basis reflecting the remaining period to maturity of the fixed income securities sold and there are no limitations as to the amounts which can be accumulated in the IMR. At December 31, 1993, the AVR of ICH's insurance subsidiaries totaled $45.0 million. The IMR of such subsidiaries was insignificant. Increases in the AVR and the IMR do not reduce either statutory or GAAP operating income, but result in a reduction in the statutory surplus of ICH's insurance subsidiaries.
Historically, insurance companies have been required to satisfy the minimum capital requirements of the states in which such companies were domiciled. Such minimum capital requirements tended to be relatively small, fixed dollar amounts that bore little, if any, reflection of the size of the company or the nature and diversification of the risks taken by the company. Over the past several years, the NAIC and various states have undertaken projects to develop risk-based capital ("RBC") requirements for insurance companies and model laws that would provide the framework for triggering a range of regulatory options in the event an insurance company failed to maintain adequate RBC levels. Effective with statutory annual statements filed for the year ending December 31, 1993 and thereafter, each life insurance company is required to calculate, utilizing NAIC formulas, their level of targeted adjusted capital. Such NAIC formulas focus on 1) asset impairment risks, 2) insurance risks, 3) interest rate risks, and 4) general business risks. A risk-based capital ratio ("RBC ratio") is then determined based on the company's level of adjusted capital and surplus, including AVR and other adjustments, to its targeted adjusted capital.
In states which have adopted the NAIC regulations, the new RBC requirements provide for four different levels of regulatory attention depending on an insurance company's RBC ratio. The "Company Action Level" is triggered if a company's RBC ratio is less than 200% but greater than or equal to 150%, or if a negative trend has occurred (as defined by the regulations) and the company's RBC ratio is less than 250%. At the Company Action Level, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. The "Regulatory Action Level" is triggered if a company's RBC ratio is less than 150% but greater than or equal to 100%. At the Regulatory Action Level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The "Authorized Control Level" is triggered if a company's RBC ratio is less than 100% but greater than or equal to 70%, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. The "Mandatory Control Level" is triggered if a company's RBC ratio is less than 70%, and the regulatory authority is mandated to place the company under its control.
Management believes that the levels of capital in ICH's insurance subsidiaries is sufficient to meet RBC requirements. Based on the NAIC's formulas, the RBC ratios for all but one of ICH's life insurance subsidiaries, based on financial statements as filed with regulatory authorities, exceeded
325% at December 31, 1993. One subsidiary's RBC ratio approximated 250% and management is in the process of evaluating alternatives to achieve at least a 300% RBC ratio for such subsidiary by year-end 1994.
From time to time, assessments are levied on ICH's insurance subsidiaries by life and health guaranty associations in states in which they are licensed to do business. Such assessments are made primarily to cover the losses of policyholders of insolvent or rehabilitated insurers. In some states, these assessments can be partially recovered through a reduction in future premium taxes. ICH's insurance subsidiaries, other than Bankers and Certified, paid assessments of $3.2 million, $2.2 million and $1.2 million in the years 1993, 1992 and 1991, respectively. Bankers and Certified paid assessments of $.6 million and $1.7 million for the ten months ended October 31, 1992 and the year 1991, respectively. Although the economy and other factors have recently caused the number and size of insurance company failures to increase, based on information currently available, ICH believes that any future assessments are not reasonably likely to have a material adverse effect on its insurance subsidiaries.
INVESTMENT PORTFOLIO
ICH pursues an investment strategy principally designed to balance the duration of investment assets against the liabilities of its insurance subsidiaries for future policy and contract benefits and, under certain circumstances, to manage its exposure to changes in market interest rates. Over the past several years, ICH has taken steps to restructure its investment portfolio in order to improve the overall quality of the portfolio. While these actions have resulted in substantially reduced exposure to credit risks, average yields have decreased from 9.1% in 1991 to 8.3% in 1992 and 6.9% in 1993. As a result of the investment portfolio restructuring, substantial investments were made in mortgage-backed securities and collateralized mortgage obligations in 1991 which were highly sensitive to subsequent changes in market interest rates and which contributed to the decline in investment yields. Further, the overall decline in market interest rates over the past several years has had a significant impact on ICH's ability to maintain the level of earnings on its invested assets.
In accordance with applicable insurance laws, ICH's insurance subsidiaries maintain substantial portfolios of investment assets that are held, in large part, to fund their future contractual obligations to policyholders. In structuring these portfolios, ICH has emphasized, and expects to continue to emphasize, investments in fixed maturities. In addition, ICH has maintained significant levels of short-term investments to meet its liquidity needs. Since 1991, fixed maturities and short-term investments have represented more than 75% of ICH's consolidated investments, while no other category of investment represented more than 10%. Additional information regarding the categories and amounts of ICH's investment assets is reflected in Note 5 of the Notes to Financial Statements.
During 1993, the NAIC initiated the process of drafting a model investment act. In general, the currently drafted investment act is substantially more restrictive than the present investment laws of the states in which ICH's insurance subsidiaries are domiciled. Management cannot predict with any certainty whether or when such a model investment act will be adopted and whether such act will "grandfather" certain existing investments. However, if adopted, it is likely that such model investment act will significantly limit the types of investments that can be made by ICH's insurance subsidiaries in future periods, as well as the amounts that can be invested in various investment categories, and could result in an overall reduction in investment yields.
Prior to 1992, ICH had carried all of its fixed maturities at amortized cost (less permanent declines), because management had stated its intent and believed ICH had the ability to hold all such investments to their ultimate maturities. If a determination was made to dispose of particular fixed maturity investments, the carrying values of such investments were adjusted to the lower of cost or market value. In 1992, management evaluated ICH's investment strategy, specifically in light of the sale of Bankers and ICH's need for liquidity. Based in part on ICH's decision to retain three independent investment advisors during 1992 to manage in excess of $1 billion of its investments, management determined that ICH's fixed maturities would be classified into three categories effective December 31, 1992. Fixed maturity investments which were determined to be readily marketable
were classified as "actively managed" and adjusted to their fair value through an adjustment to unrealized investment gains and losses in stockholders' equity. Those investments which ICH intended to sell, primarily certain mortgage-backed securities, were classified as "held for sale" and were adjusted to their fair value (if lower than cost) through a charge to earnings. Certain private placement securities which were not readily marketable and which ICH had both the ability and the positive intent to hold to maturity were classified as "held to maturity" and carried at amortized cost.
In April 1993, the Financial Accounting Standards Board 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 investments in debt and equity securities and requires that financial institutions classify their fixed maturity investments into three categories. Fixed maturity investments that an entity has the positive intent and ability to hold to maturity are to be classified as "held to maturity" and will continue to be reported at amortized cost. Fixed maturity and equity investments available for sale, which may or may not be traded before maturity, are to be marked to their current value, with any unrealized gains and losses reported as a separate component of stockholders' equity. Finally, fixed maturity and equity investments held only for trading must be marked to their current value, with any unrealized gains or losses reflected in earnings. SFAS No. 115 is required to be adopted for 1994 financial statements, but earlier adoption is encouraged. In 1993, ICH adopted the provisions of SFAS No. 115 and has categorized its fixed maturity and equity investments into two categories, available for sale and held to maturity. At year-end 1993, ICH and its subsidiaries did not hold any securities which would meet the criteria of being classified in a trading category. In its 1992 balance sheet, ICH has reclassified its "actively managed" and "held for sale" fixed maturities as available for sale.
ICH's fixed maturity portfolio generally includes government and corporate debt securities and mortgage-backed securities. Historically, this portfolio has been structured in part to balance desirable yields with credit concerns. ICH has concentrated its fixed maturity investments within categories that are rated investment-grade, while in certain instances holding selected noninvestment-grade securities that provide higher yields. ICH classifies its high-yield securities as noninvestment-grade if they are unrated or are rated less than BBB-by S&P or Baa by Moody's. Based on such classifications, ICH's noninvestment-grade fixed maturities represented 4.0% of ICH's consolidated investment portfolio at year-end 1993 as compared to 3.8% at year-end 1992 and 4.7% at year end 1991. Following is a summary of fixed maturity investments segregated by investment quality based on S&P ratings and the two categories of such investments as reflected in ICH's consolidated balance sheet at December 31, 1993 (in millions):
Investments in noninvestment-grade debt securities generally have greater risks than investment-grade securities. Risk of loss upon default by the borrower is greater with noninvestment-grade securities because these securities are generally unsecured and often are subordinated to other creditors of the issuers, and because the issuers have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recessions or increasing interest rates, than are investment-grade issuers.
ICH's subsidiaries hold substantial investments in mortgage-backed securities and collateralized mortgage obligations (collectively, "CMOs"). These investments generally offer relatively high yields and, because of the quality of the underlying collateral, are usually given the highest ratings by S&P and Moody's. Beginning in late 1990 and continuing through 1991 management utilized a strategy of investing in CMOs to enhance the credit quality of ICH's investment portfolio without incurring a reduction in investment yields. At year-end 1993, CMO's totaling $798.1 million represented 46.5% of ICH's fixed maturity investments and 30.2% of total invested assets. Of this amount, $709.2 million represented conventional CMO obligations with principal guarantees that are reflected as available for sale and carried at their fair value and $88.9 million primarily represented so-called derivative CMOs, such as residual interests in a pool or pools of mortgage loans, of which $72.7 million are reflected as available for sale at their fair value and $16.2 million are reflected as held to maturity and carried at amortized cost.
As reflected in its year-end 1992 financial statements, ICH held mortgage-backed residual interests and interest-only certificates ("IOs") with a carrying value and fair value of $422.7 million. Such year-end values were reflected net of reserves for anticipated losses in 1993 totaling $34.9 million, which had been provided based on the prepayment experience incurred and expected on the mortgage loans underlying such residual interests and IOs through the first three months of 1993. At June 30, 1993, the carrying value and fair value of such investments had declined to $358.3 million as a result of principal repayments. Based on an analysis of subsequent prepayment experience, management believed that the reserves provided at year-end 1992 had been adequate and, as a consequence, ICH did not incur any significant additional losses on its residual interests and IOs during the first six months of 1993.
Effective July 30, 1993, ICH and its subsidiaries, along with CFLIC, entered into a transaction designed to substantially reduce their exposure to the prepayment risks associated with their investments in residual interest and IO mortgage-backed securities, including liquidating a substantial portion of such investments. ICH's subsidiaries and CFLIC sold directly-owned residual interests and IOs with a carrying value of approximately $137.7 million and $26.5 million, respectively, to an unaffiliated third party, Fund America Investors Corporation II ("Fund America"). In addition, ICH and CFLIC sold to Fund America 75% of their rights with respect to residual interests in certain mortgage-backed securities which were acquired in conjunction with the sale of Bankers and are held in a special-purpose trust (the "Trust") to collateralize certain mortgage note obligations (see Note 3 of the Notes to Financial Statements included elsewhere in this Report). CFLIC had acquired its interest in the Trust as previously discussed under "Transactions With Consolidated Fidelity Life Insurance Company." Because ICH was deemed to be the Trust's sponsor and, with CFLIC, retained a majority ownership in the residual interest, the accounts of the Trust were included in ICH's consolidated balance sheet at year-end 1992 and at June 30, 1993. Following is a summary of the various accounts of the Trust as reflected in ICH's balance sheet at June 30, 1993, and ICH's net residual interest in the Trust (in millions):
The net carrying value of the 75% interests in the Trust sold by ICH and CFLIC to Fund America approximated $7.0 million and $33.7 million, respectively, at the date of sale.
Fund America sponsored the formation of a new trust (the "New Trust") into which it deposited the purchased securities. Interests in the New Trust aggregating $217 million, or 68.4% of its total outstanding securities, were sold to other unaffiliated parties. A portion of the sales proceeds were utilized to acquire additional securities which were deposited into the New Trust, including certain securities maturing in 2030 designed to assure the ultimate return of principal on the interests in the New Trust retained by ICH, its subsidiaries and CFLIC. The remaining proceeds, after underwriting expenses, were utilized to pay a portion of the purchase price for the securities purchased from ICH and its subsidiaries and CFLIC. The remainder of the purchase price was paid by issuing participation certificates representing residual interests in the pool of $101.0 million principal amount of securities placed in the New Trust. The participation certificates received in the transaction were valued for financial reporting purposes at their fair value, assuming an 11% annual return to maturity.
Before the recognition of gains totaling approximately $14.3 million resulting from the disposal of certain securities utilized to hedge prepayment risks on the mortgage-backed securities, the transactions resulted in losses for ICH and CFLIC totaling approximately $23.1 million. ICH reflected its portion of the losses resulting from these transactions as realized investment losses in its 1993 results. Following is a summary of the effects of the above-described transactions:
Because ICH and CFLIC no longer hold a direct or indirect majority interest in the Trust and have not guaranteed any portion of the collateralized mortgage note obligations, the accounts of the Trust have not been consolidated with those of the Company for periods subsequent to the sale to Fund America on July 30, 1993.
Management had originally intended to reflect ICH's investments in the Fund America certificates, its remaining interest in the Trust, and its investments in certain other residual interests at their amortized cost in the held to maturity category of fixed maturities to eliminate the accounting volatility associated with these types of investments. In late 1993, the Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board addressed "Impairment Recognition for a Purchased Investment in a Collateralized Mortgage Obligation Investment or in a Mortgage-Backed Interest-Only Certificate", in their EITF Issue No. 98-13. The focus of the EITF issue involved the criteria to be used to determine when writedowns should be taken on these types of investments as a result of the issuance of SFAS No. 115. ICH had previously determined when writedowns would be taken, based on an earlier EITF consensus, utilizing the undiscounted expected future cash flows on these types of investments. The writedown required under this approach was the amount necessary to reduce the carrying value of an individual security to a zero expected future yield and was reflected as a realized investment loss. The EITF reached a tentative consensus that the criteria for determining when future writedowns were required should be based on the discounted expected future cash flows, utilizing a "risk-free" rate of return. If the discounted cash flows are less than the carrying value of the investment, a permanent impairment in the value of the investment is to be recognized. Under the
provisions of SFAS No. 115, if impairment is indicated, an individual security should be written down to its fair value as a new cost basis and the writedown should be accounted for as a realized loss. ICH has implemented the provisions of EITF Issue No. 93-18 and, in conjunction with its adoption of SFAS No. 115 effective as of December 31, 1993, has reflected writedowns relative to certain residual interest mortgage-backed securities totaling $4.9 million, net of tax effects. Such writedowns have been reflected as the cumulative effect of a change in accounting method in the 1993 statement of earnings. The EITF is also expected to address at a meeting scheduled for March 24, 1994, whether, due to their nature, these types of investments can ever be classified as held to maturity under the provisions of SFAS No. 115. Authoritative sources have indicated that the EITF will likely require that these types of investments be classified as available for sale and be reflected at their fair value. Accordingly, at December 31, 1993, ICH has classified its investments in the Fund America certificates and its remaining investment in the Trust as available for sale and has reduced the carrying value of such investments from $95.5 million to their estimated fair value of $67.1 million. Such reduction, totaling $28.4 million, has been reflected as an unrealized investment loss through a charge to stockholder's equity. The fair value of these investments was estimated by an investment banking firm assuming an 11% annual return to maturity.
At December 31, 1993, mortgage loans principally involving commercial real estate totaled $138.5 million, representing approximately 5.2% of ICH's investment portfolio. ICH has a stated policy of not directly initiating or making new mortgage loans, except under limited circumstances, including primarily loans to finance sales of company-owned real estate. New mortgage loans have totaled approximately $3.1 million, $17.0 million and $12.2 million during 1993, 1992 and 1991, respectively. Substantially all other mortgage loans owned by ICH and its subsidiaries were as a result of acquisitions of life insurance companies in 1986 and prior years. Delinquencies on mortgage loans in excess of 60 days represented approximately .2% of total mortgage loans outstanding, as compared to 4% at year-end 1992. Management believes that its mortgage loan portfolio is well seasoned and that the collateral underlying these mortgage loans is sufficient to recover the carrying value of such investments and, as a result, no significant losses should be incurred.
Real estate investments totaling $67.5 million and home office real estate totaling $13.3 million represented 2.5% and .5% of ICH's investment portfolio, respectively, at December 31, 1993. ICH has a stated policy of not directly making real estate investments, except for foreclosures on its existing mortgage loans. Mortgage loan foreclosures totaled $3.2 million, $5.7 million and $20.9 million for the three years 1993, 1992 and 1991, respectively. During 1993, ICH completed its obligation to purchase certain real estate from former subsidiaries for approximately $19 million. In addition, in conjunction with the sale of Bankers in 1992, ICH purchased all of the real estate held by Bankers, primarily its home office real estate, for $9 million. Bankers has entered into a long-term lease for a portion of the property sold to ICH and ICH is attempting to sell the remaining properties. The Bankers real estate has been independently appraised at a value in excess of ICH's carrying value.
At December 31, 1993, ICH and its subsidiaries held limited partnership interests in various partnerships with a carrying value totaling $43.6 million, as compared to $39.8 million at year-end 1992 and $36.9 million at year-end 1991. These investments were made primarily to participate in the potential appreciation resulting from certain leveraged buyouts and corporate reorganizations. In addition, included in such investments at year-end 1993 was a $25.0 million investment, representing a 49% limited partnership interest, in a partnership formed to acquire through auction certain mortgage loans and real estate formerly held by failed savings and loan associations for resale. ICH believes that on a selective basis these investments offer attractive risk-adjusted returns; however, such investments are not readily marketable and, in the event of a need for liquidity, ICH may be unable to quickly convert such investments into cash. See Note 6 of the Notes to Financial Statements for additional information regarding ICH's investments in limited partnerships.
Included in the limited partnership investments at year-end 1991 was ICH's 21.4% interest in Conseco Capital Partners, L.P. ("Predecessor CCP") with a carrying value of $17.0 million. In 1992, Predecessor CCP formed a new insurance holding company, CCP Insurance, and completed an initial
public offering of shares of CCP Insurance common stock. ICH's subsidiaries received 1,764,439 shares of CCP Insurance in exchange for their investment in Predecessor CCP and ICH's subsidiaries acquired an additional 525,000 shares of CCP Insurance through its offering. In September 1993, CCP Insurance completed an underwritten primary and secondary offering of shares of its common stock. ICH's subsidiaries sold all of their 1,764,439 shares of CCP insurance common stock in the offering and realized investment gains totaling $27.8 million. In addition, during 1993, ICH's subsidiaries sold 455,375 of the 525,000 shares of CCP Insurance acquired in its initial public offering and realized additional investment gains totaling $5.3 million.
Included in the limited partnership investments at year-end 1992 and 1991 was ICH's investment in the HMC/Life Partners, L.P. with a carrying value of approximately $5.0 million. During March 1993, Life Partners Group, Inc. ("LPG"), the holding company formed to acquire certain subsidiaries from ICH in 1990, completed an initial public offering of 15.2 million shares of its common stock, or a 58.5% interest in LPG, at $17 per share. ICH had acquired a 31% interest in the HMC/Life Partners, L.P. at the time of the sale of such subsidiaries and the partnership, in turn, directly owned 5.1 million shares of the LPG common stock. Based on an assumed liquidation of the partnership and distribution of shares under provisions of the partnership agreement, the holder of ICH's partnership interest would be entitled to receive shares of LPG common stock with a fair value at December 31, 1993, of approximately $21.3 million, or $16.3 million more than the adjusted cost of ICH's investment in the partnership. As discussed earlier under "Transactions With Consolidated Fidelity Life Insurance Company," the investment in the HMC/Life Partners, L.P. was transferred to CFLIC in exchange for preferred stock as the first step in a series of transactions to terminate certain reinsurance arrangements involving CFLIC and Southwestern.
During 1993, two other companies controlled by partnerships in which ICH's subsidiaries had ownership interests completed initial public offerings of shares of their common stock. Assuming a liquidation of the partnerships and a distribution of the shares of common stock held by the partnerships, ICH's subsidiaries would be entitled to receive shares of common stock with a fair value totaling $5.3 million in excess of their adjusted cost basis in such partnerships. At December 31, 1993, the carrying values of such partnership interests were adjusted to reflect the increase in value, with a corresponding increase in unrealized investment gains reflected in stockholders' equity. In addition, during 1993, ICH reflected a $5.0 million writeoff of a partnership interest through realized investment losses following the commencement of bankruptcy proceedings by the company controlled by such partnership.
At December 31, 1993, ICH had pre-tax unrealized investment gains totaling $33.9 million, consisting of $21.4 million of unrealized gains related to available for sale fixed maturities, $7.2 million of unrealized gains attributable to equity securities, and $5.3 million of unrealized gains attributable to investments in limited partnerships. Such unrealized investment gains are reflected in stockholders' equity, net of a $10.4 million adjustment in deferred policy acquisition costs and other policy liabilities, a $5.2 million adjustment for the minority interest in certain unrealized investment losses and $8.2 million in deferred income tax effects. At December 31, 1992, pre-tax unrealized investment gains totaled $28.5 million, of which $24.1 million was attributable to ICH's equity investment in CCP Insurance, and were reflected in stockholders' equity, net of $9.7 million in deferred income tax effects. The unrealized gains related to available for sale fixed maturities are primarily as a result of declines in market interest rates between the two dates. Except as may be required to meet its liquidity requirements, ICH has no current plans over the near-term to liquidate a significant portion of such available for sale fixed maturities to realize such gains.
The following table reflects investment writedowns which were included in realized investment gains or losses during each of the three years in the period ending December 31, 1993:
The writedowns in fixed maturity investment in 1993 and 1991 were related to noninvestment-grade securities. As a result of reductions in market interest rates and a corresponding increase in mortgage loan refinancings, ICH incurred substantial writedowns related to its residual interests and interest-only CMOs in 1992. As previously discussed, ICH substantially reduced its exposure to such investments and, except for $7.6 million of writedowns taken in conjunction with the adoption of SFAS No. 115 reflected as a cumulative effect of a change in accounting method, there were no similar writeoffs during 1993. Investment real estate writedowns have increased over the three year period as a result of the general deterioration in real estate markets. Because of the factors discussed above, ICH's losses on its mortgage loan portfolio have been nominal during the three year period. The $18.4 million writedown in 1991 related to a reinsurance treaty with Executive Life Insurance Company. Such treaty was terminated in 1992 without further writedowns required.
LIQUIDITY AND CAPITAL RESOURCES
ICH reduced its reported indebtedness by $75.5 million in 1991, $162.8 million in 1992 and $125.3 million in 1993. Such reductions totaling $363.6 million were effected primarily through ICH's prepayment of $168.4 million of senior secured debt and subordinated debt with proceeds from the sale of Bankers in 1992 and BLHC in 1993, through a $45 million prepayment of senior secured indebtedness in 1992, and through the payment of $146 million of scheduled subordinated debt sinking fund and principal installments.
The following table sets forth, for the periods indicated, certain ratio data regarding the operations of ICH and its consolidated subsidiaries. Pro forma ratio data is presented as if the sale of Bankers and ICH's investment in BLHC had occurred as of the beginning of each period presented and is based on the same assumptions utilized in preparing the pro forma results of operations reflected in Note 2 of the Notes to Financial Statements, including elimination of the after-tax gains on the sales of Bankers in 1992 and the Company's investment in BLHC in 1993.
Realized investment losses (resulting primarily from writedowns) reduced operating earnings by $119.1 million and $26.4 million for 1992 and 1991, respectively. See "Insurance Operations" following for additional information regarding items of an infrequent and non-recurring nature which have affected ICH's operating results.
INSURANCE OPERATIONS
The primary sources of liquidity for ICH's insurance subsidiaries include operating cash flows and short-term investments. The net cash provided by operating activities and by policyholder contract deposits of ICH and its subsidiaries, after the payment of policyholder contract withdrawals and benefits, operating expenses, and interest requirements approximated $87.7 million in 1992 and $220.7 million in 1991. In 1993, such operating cash flows resulted in net cash requirements totaling approximately $205.5 million. Exclusive of withdrawals by holders of GICs as discussed below, cash provided by operating activities during 1993 totaled approximately $124.5 million. ICH believes that its short-term investments are readily marketable and can be sold quickly for cash. Cash and short-term investments totaled $366.9 million, or 14% of consolidated investments, at year-end 1993, compared to $421.8 million or 14% at year-end 1992 and $386.5 million or 9% at year-end 1991.
The principal requirement for liquidity of ICH's insurance subsidiaries is their contractual obligations to policyholders, including policy loans and payments of benefits and claims. As a result of continued cash flows of its insurance subsidiaries, ICH believes that reserves maintained by such subsidiaries have been adequate to pay policy benefits and claims. Further, policy loans by ICH's subsidiaries have represented 7% or less of ICH's consolidated investment assets during the past three years.
As previously discussed, the claims-paying ratings assigned to certain of ICH's subsidiaries by various nationally recognized statistical ratings organizations were lowered during 1992 and 1993. Except for withdrawals made by certain GIC holders, management believes ICH's subsidiaries have not experienced more than normal policy surrenders and withdrawals as a result of these ratings downgrades. For the year ended December 31, 1993, policyholder contract withdrawals, principally GICs, exceeded policyholder contract deposits by approximately $207.4 million. Withdrawals by GIC
holders totaled $329.0 million. Approximately $184.3 million of such withdrawals represented scheduled maturities of GICs which were not reinvested with an ICH subsidiary. In addition, as a result of the previously discussed restructuring of ICH's holding company system, the surplus of such subsidiary was significantly reduced and, as a consequence, some policyholders became entitled to an early withdrawal of their GICs. The subsidiary also voluntarily offered certain other GIC holders the right of early withdrawal. Unscheduled and early GIC withdrawals totaled $144.7 million. Because of its available liquidity and readily marketable securities, the subsidiary has not encountered, and management does not anticipate that the subsidiary will encounter, any difficulty in meeting its obligations relative to such withdrawals. The substantial withdrawal of GICs during 1993 is expected to have a positive effect on ICH's future results of operations because the rates of interest being credited to such GICs exceeded the rates ICH's subsidiary was earning on the related invested assets.
Certain of ICH's insurance subsidiaries have ceded blocks of insurance to unaffiliated reinsurers to provide funds for financing acquisitions and other purposes. These reinsurance transactions, or so-called "surplus relief reinsurance," represent financing arrangements and, in accordance with generally accepted accounting practices, are not reflected in the accompanying financial statements except for the risk fees paid to or received from reinsurers. Net statutory surplus provided by such treaties before tax effects totaled $51.5 million at December 31, 1993, or approximately 41% less than the $87.5 million of surplus relief at December 31, 1992. These arrangements are expected to terminate over the next several years through the recapture of the ceded blocks of business and such recaptures will result in a charge to the statutory earnings of the recapturing companies. During 1993, a treaty that had provided approximately $22.2 million of surplus relief for an ICH subsidiary as of year-end 1992 was recaptured in conjunction with ICH's restructuring of its insurance holding company system.
PARENT COMPANY
The primary sources of liquidity for ICH have historically included dividends and loans from its insurance subsidiaries and payments of principal and interest on surplus debentures issued by certain insurance subsidiaries. As previously discussed, in 1993, the sale of ICH's investment in BLHC provided a substantial amount of liquidity for the parent company.
The unpaid principal balance of surplus debentures issued to ICH by its insurance subsidiaries totaled $247.6 million at December 31, 1992 and $607.2 million at December 31, 1991. Of the 1992 amount, surplus debentures in the aggregate unpaid principal amount of $141.8 million was payable by Southwestern and $105.8 million was payable by Modern American. In 1993, Southwestern repaid the remaining balance on its surplus debenture utilizing proceeds from its 1992 sale of Bankers. In the restructuring of ICH's insurance holding company system in 1993, the surplus debenture from Modern American was retired and added to ICH's investment in its subsidiaries. At December 31, 1993, there were no remaining surplus debentures due ICH by its subsidiaries.
State insurance laws generally restrict the ability of insurance companies to make loans to affiliates or to pay cash dividends in excess of the greater of such companies' net gains from operations during the preceding year or 10% of their policyholder surplus determined in accordance with accounting practices prescribed by such states. These regulatory restrictions historically have not affected the ability of ICH to meet its liquidity requirements. However, certain states in which ICH's subsidiaries are domiciled, including New York and Kentucky, have adopted laws that have restricted the payment of cash dividends to the lesser of such companies' net gains from operations or 10% of their policyholder surplus. Other states may consider similar legislation in future periods or may consider legislation that would base the level of cash dividends which may be paid to the maintenance of specified risk-based capital levels. The adoption of such laws could significantly reduce the level of cash dividends that could be paid without regulatory approval.
ICH received cash dividends from Modern American totaling $149 million in 1991, but received no cash dividends from its insurance subsidiaries in either 1993 or 1992. In 1992, Modern American agreed with the Missouri Department of Insurance that it would not pay any dividends without obtaining the prior approval from the Missouri Department and, in 1993, Southwestern agreed with the Texas Department that it would not pay any dividend without giving it thirty days prior notice.
The restructuring of ICH's insurance holding company system in 1993 substantially reduced the size of Modern American and it no longer holds title to the common stock of any of ICH's insurance subsidiaries. Therefore, the restrictions on Modern American's ability to pay dividends are not expected to have a significant affect on future dividends to ICH from ICH's subsidiaries. In addition, as a result of the restructuring, all of ICH's insurance subsidiaries, other than Constitution Life Insurance Company and Bankers Life and Casualty Company of New York, are aligned horizontally beneath ICH and, as a consequence, are expected to be able to make direct payments of dividends to ICH in future periods.
Prior to 1992, ICH had issued demand and collateralized notes to certain of its subsidiaries in order to meet short-term liquidity requirements. At December 31, 1991, ICH's obligations to its subsidiaries under such notes, including accrued interest thereon, totaled $47.6 million. Although management believed such loans met the investment criteria of the various states, during 1993 and 1992 ICH repaid all of such obligations to its subsidiaries. ICH does not intend to utilize such borrowings in future periods.
ICH's principal needs for liquidity are debt service and, to a lesser extent, preferred dividend requirements. ICH's consolidated indebtedness totaled approximately $418.0 million at December 31, 1993, compared to $543.3 million at December 31, 1992, and $706.1 million at December 31, 1991. Substantially all indebtedness of ICH was incurred in the connection with acquisitions of subsidiaries in periods prior to 1987, including collateralized senior debt and unsecured subordinated debt, a portion of which was exchanged for new debt in 1993. See Note 3 of the Notes to Financial Statements for additional information regarding ICH's consolidated indebtedness, including annual maturities.
Primarily as a result of the sale for cash of ICH's interest in BLHC in 1993, ICH believes that it has adequate resources to meet its existing commitments, including preferred stock dividends, for all of 1994. The following table reflects ICH's cash sources and requirements on a projected basis for 1994 and on an actual basis for 1993.
Cash available at the end of 1993 includes approximately $60.3 million of readily marketable fixed maturity investments which were acquired for the purpose of obtaining higher yields than could be achieved through holdings in short-term investments. The 1994 projected cash requirements assume no sinking fund payments relative to ICH's Old Notes. See "Changes in Capital Structure" for a discussion of ICH's options relative to sinking fund requirements in 1994. In addition, the 1994 projections assume that the CFLIC transactions with ICH will be effected during the 1994 second quarter, including the redemption of CFLIC's preferred stock by the return to ICH of its $30 million senior secured loan and ICH's Series 1986-A and Series 1987-B preferred stocks. See "Transactions With Consolidated Fidelity Life Insurance Company."
As a result of the acquisition and retirement of ICH's Class B Common Stock in early 1994, management now believes that ICH has improved its ability to refinance its presently outstanding debt at substantially reduced interest rates. Such a refinancing is, of course, dependent on numerous factors, such as an improvement in the ratings assigned by nationally recognized statistical rating organizations, market interest rates, a successful underwriting, and other factors. ICH intends to monitor these factors closely over the next several months to determine whether such a refinancing is possible. There can be no assurance that ICH will, in fact, attempt to restructure its presently outstanding debt; however, in the event that it does, the 1994 projected cash sources and requirements as reflected above could materially change.
ICH's actual cash sources in 1993 were approximately $295.6 million more than were previously projected for 1993, substantially all of which were attributable to ICH's sale of its investment in BLHC for $287.6 million. Actual cash requirements in 1993 exceeded projected requirements by approximately $174.3 million. Significant items that were not included in the 1993 projections and that accounted for a substantial portion of the increase in cash requirements include ICH's redemption of $100 million of its outstanding preferred stock, an additional $45.9 million redemption of its Debentures, and intercompany income tax allocation payments to ICH's insurance subsidiaries totaling $15.0 million. The increase in tax allocation payments was a result of the BLHC transaction which resulted in a taxable gain and reimbursement to ICH's subsidiaries for utilization by ICH of their tax loss carryforwards. Primarily as a result of the increase in cash sources, which was not completely offset by an increase in cash requirements, available cash and marketable securities at the end of 1993 was approximately $121.3 million more than originally projected.
RESULTS OF OPERATIONS
ICH's results in 1993 and 1992 have been affected by numerous items of an infrequent and non-recurring nature. In 1993, ICH realized significant gains on the sale of its investment in BLHC, other invested assets, and the termination of a reinsurance arrangement with Bankers, and realized a benefit from the change in corporate income tax rates. In addition, significant writedowns of certain capitalized costs and operating facilities were taken in connection with the continuation of an operational consolidation and provisions were made for the costs associated with agreements entered into with ICH's former controlling shareholders and certain other contingencies. In 1992, ICH realized a gain on the sale of Bankers, which was offset by charges for significant losses on the portfolio of CMO residual interests and IOs, a litigation settlement, costs incurred to modify a data processing services
arrangement, and costs incurred or accrued relative to an operational consolidation. The following table reflects the results of ICH's basic operations from 1991 through 1993 and the effects that the above described charges and credits had on ICH's operating results for each of the three years.
The decline in pre-tax operating earnings from $59.6 million in 1991 to $47.7 million in 1992 was attributable, in part, to including Bankers' results for only the first ten months of 1992 compared to the full year in 1991. ICH was unable to effectively redeploy the proceeds from the sale of Bankers during the last two months of 1992 to replace the reduction in operating earnings resulting from such sale. In addition, a reduction in yields on invested assets between 1991 and 1992 contributed to a narrowing of the spreads between earnings on invested assets and interest credited to policyholders' accounts or required to meet policyholder obligations and further contributed to the reduction in operating earnings. The decline in the pre-tax operating earnings of $47.7 million to a pre-tax operating loss of $6.6 million in 1993 reflects, in part, the exclusion of Bankers' results for all of 1993. ICH did reflect its equity in the operating results of BLHC for the first nine months of 1993 totaling $29.1 million. However, ICH was still unable in 1993 to redeploy proceeds from the sale to fully replace the earnings of Bankers. Following the sale of its interest in BLHC in September 1993, ICH has methodically proceeded to utilize its available liquidity to further reduce the costs of its capital structure, but during the interim period has had to maintain larger than desirable amounts invested in lower-yielding short-term investments. In addition, interest spreads relative to ICH's insurance operations further narrowed in 1993 resulting in reduced operating earnings, and ICH incurred sizeable losses in its group health operations.
ANALYSIS OF OPERATING RESULTS BY INDUSTRY SEGMENT
ICH's major industry segments consist of individual life insurance, individual health insurance, group and other insurance, accumulation products, and corporate (including surplus investment). The following table sets forth the consolidated revenues, expenses, pre-tax operating earnings and product sales attributed or allocated to each industry segment. "Pre-tax operating earnings (loss)" reflected in the table represent ICH's consolidated operating earnings or loss before realized investment gains or losses, corporate interest expense, amortization of excess cost, provision for income
taxes, the cumulative effect of accounting changes, and extraordinary gains and losses. See Note 17 of the Notes to Financial Statements and Schedule V of the Financial Statement Schedules for additional information regarding ICH's segment results.
INDIVIDUAL LIFE. Revenues of the individual life insurance segment accounted for approximately 37.8% of consolidated revenues excluding corporate revenues and realized investment gains and losses in 1993, as compared to 20% in 1992 and 21% in 1991. Such increase in 1993 is directly attributable to the sale of Bankers in 1992. Bankers revenues had been derived predominantly from sales of individual health insurance products and, as a result of the sale, the relative proportion of ICH's revenues attributable to the individual life insurance segment increased significantly. Most individual life insurance sales over the last three years were of universal and interest-sensitive life insurance products, although several new traditional whole life products were introduced into the marketplace during 1993. Exclusive of sales by Bankers, individual life sales have declined from $21.0 million in 1991 to $14.0 million in 1992 to $13.1 million in 1993. Management believes these declines are attributable to the downgrade in the claims-paying rating of ICH's most significant life insurance subsidiary, Southwestern, and to slow market acceptance of several new products introduced during 1991. However, as a result of changes in marketing strategies to target sales in the senior citizen marketplace and the new products introduced in 1993, sales of individual life insurance products increased significantly in the latter half of 1993, exceeding sales during the comparable period in 1992.
Pre-tax operating earnings of the individual life insurance segment decreased from $80.0 million in 1991 to $42.5 million in 1992, but increased to $45.1 million in 1993. Included in pre-tax operating earnings in 1993 was a non-recurring gain on the termination of a reinsurance arrangement between an ICH subsidiary and Bankers totaling $22.6 million. Excluding such gain, pre-tax operating earnings in 1993 totaled $22.5 million. Bankers derived substantial profits from its individual life insurance business and the sale of Bankers accounts for a significant portion of the decline in pre-tax operating earnings of this segment. Declining market interest rates and the reduced yields earned by ICH on its investment portfolio have also contributed to the decline in the operating profits of this segment. Over one-half of ICH's life insurance reserves represent reserves on traditional life insurance products having fixed contractual interest rates. Consequently, declining investment yields have resulted in significantly reduced profit margins on the traditional block of business. Remaining life insurance reserves consist primarily of reserves on interest-sensitive products and credited rates on such policies have been and are continuing to be reduced to correspond with the decline in yields on investments.
Management expects to continue to emphasize growth in its individual life insurance segment and, barring a further decline in investment yields, believes the changes made in its marketing strategies and the introduction of new products in 1993 will result in increased sales of individual life insurance products and an improvement in the operating results of this segment in 1994.
INDIVIDUAL HEALTH. Sales and revenues in the individual health segment declined significantly in 1993 as a result of the sale of Bankers. Individual health premiums earned by Bankers represented approximately 74.8% of total individual health premiums in 1992 and 75.7% in 1991. The individual health premiums earned in 1993 and the remaining premiums earned in each of 1992 and 1991 were primarily attributable to Union Bankers Insurance Company ("Union Bankers") and Bankers Multiple Line Insurance Company ("Bankers Multiple"), former Bankers subsidiaries which were retained by ICH when Bankers was sold. Union Bankers has emphasized the sale of Medicare supplement products through brokerage agencies. Bankers Multiple specializes in the sale of comprehensive health products through a large general agency. Another ICH subsidiary, Integrity National Life Insurance Company, sells individual health insurance products, primarily Medicare supplement business, in the home service market.
Exclusive of Bankers in 1992, new sales of individual health products increased from $60.3 million in 1992 to $63.6 million in 1993 and premiums earned increased from $216.2 million in 1992 to $220.3 million in 1993. The ratio of policy benefits to premiums earned (exclusive of Bankers) declined from 68.4% in 1992 to 62.3% in 1993, resulting in an approximately $15.0 million improvement in the gross operating margins of ICH's insurance subsidiaries.
Management expects to continue to emphasize growth in the individual health segment, primarily in the senior citizens market through the sales of Medicare supplement and long-term care, or nursing home, products.
GROUP AND OTHER INSURANCE. New sales of group life and health insurance increased from $47.3 million in 1991 to $61.9 million in 1992, but declined to $41.2 million in 1993. All sales of new group business in 1993 were made by Philadelphia American Life Insurance Company ("Philadelphia American"), as were substantially all new sales in 1992. Several large group health cases were added at the end of 1992, increasing the volume of new 1992 sales; however, primarily as a result of competitive factors, Philadelphia American purposely did not attempt to achieve the same level of new sales during 1993. In addition to revenues from sales of group insurance products, Philadelphia American derives substantial revenues from administrative services only ("ASO") contracts whereby it process claims for non-affiliated groups without assuming underwriting risks. Bankers Multiple also underwrites a profitable real estate agents errors and omissions product, the results of which are included in the group and other insurance segment.
While sales of new group business declined during 1993 as compared to 1992, earned premiums of this segment (excluding Bankers) increased from $103.8 million in 1992 to $136.5 million in 1993 as a result of sales in 1992. The related ratio of policy benefits to earned premiums of the group segment increased dramatically from 62.9% in 1992 to 74.8% in 1993 and contributed to a pre-tax operating loss of $12.9 million in 1993, as compared to pre-tax operating earnings of $5.1 million in 1992. During the last half of 1993, Philadelphia American encountered an unexpected increase in claim costs driven by an upswing in the utilization and cost of physician services and several large individual claims covered under group plans. Additionally, in the course of evaluating Philadelphia American's results for the fourth quarter of 1993, management determined that errors had been made in the second and third quarters of 1993 in accounting for certain reinsurance activities and had resulted in an approximate $7.4 million overstatement of Philadelphia American's pre-tax operating earnings for such periods. These errors contributed to an inadequate assessment of the need for premium rate increases on certain of Philadelphia American's group health cases, which, in turn, contributed to the adverse claims experience on these cases which continued into the 1993 fourth quarter. Management has taken several actions which are expected to rapidly reduce losses and return this segment to profitability in 1994. These actions include 1) terminating several large, but unprofitable group cases at or near the end of 1993, 2) identifying several additional group cases which will not be renewed during the first six months of 1994, and 3) implementing substantial rate increases to restore profitability to its remaining group business. In addition, internal controls at Philadelphia American have been strengthened and personnel changes have been made to prevent a future reoccurrence of accounting errors in reported results.
Because of uncertainties regarding the potential impact of currently proposed national health care reforms, management does not believe that it would be prudent to presently invest additional capital resources to grow the group segment of its business. However, Philadelphia American intends to actively pursue new ASO business to more fully utilize its present claims processing capabilities without incurring additional underwriting risks.
ACCUMULATION PRODUCTS. Sales of accumulation products, primarily GICs, declined significantly in 1993 as compared to prior periods. In 1993, new GIC sales totaled $5.3 million, as compared to $292.1 million in 1992. Such decline in GIC sales was offset, in part, by an increase in new annuity sales. ICH's subsidiaries produced $84.6 of annuity sales, principally single premium deferred annuities, in the accumulation segment in 1993, as compared to $27.2 million in 1992 (excluding Bankers). The substantial decline in GIC sales was directly attributable to a downgrade in the claims-paying ratings assigned to an ICH subsidiary as previously discussed. As a result of these ratings downgrades, ICH's subsidiaries redirected their marketing efforts in 1993 to sales of annuities in the less ratings-sensitive individual marketplace.
The accumulation products segment reflected a pre-tax operating loss of $6.7 million in 1993, as compared to a slight profit in 1992. The loss was primarily attributable to the decline in yields earned on invested assets during 1993. Substantially all of the $329.0 million in GIC liabilities which were withdrawn in 1993 bore interest at guaranteed fixed rates which, in many cases, exceeded rates being earned on the related invested assets. At year-end 1993, approximately 75% of the remaining $377.7 million in GIC liabilities bear interest at floating rates and a substantial portion of the remaining fixed rated liabilities are expected to be withdrawn in 1994. As a consequence, and barring a further decline in investment yields, management anticipates that the accumulation segment will realize a return to profitability in 1994.
Because of its present claims-paying ratings, ICH's insurance subsidiaries have effectively withdrawn from the GIC marketplace. Management expects to continue to emphasize sales of new annuities.
CORPORATE. Revenues allocated to the corporate segment include investment income on the capital and surplus of ICH's insurance subsidiaries. In addition, such revenues also include gains on the sale of ICH's investment in BLHC in 1993 and its investment in Bankers in 1992. Historically, ICH has allocated all corporate overhead expenses to the various operating segments. In 1993, $45.6 million in expenses were allocated to the corporate segment, including $23.9 million in writeoffs of capitalized data processing costs and certain home office real estate, a $9.0 million provision for services agreements entered into with ICH's former controlling shareholders, an $9.3 million provision for anticipated costs of litigation and other contingencies, and $4.4 million of expenses associated with the restructuring of ICH's collateralized mortgage note obligation. In 1992, $41.5 million of expenses were allocated to this segment, including an $18.0 million litigation settlement, $12.6 million of costs associated with modifying its data processing servicing arrangements with Perot Systems, and $10.9 million in costs related to a planned operational consolidation of three of ICH's Texas-based insurance subsidiaries.
INTEREST EXPENSE AND PREFERRED DIVIDEND REQUIREMENTS
ICH's consolidated interest expense totaled $66.2 million in 1993, $79.0 million in 1992 and $98.6 million in 1991. The reductions in interest expense were primarily as a result of the principal reductions in ICH's long-term indebtedness made during the periods as previously discussed under "Liquidity and Capital Resources." The reductions in interest expense in 1993 and 1992 were offset, in part, by the interest expense incurred relative to collateralized mortgage note obligations totaling $6.0 million in 1993 and $2.3 million in 1992. The collateralized mortgage note obligations were initially incurred in conjunction with the sale of Bankers in 1992. As a result of the transactions entered into in July 1993 to reduce ICH's exposure to prepayment risks on certain mortgage-backed securities (see "Investment Portfolio"), the accounts of a special-purpose trust, which included the collateralized mortgage note obligations and the related interest expense, are no longer included in ICH's consolidated balance sheet or statement of earnings after July 30, 1993.
Preferred dividend requirements totaled $28.8 million in 1993 and $30.8 million in each of 1992 and 1991. As the result of the redemption of $100 million stated value of ICH's preferred stocks in 1993, preferred dividend requirements are expected to be reduced to approximately $17.3 million in 1994. Assuming the completion of the transactions with CFLIC by March 31, 1994, as previously discussed under "Transactions With Consolidated Fidelity Life Insurance Company," ICH's preferred dividend requirements in 1994 would be reduced by an additional $2.5 million.
INCOME TAX PROVISIONS AND DEFERRED INCOME TAX ASSETS
In 1993, income tax expense represented approximately 31% of consolidated operating earnings before income taxes, or 4% less than the expected corporate income tax rate. During 1993, the corporate income tax rate was increased from 34% to 35%, retroactive to January 1, 1993. The effect of such rate increase on ICH's deferred income tax asset as of the beginning of 1993, a benefit totaling $3.5 million, has been included in the 1993 income tax provision. Other significant items affecting the
1993 effective income tax rate included a reduction in the valuation allowance for ICH's deferred income tax asset based on the utilization of available loss carryforwards to offset income taxes otherwise payable as a result of the BLHC sale and other investment gains and the utilization of capital loss carryforwards which had previously not been reflected for financial reporting purposes. In 1992, ICH reported an income tax credit totaling $69.2 million on a consolidated operating loss before income taxes of $18.4 million. This unusual relationship was primarily attributable to the significant tax basis gain on the sale of Bankers and a reduction in the Company's valuation allowance for its deferred tax asset as a result of utilizing available capital loss carryforwards to reduce taxes otherwise payable as a result of such gain. In 1991, income tax expense represented 24% of consolidated operating earnings before income taxes. The effective rate was approximately 10% lower than the expected rate, substantially all of which was attributable to a reduction in the deferred tax asset valuation allowance based on tax planning strategies for the utilization of a portion of ICH's capital loss carryforwards. See Note 13 of the Notes to Financial Statements for an analysis of the various components affecting ICH's income tax provisions.
At December 31, 1993 and 1992, ICH reported deferred income tax assets totaling $53.0 million and $121.0 million, respectively. The substantial reduction in the deferred income tax asset between the periods is primarily as a result of the tax effects associated with the gains realized in 1993 from the sales of ICH's interest in BLHC and other capital gains. The tax assets were comprised of the tax benefit (cost) associated with the following types of temporary differences based on the respective 35% and 34% tax rates in effect at the end of 1993 and 1992:
Operating and capital loss carryforwards have significantly different characteristics as to expiration dates and their usability. For federal income tax purposes, operating losses may be carried forward for a maximum of fifteen years from the year they are incurred; capital losses may be carried forward for a maximum of five years. In addition, ordinary loss carryforwards may be utilized to offset ordinary income or capital gains, whereas capital loss carryforwards can only be utilized to offset capital gains. As a consequence, taxpayers have substantially more flexibility in being able to utilize operating loss carryforwards than capital loss carryforwards. For federal income tax purposes, at December 31, 1993, ICH's subsidiaries had $39.0 million of ordinary loss carryforwards expiring in 2005 and $14.9 million of capital loss carryforwards expiring in 1998.
Management has periodically assessed the ability of ICH's insurance subsidiaries to produce taxable income in future periods sufficient to fully utilize their operating book/tax temporary differences and tax loss carryforwards. These assessments have included actuarial projections under alternative scenarios of future profits on the existing insurance in force of ICH's insurance subsidiaries, including provisions for adverse deviation, adjusted to reflect ICH's anticipated debt service costs. While management believes that there will be sufficient future taxable income to realize substantially
all of the benefit of ICH's remaining temporary differences, valuation allowances totaling $16.3 million and $24.2 million were provided against ICH's deferred tax assets at December 31, 1993 and 1992, respectively, to reflect the uncertainties of realizing all of the benefits of available tax loss carryforwards.
Alternative minimum tax ("AMT") credit carryforwards result from the acceleration of income taxes under certain circumstances and can be carried forward for an indefinite period. The $13.9 million and $11.7 million component of ICH's deferred income tax assets at December 31, 1993 and 1992, respectively, represents taxes incurred under AMT provisions which are expected to be recovered through reduced income tax payments over the next several years.
CUMULATIVE EFFECT OF ACCOUNTING CHANGES
Effective January 1, 1993, ICH adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $1.8 million, after tax effects. In addition, effective December 31, 1993, ICH adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $4.9 million, after tax effects. Effective January 1, 1991, ICH adopted SFAS No. 109, "Accounting for Income Taxes," and the benefit of the cumulative effect of the adoption of the accounting change as of that date totaled $8.8 million.
EXTRAORDINARY LOSSES
For the years 1993 and 1992, ICH incurred extraordinary losses, net of tax effects, totaling $1.9 million and $4.3 million, respectively. The extraordinary losses in both periods were related to early extinguishment of debt. See Note 15 of the Notes to Financial Statements for an analysis of the components of such losses.
IMPACT OF INFLATION
Medical cost inflation has had a significant impact on the individual health and group health lines of business. Benefit costs have continued to increase in recent years in excess of the Consumer Price Index and will likely continue. This impact, however, has been substantially offset by increases in premium rates. Management does not believe that inflation has otherwise had a significant impact on its results of operations over the past three years.
KNOWN TRENDS AND UNCERTAINTIES WHICH MAY AFFECT FUTURE RESULTS
PROPOSED HEALTH CARE REFORM
President Clinton has targeted health care reform as a top domestic priority of his administration, and has proposed to Congress legislation, the American Health Security Act, that would significantly change the manner in which the entire health care industry operates. The reform legislation proposed by the Clinton administration would ultimately guarantee universal access to health care coverage and create purchasing alliances for government established health care plans. Alternative legislative proposals that have been developed to reform the health care system have goals ranging from universal access to health care coverage through managed competition to health care cost containment through, among other things, health insurance reform. ICH currently cannot predict what impact health care reform proposals will have on the health insurance industry, whether any health insurance measures will be adopted in the foreseeable future or, if adopted, whether such reform proposals or measures will have a material effect on its operations.
FEDERAL INCOME TAX AUDIT ISSUES
See Note 12 of the Notes to Financial Statement for a discussion of potential income tax audit issues.
ITEM 8. | 49588 | 1993 |
Item 6. Selected Financial Data
The Selected Financial and Operating Data on page 6 of the Company's 1993 Annual Report to Shareowners is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The Management's Discussion and Analysis of Results of Operations and Financial Condition on pages 7 through 12 of the Company's 1993 Annual Report to Shareowners is incorporated herein by reference.
Item 8. | 732712 | 1993 |
Item 6. Selected Financial Data -----------------------
Notes to Selected Financial Data
(1) Expenses were offset by $5,218 and $3,055 of investment income for the years ended December 31, 1990 and 1989, respectively, that was estimated would not have been earned but for the Chapter 11 reorganization proceedings. Subsequent to the Effective Date, investment income is no longer offset against reorganization expenses.
(2) Includes a 1992 write-off of unamortized original issue discount and unamortized issuance costs on the Senior Notes that were redeemed and a 1992 accrual of a distribution payable pursuant to the Reorganization Plan based on the Company's consolidated net worth as of December 31, 1992. Includes a 1991 accrual of a distribution payable pursuant to the Reorganization Plan based on the Company's consolidated net worth as of December 31, 1991 and a write- off of original issue discount on Senior Notes that were to be redeemed. Includes a 1990 gain with respect to the Independence Health Plan of Southeastern Michigan, Inc. settlement and the discharge of pre-petition liabilities pursuant to the Reorganization Plan (see "Item 8. Financial Statements and Supplementary Data - Note 3 to the Company's Consolidated Financial Statements").
(3) As provided in the Reorganization Plan, previously outstanding common stock was cancelled, and 10,000 shares of Common Stock were issued. Accordingly, per share information for 1990 was calculated by using the 10,000 shares plus common equivalent shares of stock options and Warrants when dilutive. Net loss per common and common equivalent share previously reported for 1989 was calculated based on 34,640 shares of old common stock. Therefore, the net loss per common and common equivalent share amount for 1989 is not comparable to 1993, 1992, 1991 and 1990 and, accordingly, has been omitted.
(4) Includes long-term liabilities of $504, $1,015, $63,177, $63,388 and $12,323 in 1993, 1992, 1991, 1990 and 1989, respectively, and in 1989 pre-petition liabilities of $843,713.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition ----------------------------------------------------------- and Results of Operations -------------------------
The year ended December 31, 1993 compared to the year ended December -------------------------------------------------------------------- 31, 1992. ---------
Maxicare Health Plans, Inc. (the "Company") reported net income of $5.6 million for the year ended December 31, 1993, compared to a net loss of $3.1 million, including extraordinary charges of $14.2 million, for the same period of 1992. Net income per common share available to common shareholders increased to $.02 for the year ended December 31, 1993 compared to a net loss per common share available to common shareholders of $.71 for the same period in 1992.
For the year ended December 31, 1993, the Company reported operating revenues of $440.2 million, a 6% increase over the $414.5 million reported for the year ended December 31, 1992. The increase in revenues primarily results from the Company experiencing an increase in membership and modest premium rate increases. The increase in year-to-date operating revenues for 1993 was more than offset by an increase in health care expenses, contributing to a decrease in income from operations to $413,000 from $7.8 million for fiscal year 1992. Health care expenses increased for the year ended December 31, 1993 primarily because of a $7.0 million one-time charge reported in the third quarter of 1993 for previously unanticipated actual and projected health care costs. These costs primarily resulted from changes in the Indiana marketplace, the restructuring of relationships among the Company and its health care providers as well as unanticipated increases in high cost health care procedures. The provider network restructuring which began in mid 1992 has been substantially completed as of the first quarter of 1994.
Marketing, general and administrative expenses increased $2.2 million to $41.0 million for the year ended December 31, 1993 as compared to 1992; however, these expenses have decreased as a percentage of operating revenues.
The Company's consummation of the sale of $60 million of Series A preferred stock on March 11, 1992 and the redemption on April 13, 1992 of the entire outstanding principal, plus accrued interest on, the Senior Notes resulted in the Company reporting a $14.2 million extraordinary loss in the first quarter of 1992, the payment of $5.4 million in preferred stock dividends in 1993 and a decrease in year- to-date interest expense of $2.7 million for 1993 (see "Item 8. | 722573 | 1993 |
Item 6. Selected Financial Data
The information required by this item is included in the registrant's Annual Report to Shareholders for the year ended December 31, 1993 on page 48 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 the registrant's Annual Report to Shareholders for the year ended December 31, 1993 on pages 30 through 33 and is incorporated herein by reference.
Item 8. | 64803 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
[Furnish the information required by Item 301 of Regulation S-K.]
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
[Furnish the information required in Item 303 of Regulation S-K.]
ITEM 7A. | 817473 | 1993 |
Item 6. Selected Financial Data
The following selected financial data, in the opinion of the Company, includes adjustments, which are normal and recurring in nature, necessary for the fair presentation of the results of operations and financial position. See Item 7. | Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion analyzes significant changes in the components of net income and financial condition during the years 1993 and 1992. See Note 1 of the Notes to Financial Statements for a discussion of the merger of Iowa Electric Light and Power Company (IE) and Iowa Southern Utilities Company (IS), effective December 31, 1993, that formed the Company.
RESULTS OF OPERATIONS
The Company's net income increased $23.5 million during 1993 and decreased $1.8 million during 1992. The 1993 results reflect the acquisition of the Iowa service territory of Union Electric Company (UE) (as discussed in Note 3 of the Notes to Financial Statements) and a return to more normal weather conditions in the Company's service territory. The floods in Iowa in 1993 did not significantly affect the Company's results of operations. The 1992 results were adversely affected by extremely cool summer weather and a mild winter in the Company's service territory.
The Company's operating income increased $25.0 million and $0.6 million during 1993 and 1992, respectively, as compared to prior years. Reasons for the changes in the results of operations are explained in the following discussion.
ELECTRIC REVENUES
Electric revenues and Kwh sales (excluding off-system sales) increased $87.5 million and 25%, respectively, during 1993. In 1992, electric revenues and Kwh sales decreased $19.6 million and 1.5%, respectively. The 1993 sales increase is attributable to the acquisition of the UE territory and a return to more normal weather conditions. After adjusting for these items, underlying electric sales increased 6% in 1993, which reflects the economic growth in the industrial and commercial customer base.
The 1992 Kwh sales decrease reflects unusually mild weather conditions in the Company's service territory. Residential sales, which are the most weather sensitive, decreased 9.5%. However, industrial sales, which are less sensitive to weather, increased approximately 5.5%. Adjusting for the effects of weather, Kwh sales increased 2.7%, reflecting economic growth in the Company's service territory.
The Company's electric tariffs include energy adjustment clauses (EAC) that are designed to currently recover the costs of fuel and the energy portion of purchased power billings to customers. See Note 2(g) of the Notes to Financial Statements for discussion of the EAC. The increase in electric revenues for 1993 is primarily because of the sales increase and increased recovery of fuel costs through the EAC.
The revenue decrease in 1992 was primarily related to the lower Kwh sales discussed above and lower off-system sales to other utilities. A rate decrease in the former IS service territory that became effective in September 1991 contributed to the revenue decrease to a lesser extent. These items were partially offset by the effect of the rate increase in the former IE service territory that became effective in December 1991. See Note 4(b) of the Notes to Financial Statements for a discussion of the electric rate case in the former IE service territory.
GAS REVENUES
Gas revenues increased $14.9 million and $8.4 million during 1993 and 1992, respectively. Gas sales in therms (including transported volumes) increased 5.3% in 1993 and were flat in 1992. Gas sales also reflect the effects of weather. Adjusting for the effects of weather, gas sales decreased 1.5% in 1993 and increased 1.5% in 1992.
The Company's tariffs include purchased gas adjustment clauses (PGA) that are designed to currently recover the cost of gas sold. See Note 2(g) of the Notes to Financial Statements for discussion of the PGA.
Gas revenues increased in 1993 and 1992 substantially because of increased costs of gas recovered through the PGA and the effect of gas rate increases in the former service territory of both IE and IS, that became effective in September 1992. The 1993 sales increase also contributed to the revenue increase for that year. See Note 4(a) of the Notes to Financial Statements for a discussion of the gas rate increases.
STEAM REVENUES
Steam revenues increased $1.1 million during 1993 and decreased $0.6 million during 1992, primarily related to fluctuations in sales volumes among large industrial customers.
OPERATING EXPENSES
Fuel for production increased $14.3 million in 1993 because of increased availability of the Company's fossil-fueled generating stations, which experienced extended maintenance outages in 1992, and because of increased sales. Fuel for production decreased $17.8 million during 1992 primarily because of a nuclear refueling outage at the Duane Arnold Energy Center (DAEC), maintenance outages at the fossil-fueled generating stations and the lower electric sales. There were refueling outages in 1993 and 1992, but no such outage in 1991. The decrease in Kwh generation during the refueling and maintenance outages was substantially replaced by purchased power.
Purchased power increased $18.7 million in 1993, of which approximately $14.7 million represents increased energy purchases and approximately $4.0 million is a net increase in capacity charges. The increase in energy purchases is because of the increased Kwh sales. The increased capacity costs reflect the contracts associated with the acquisition of the UE service territory, partially offset by the expiration, in April 1993, of the purchase power agreement with the City of Muscatine. (See Note 12(b) of the Notes to Financial Statements). Purchased power increased $4.5 million in 1992 because of increased purchases during the refueling and maintenance outages, partially offset by lower purchases related to lower off-system sales.
Gas purchased for resale increased $7.5 million and $5.1 million during 1993 and 1992, respectively. The increases are primarily because of increased per unit gas costs, and in 1993, increased sales.
Other operating expenses increased $3.6 million in 1993 and decreased $5.2 million during 1992. The 1993 increase is primarily because of increased labor and benefit costs and higher electric and gas transmission and distribution costs, partially offset by lower non-labor costs at the DAEC. The 1992 decrease was substantially related to a regulatory disallowance of $3.9 million recorded in April 1991, after the Iowa Utilities Board (IUB) denied recovery of previously deferred former manufactured gas plant (FMGP) clean-up costs. Lower non-labor costs at the DAEC and lower Nuclear Regulatory Commission fees, partially offset by increased labor and benefit costs, also affected 1992.
Maintenance expenses increased $6.6 million during 1993 and were flat in 1992. The 1993 increase is primarily because of increased maintenance at the Company's fossil-fueled generating stations and the DAEC. The 1992 maintenance expenses reflect increased maintenance at fossil-fueled generating stations, substantially offset by lower maintenance costs at the DAEC.
Depreciation and amortization increased during both years primarily because of increases in utility plant in service, including the acquisition of the UE territory on December 31, 1992. An increase in the average gas utility property depreciation rate, resulting from an updated depreciation study, also contributed to the 1993 increase. Depreciation and amortization expenses for both years include $5.5 million for the DAEC decommissioning provision, which is collected through rates.
Property taxes increased $4.8 million during 1993, primarily because of the acquisition of the UE service territory and increases assessed values.
Federal and state income taxes included in operating expenses increased $18.0 million in 1993 primarily because of increases in taxable income and an increase of 1% in the Federal statutory income tax rate. Such income taxes decreased $1.9 million in 1992 primarily because of adjustments of $1.5 million recorded in the second quarter of 1992 to previously recorded tax reserves and a reduction in taxable income.
INTEREST EXPENSE
Interest expense (long-term debt and other combined) increased in 1993 and 1992 primarily because of an increase in the average amount of debt outstanding. A reduction in the average interest rate in 1993 substantially offset the effect of the higher average outstanding debt. The lower average interest rate reflects the refinancing of certain long-term debt issues at lower rates and lower-cost short-term borrowings outstanding for interim periods between the redemption of certain long-term debt series and the issuance of their long-term replacements. Interest expense related to the Company's reserves for rate refunds also contributed to the increase in 1992.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements are primarily attributable to its construction programs and debt maturities. Cash and temporary cash investments increased $16.6 million during 1993. In 1993, cash flows from operating activities were $149 million. These funds were primarily used for construction and acquisition expenditures and to pay dividends.
It is anticipated that the Company's future capital requirements will be met by cash generated from operations and external financing. The level of cash generated from operations is partially dependent upon economic conditions, legislative activities, environmental matters and timely rate relief. (See Notes 4 and 12 of the Notes to Financial Statements). Access to the long-term and short-term capital and credit markets is necessary for obtaining funds externally.
The Company's liquidity and capital resources will be affected by environmental and legislative issues, including the ultimate disposition of remediation issues surrounding the FMGP issue, the Clean Air Act as amended, the National Energy Policy Act of 1992, and Federal Energy Regulatory Commission (FERC) Order 636, as discussed in Note 12 of the Notes to Financial Statements. Consistent with rate making principles of the IUB, management believes that the costs incurred for the above matters will not have a material adverse effect on the financial position or results of operations of the Company.
The IUB has adopted rules which require the Company to spend 2% of electric and 1.5% of gas gross retail operating revenues annually for energy efficiency programs. Energy efficiency costs in excess of the amount in the most recent electric and gas rate cases are being recorded as regulatory assets. At December 31, 1993, the Company had $18.5 million of such costs recorded as regulatory assets. The Company will make its initial filing for recovery of the costs in 1994.
CONSTRUCTION AND ACQUISITION PROGRAM
The Company's construction and acquisition program anticipates expenditures of $150 million for 1994, of which approximately 44% represents expenditures for electric transmission and distribution facilities, 18% represents fossil-fueled generation expenditures and 10% represents nuclear generation expenditures. Substantial commitments have been made in connection with such expenditures.
The Company's levels of construction and acquisition expenditures are projected to be $149 million in 1995, $144 million in 1996, $149 million in 1997 and $160 million in 1998. It is estimated that approximately 80% of construction expenditures will be provided by cash from operating activities (after payment of dividends) for the five year period 1994-1998.
Capital expenditure and investment and financing plans are subject to continual review and change. The capital expenditure and investment program may be revised significantly as a result of many considerations including changes in economic conditions, variations in actual sales and load growth compared to forecasts, requirements of environmental, nuclear and other regulatory authorities, acquisition opportunities, the availability of alternate energy and purchased power sources, the ability to obtain adequate and timely rate relief, escalations in construction costs and conservation and energy efficiency programs.
LONG-TERM FINANCING
Other than periodic sinking fund requirements which the Company intends to meet by pledging additional property, $124 million of long-term debt, including four series of First Mortgage Bonds aggregating $123 million, will mature prior to December 31, 1998. The Company intends to refinance the majority of the debt maturities with long-term debt.
In order to provide an up-to-date instrument for the issuance of bonds, notes or other evidence of indebtedness, the Company has entered into an Indenture of Mortgage and Deed of Trust dated September 1, 1993 (New Mortgage). The lien of the New Mortgage is subordinate to the lien of the Company's first mortgages until such time as all bonds issued under the first mortgages have been retired and such mortgages satisfied. The New Mortgage provides for, among other things, the issuance of Collateral Trust Bonds upon the basis of First Mortgage Bonds being issued. Accordingly, to the extent that the Company issues Collateral Trust Bonds on the basis of First Mortgage Bonds, it must comply with the requirements for the issuance of First Mortgage Bonds under the Company's first mortgages. Under the terms of the New Mortgage, the Company has covenanted not to issue any additional First Mortgage Bonds under its first mortgages except to provide the basis for issuance of Collateral Trust Bonds.
In November 1993, the Company entered into arrangements with various cities in the State of Iowa (Cities), whereby the Cities issued an aggregate of $19.4 million of pollution control revenue refunding bonds (PCRRBs), all at 5.5%, due 2023. Each series of the PCRRBs is secured, in part, by payments on a corresponding principal amount of Collateral Trust Bonds, at 5.5%, due 2023. The proceeds received by the Company in the transaction were used to redeem $10.2 million of Pollution Control Obligations, 5.75%, due serially 1995-2003 and an aggregate of $9.2 million of First Mortgage Bonds, Series P & Q, 6.7%, due 2006.
In October 1993, the Company sold $100 million aggregate principal amount of Collateral Trust Bonds, 6% Series, due 2008, and 7% Series, due 2023. A portion of the proceeds from the Collateral Trust Bonds was used to retire short-term debt, with the balance used for general corporate purposes, including support of the Company's construction program.
In May 1993, the Company redeemed First Mortgage Bonds Series K, 8-5/8%, principal amount of $20 million, and Series R, 8-1/4%, principal amount of $25 million and First Mortgage Bonds Series 8-3/4%, principal amount of $15 million. The redemptions were completed with proceeds from short-term borrowings and, as discussed above, long-term debt was ultimately issued to replace the short-term borrowings.
The Indentures pursuant to which the Company issues First Mortgage Bonds constitute direct first mortgage liens upon substantially all tangible public utility property and contain covenants which restrict the amount of additional bonds which may be issued. At December 31, 1993, such restrictions would have allowed the Company to issue $258 million of additional First Mortgage Bonds. The Company intends to file in the first quarter of 1994 with the FERC for authority to issue $250 million of long-term debt. The Company is currently authorized by the SEC to issue $50 million of long-term debt under an existing registration statement. The Company expects to issue up to $150 million in 1994. The proceeds are expected to be used for the early redemption of three series of First Mortgage Bonds aggregating $55 million, which have not yet been called, and for general corporate purposes, including support of its construction program.
The Articles of Incorporation of the Company authorize and limit the aggregate amount of additional shares of Cumulative Preferred Stock and Cumulative Preference Stock which may be issued. At December 31, 1993, the Company could have issued an additional 700,000 shares of Cumulative Preference Stock and 100,000 additional shares of Cumulative Preferred Stock.
The Company's capitalization ratios at year-end were as follows:
1993 1992
Long-term debt 48% 50% Preferred stock 2 2 Common equity 50 48 100% 100%
SHORT-TERM FINANCING
For interim financing, the Company is authorized by the FERC to issue, through 1994, up to $125 million of short-term notes. This availability of short-term financing provides the Company flexibility in the issuance of long-term securities. At December 31, 1993, the Company had outstanding short-term borrowings of $24 million.
The Company has two agreements, both of which expire in 1994, with separate financial institutions to sell up to $65 million of its utility accounts receivable. The Company intends to consolidate the agreements into one new agreement in 1994. At December 31, 1993, the Company had sold $53.2 million under the agreements.
At December 31, 1993, the Company had bank lines of credit aggregating $67.7 million and was using $19.0 million of its lines to support commercial paper and $7.7 million to support certain pollution control obligations. Commitment fees are paid to maintain these lines and there are no conditions which restrict the unused lines of credit. In addition to the above, the Company has an uncommitted credit facility with a financial institution whereby it can borrow up to $50 million. Rates are set at the time of borrowing and no fees are paid to maintain this facility. At December 31, 1993, $5.0 million was borrowed at 3.4% under this facility. The Company also has a letter of credit in the amount of $3.4 million supporting two of its variable rate pollution control obligations.
EFFECTS OF INFLATION
Under the rate making principles prescribed by the regulatory commissions to which the Company is subject, only the historical cost of plant is recoverable in revenues as depreciation. As a result, the Company has experienced economic losses equivalent to the current year's impact of inflation on utility plant.
In addition, the regulatory process imposes a substantial time lag between the time when operating and capital costs are incurred and when they are recovered. The Company does not expect the effects of inflation at current levels to have a significant effect on its results of operations.
Selected Quarterly Financial Data (unaudited)
The following unaudited quarterly data, in the opinion of the Company, includes adjustments, which are normal and recurring in nature, necessary for the fair presentation of the results of operations and financial position.
Quarter Ended March June September December 31 30 30 31 (in thousands) Operating revenues $193,784 $148,919 $187,392 $183,655 Operating income 24,100 18,095 36,095 25,629 Net income 14,422 10,491 26,213 16,844 Net income available for common stock 14,193 10,262 25,985 16,616
Operating revenues $166,494 $132,843 $145,003 $165,922 Operating income 17,721 15,755 26,034 19,429 Net income 9,522 7,501 17,561 10,707 Net income available for common stock 9,022 7,002 17,059 10,479
The above amounts were affected by seasonal weather conditions and the timing of utility rate changes. Rate activities are discussed in Note 4 of the Notes to Financial Statements.
The 1993 results were affected by the acquisition of the Iowa service territory from Union Electric Company, as discussed in Note 3 of the Notes to Financial Statements. Refer to Management's Discussion and Analysis for discussion of the adverse effect of weather upon 1992 results, primarily in the third quarter.
Item 8. | 52485 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 8. | 310569 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------
The following table sets forth selected historical consolidated financial data of the Company for the four years ended December 31, 1993, and for the period January 27, 1989 the date on which the Company was incorporated, through December 31, 1989, and selected historical consolidated financial data of the Railroad as predecessor of the Company for the period January 1, 1989, through March 16, 1989, all derived from the consolidated financial statements of the Company which were audited by Arthur Andersen & Co. This summary should be read in conjunction with the consolidated financial statements included elsewhere in this Report and the schedules and notes thereto.
The purchase method of accounting was used to record the assets acquired and liabilities assumed by the Company in 1989.
The following notes are an integral part of the consolidated financial statements.
The following notes are an integral part of the consolidated financial statements.
The following notes are an integral part of the consolidated financial statements.
The following notes are an integral part of the consolidated financial statements.
1. THE COMPANY
Illinois Central Corporation, a holding company, (hereinafter, the "Company") was incorporated under the laws of Delaware. The Company was formed originally for the purpose of acquiring, through a wholly-owned subsidiary, the outstanding common stock of Illinois Central Transportation Company ("ICTC"). Following a tender offer and several mergers, the Illinois Central Railroad Company ("Railroad") is the surviving corporation and the successor to ICTC and now a wholly-owned subsidiary of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant investments in affiliated companies are accounted for by the equity method. Transactions between consolidated companies have been eliminated in the accompanying consolidated financial statements.
PROPERTIES
Depreciation is computed by the straight-line method and includes depreciation on properties under capital leases. The depreciation rates for the equipment owned by the Company's finance subsidiary are based on estimated useful life and anticipated salvage value. Lives used range from 18 to 20 years. At the Railroad, depreciation for track structure, other road property, and equipment is calculated using the composite method. In the case of routine retirements, removal cost less salvage recovery is charged to accumulated depreciation. Expenditures for maintenance and repairs are charged to operating expense.
The Interstate Commerce Commission ("ICC") approves the depreciation rates used by the Railroad. In 1991, the Railroad completed a study which resulted in revised depreciation rates for road properties (excluding track properties) and equipment. The revised rates did not and will not have a significant effect on operating results. The approximate ranges of annual depreciation rates for major property classifications are as follows:
Road properties .................1% - 8% Transportation equipment ........1% - 7%
In 1989, the Company initiated a program to convert approximately 500 miles of double track main line to a single track main line, with a centralized traffic control system. This program was completed successfully in 1991.
REVENUES
Revenues are recognized based on services performed and include estimated amounts relating to movements in progress for which the settlement process is not complete. Estimated revenue amounts for movements in progress are not significant.
INCOME TAXES
Effective January 1, 1992, the Company adopted the Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). Under SFAS No. 109, deferred income taxes are accounted for on the asset and liability method by applying enacted statutory tax rates to differences ("temporary differences") between the financial statement carrying amounts and the tax bases of assets and liabilities. The resulting deferred tax assets and liabilities represent taxes to be collected or paid in the future when the related assets and liabilities are recovered and settled, respectively. See Note 10 for discussion of the 1992 impact of adopting SFAS No. 109.
CASH AND TEMPORARY CASH INVESTMENTS
Cash in excess of operating requirements is invested in certain funds having original maturities of three months or less. These investments are stated at cost, which approximates market value.
INCOME PER SHARE
Income per common share of the Company is based on the weighted average number of shares of common stock and common stock equivalents outstanding for the period. Dilution, which could result if all outstanding common stock equivalents were exercised, is not significant.
FUTURES, OPTIONS, CAPS, FLOORS AND FORWARD CONTRACTS
In March 1990, the FASB issued Statement of Financial Accounting Standards No. 105 "Disclosure of Information about Financial Instruments with Off Balance Sheet Risk and Financial Instruments with Concentration of Credit Risk" ("SFAS 105"). Disclosures required by SFAS 105 are found in various notes where the financial instruments or related risks are discussed. See specifically Notes 6, 7, 8, and 13.
CASUALTY AND FREIGHT CLAIMS
The Company accrues for injury and damage claims outstanding based on actual claims filed and estimates of claims incurred but not filed. Estimated amounts expected to be settled within one year are classified as current liabilities in the accompanying Consolidated Balance Sheets.
EMPLOYEE BENEFIT PLANS
All employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contribution costs of the plan are funded currently.
Mr. E. L. Moyers, former Chairman, President and Chief Executive Officer ("Mr. Moyers") is covered by a supplemental plan which is discussed in Note 9.
Effective January 1, 1993, the Company adopted both the Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("SFAS No. 106") and the Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" ("SFAS No. 112"). SFAS No. 106 requires that future costs associated with providing postretirement benefits be recognized as expense over the employees' requisite service period. The pay-as-you-go method used prior to 1993 recognized the expense on a cash basis. SFAS No. 112 establishes accounting standards for employers who provide postemployment benefits and clarifies when the expense is to be recognized. In accordance with the provisions of these standards, years prior to 1993 have not been restated. See Note 9 for discussion of the impact of adopting SFAS No. 106 and SFAS No. 112.
RECLASSIFICATIONS
Certain items relating to prior years have been reclassified to conform to the presentation in the current year.
3. EXTRAORDINARY ITEM AND REFINANCING
The 1993 extraordinary loss resulted from the retirement of the Railroad's 14-1/8% Senior Subordinated Debentures (the "Debentures") and refinancing the Permanent Facility. The loss was $23.4 million, net of tax benefits of $12.6 million. The loss resulted from the premium paid, the write-off of unamortized financing fees and debt discount and costs associated with the calling of the $10.3 million of Debentures not tendered. The net proceeds of the 6.75% Notes (see Note 8), borrowings under the $180 million Revolving Credit Facility and other available cash were used to fund the retirement of the Debentures.
4. OTHER INCOME, NET
Other Income, Net consisted of the following ($ in millions):
Years Ended December 31, 1993 1992 1991 Income, net.............. $ 3.9 $ 3.8 $ 3.0 Net gains on real estate sales................... .8 .4 .7 Net gain (loss) on disposal of rolling stock........ (2.3) - - Equity in undistributed earnings of affiliates.. .5 .3 .4 Net gain on Series K..... - - 3.6 Other, net............... (1.2) (2.5) (2.0) ------ ------ ------ Other Income, Net....... $ 1.7 $ 2.0 $ 5.7
5. SUPPLEMENTAL CASH FLOW INFORMATION
Cash changes in components of working capital, exclusive of Current Maturities of Long-Term Debt, included in the Consolidated Statements of Cash Flows were as follows ($ in millions):
Years Ended December 31, 1993 1992 1991
Receivables, net.... $ (3.9) $ 4.7 $ (2.6) Materials and supplies (1.4) (3.2) (.6) Other current assets.. (1.5) .3 1.0 Accounts payable... 1.1 (5.7) (5.0) Income taxes payable 13.6 .5 (5.4) Accrued redundancy reserves............ (2.6) (11.0) (11.7) Other current liabilities......... (6.1) (1.4) (.4) ------- -------- -------- $ (.8) $ (15.8) $ (24.7)
Included in changes in Other Liabilities and Reserves is approximately $6.3 million and $23.4 million for the years ended December 31, 1993 and 1992, respectively, reflecting proceeds from the settlement of casualty claims with numerous insurance carriers.
In 1993, the Railroad entered into a capital lease for 200 covered hoppers. The lease expires in 2003. See Note 7 for a recap of the present value of the minimum lease payments.
In 1991, the Railroad retired several Long- Term Debt obligations, most significantly its $150 million 15.5% Series K First Mortgage Bonds ("Series K"). These retirements resulted in non- cash reductions of debt balances of $4.6 million. Also, in 1991 the balance of a long term investment was reduced by $2.5 million.
6. MATERIALS AND SUPPLIES
Materials and Supplies, valued using the average cost method, consist of track material, switches, car and locomotive parts and fuel. The Railroad entered into various hedge agreements designed to mitigate significant changes in fuel prices. As a result, approximately 93% of the short-term diesel fuel requirements through March 1995 and 46% through June 1995 are protected against significant price changes based on the average near-by contract for Heating Oil #2 traded on the New York Mercantile Exchange.
7. LEASES
As of December 31, 1993, the Company leased 6,709 of its cars and 166 of its locomotives. The majority of these leases have original terms of 15 years and expire between 1994 and 2001. Under the terms of the majority of its leases, the Company has the right of first refusal to purchase, at the end of the lease terms, certain cars and locomotives at fair market value. Other leases include office and computer equipment, vehicles and office facilities.
Net obligations under capital leases at December 31, 1993 and 1992, included in the Consolidated Balance Sheets are $5.4 million and $.2 million, respectively.
At December 31, 1993, minimum rental payments under capital and operating leases that have initial or remaining noncancellable terms in excess of one year were as follows ($ in millions):
Capital Operating Leases Leases
1994 ............................$ .9 $ 34.6 1995 ............................ .9 28.4 1996 ............................ .8 19.3 1997 ............................ .8 7.8 1998 ............................ .8 4.2 Thereafter ...................... 3.1 17.4 ---- ------ Total minimum lease payments... 7.3 $111.7
Less: Imputed interest .......... 1.9 Present value of minimum ---- payments..................... $5.4
Total rent expense applicable to noncancellable operating leases amounted to $45.2 million in 1993, $46.2 million for 1992 and $48.5 million for 1991. Most of the leases provide that the Company pay taxes, maintenance, insurance and certain other operating expenses.
8. LONG-TERM DEBT AND INTEREST EXPENSE
Long-Term Debt at December 31, consisted of the following ($ in millions):
At December 31, 1993, the aggregate annual maturities and sinking fund requirements for debt payments for 1994 through 1999 and thereafter are $24.3 million (includes bridge financing of $21.7 million (see below)), $2.3 million, $80.6 million, $2.7 million, $57.6 million, $61.2 million and $155.9 million, respectively. The weighted- average interest rate for 1993 and 1992 on total debt excluding the effect of discounts, premiums and related amortization was 9.1% and 10.8%, respectively.
In November 1993, the Railroad initiated a public commercial paper program. The commercial paper is rated A2 by S&P, by Fitch and P3 by Moody's and is supported by a new $100 million Revolver with the Railroad's bank lending group. The Railroad views this program as a significant long-term funding source and intends to issue replacement notes as maturities occur. Therefore, the $38.1 million outstanding at December 31, 1993 has been classified as long-term.
In connection with the commercial paper program, the bank lending group agreed to replace the $180 million Revolving Credit Facility (see below) with (i) a new $100 million Revolver, due 1996 and (ii) a $50 million 364-day facility due October 1994 ("Bank Line"). The new Revolver will be used primarily for backup for the commercial paper but can be used for general corporate purposes. The available amount is reduced by the outstanding amount of commercial paper borrowings and any letters of credit issued on behalf of the Railroad under the facility. No amounts have been drawn under the Revolver. The $100 million was limited to $57.9 million because $38.1 million in commercial paper was outstanding and $4.0 million in letters of credit had been issued. The Bank Line was structured as a 364-day renewable instrument and the Company intends to renew it on an on-going basis. The $40 million outstanding at December 31, 1993, has therefore been classified as long-term.
The Company's financing/leasing subsidiaries have approximately $13.0 million in long-term borrowing agreements which were used to acquire a total of 61 locomotives during 1993 and 1991. Such borrowings are secured by equipment which is leased to the Railroad. These agreements mature in 1999 and 2000. One subsidiary used a short- term bridge financing of $21.7 million to acquire 1,522 box cars in December 1993. The bridge financing must be repaid or refinanced prior to March 3, 1994. The Company expects to refinance this debt with either a seven year floating or fixed rate term loan or a combination revolving facility and term loan also with a floating or fixed rate. During April 1993, the Company and the Railroad reached an agreement with its bank lending group and the holders of the privately placed $160 million Senior Secured Notes ("Senior Notes") for a release of all collateral and those instruments are now unsecured. The bank agreed to replace the Permanent Facility with a $180 million Revolving Credit Facility. This was done in connection with the tender offer made by the Railroad for all of the Debentures.
The tender offer was funded by issuance of new $100 million 6.75% Notes, due 2003 (the "Notes"), borrowing under a $180 million Revolving Credit Facility negotiated with the banks which replaced the Permanent Facility and cash on hand. See Note 3 for discussion of the extraordinary loss incurred upon tender for the Debentures. The Railroad irrevocably placed $12.6 million on deposit with a trustee to cover principal, a 6% premium and interest through the first call date of October 1, 1994, for the untendered Debentures.
The Notes (issued at a slight discount 1.071%) pay interest semiannually in May and November and are covered by an Indenture. Of the Senior Notes, $109.8 million bears interest at a rate of 10.02% and $50 million at 10.4%. Principal payments of $55 million are due in each of 1998 and 1999, and $25 million in each of 2000 and 2001. The Senior Notes are governed by a Note Purchase Agreement.
Various borrowings of the Company's subsidiaries are governed by agreements which contain certain affirmative and negative covenants customary for facilities of this nature including restrictions on additional indebtedness, investments, guarantees, liens, distributions, sales and leasebacks, and sales of assets and capital stock. Some also require the Railroad to satisfy certain financial tests, including a leverage ratio, an earnings before interest and taxes to interest charges ratio, debt service coverage, and minimum consolidated tangible net worth requirements. The Railroad may be required to apply 100% of net after-tax proceeds of sales aggregating $2.5 million or greater of certain assets to reduce Revolver commitments. The holders of the Senior Notes can elect to receive a pro-rata share of after-tax proceeds.
Interest Expense, Net consisted of the following ($ in millions):
Years Ended December 31, 1993 1992 1991 ---- ---- ---- Interest expense........ $35.2 $46.2 $59.7 Less: Interest capitalized..... .8 .6 .4 Interest income..... 1.3 2.0 4.2 ----- ----- ----- Interest Expense, Net... $33.1 $43.6 $55.1
9. EMPLOYEE BENEFIT PLANS
Retirement Plans. All employees of the Railroad are covered under the Railroad Retirement Act. In addition, management employees of the Railroad are covered under a defined contribution plan. Contributions under the plan vest immediately. Expenses relating to the defined contribution plan were $.4 million for each of the years ended December 31, 1993, 1992 and 1991.
Mr. Moyers is covered by a non-qualified, unfunded supplemental retirement benefit agreement which provides for a defined benefit payable annually, commencing upon death, permanent disability or retirement (with benefits arising from retirement commencing upon his attaining age 65 and compliance with certain non-competition agreements), in the amount of $250,000 per year for a maximum of 15 years. In accordance with the term of the agreement, no payments will be made while Mr. Moyers is employed by another Class I railroad. The present value of this agreement was included in the 1992 special charge. See Note 15.
Postretirement Plans. In addition to the Company's defined contribution plan for management employees, the Company has three benefit plans which provide some postretirement benefits to most former full-time salaried employees and selected former union represented employees. The medical plan for salaried retirees is contributory, with retiree contributions adjusted annually if expected inflation rate exceeds 9.5%, and contains other cost sharing features such as deductibles and co-payments. The Company's contribution will be fixed at the 1999 year end rate for all subsequent years. Salaried retirees are covered by a life insurance plan which provides a nominal death benefit and is non-contributory. The medical plan for locomotive engineers who retired under a special early retirement program in 1987 provides non-contributory coverage until age 65. All benefits under this plan terminate in 1998.
There are no plan assets and the Company will continue to fund these benefits as claims are paid as was done in prior years.
Postemployment Benefit Plans. The Company provides certain postemployment benefits such as long-term salary continuation and waiver of medical and life insurance co-payments while on long-term disability.
SFAS No. 106 and SFAS No.112. As described in Note 2 effective January 1, 1993 the Company adopted SFAS No. 106 and SFAS No. 112. With respect to SFAS No. 106, the Company elected to immediately recognize the transition asset associated with adoption which resulted because the Company had previously recorded an amount under purchase accounting to reflect the estimated liability for such benefits as of the acquisition date of ICTC.
As a result of adopting these two standards, the Company recorded a decrease to net income of $84,000 (net of taxes of $46,000) as a cumulative effect of changes in accounting principles ($ in millions):
Postretirement Benefits (SFAS No. 106): APBO at January 1, 1993: Medical......................... $36.5 Life............................ 2.3 ----- Total APB................. 38.8 Liability previously recorded..... (40.3) ----- Transition Asset.......... 1.5 Postemployment Benefits Obligation at January 1, 1993 (SFAS 112)..... (1.6) ----- Pre-tax Cumulative Effect of Changes in Accounting Principles.......... (.1) Related tax benefit.................. - ----- Cumulative Effect of Changes in Accounting Principles.......... $ (.1) =====
Per Share Impact..................... $ - =====
In accordance with each standard, years prior to 1993 have not been restated. For 1993, the adoption of these two standards had no significant effect on income before cumulative effect of changes in accounting principles as compared to the Company's prior pay-as-you-go method of accounting for such benefits.
The accumulated postretirement benefit obligations ("APBO") of the postretirement plans were as follows ($ in millions):
January December 31, 1993 1, 1993 Medical Life Total Total Accumulated post- retirement benefit obligation: Retirees....... $26.4 $ 2.4 $28.8 $33.4 Fully eligible active plan participants.. .7 - .7 .7 Other active plan participants.. 4.7 - 4.7 4.7 ----- ----- ----- ----- Total APBO.... $31.8 $ 2.4 34.2 38.8
Unrecognized net gain.......... 5.0 - Accrued liability for post- retirement benefits....... $39.2 $38.8 ===== =====
The weighted-average discount rate used in determining the accumulated post-retirement benefit obligation was 8.0% at January 1, 1993. As a result of the Company's improved financial condition and recognizing the overall shift in the financial community, the Company lowered the weighted-average discount rate to 7.25% as of December 31, 1993. The change in rates resulted in approximately $2.0 million actuarial loss. The loss was offset by actual experience gains, primarily fewer claims and lower medical rate inflation, which resulted in a $5.0 million unrecognized net gain as of December 31, 1993.
The components of the net periodic postretirement benefits cost for 1993 were as follows ($ in millions):
Service costs........................ $ .1 Interest costs....................... 3.0 Net amortization of Corridor excess.. - -----
Net periodic postretirement benefit costs...................... $ 3.1
The weighted-average annual assumed rate of increase in the per capital cost of covered benefits (e.g., health care cost trend rate) for the medical plans is 14.0% for 1993 and is assumed to decrease gradually to 6.25% by 2001 and remain at that level thereafter. The health care cost trend rate assumption normally has a significant effect on the amounts reported; however, as discussed, the plan limits annual inflation for the Company's portion of such costs to 9.5% each year. Therefore, an increase in the assumed health care cost trend rates by one percentage point in each year would have no impact on the Company's accumulated postretirement benefit obligation for the medical plans as of December 31, 1993, or the aggregate of the service and interest cost components of net periodic postretirement benefit expense in future years.
10. PROVISION FOR INCOME TAXES
Effective January 1, 1992, the Company adopted the Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). As a result, the Company recorded a $23.4 million ($.55 per share) reduction in its accrued net deferred income tax liability as of January 1, 1992. The gain recorded upon adoption could not be recognized previously in accordance with SFAS No. 96 which the Company had adopted in 1988.
The Company elected to report this change as the cumulative effect of a change of accounting principle. Therefore, prior year amounts were not restated.
On August 10, 1993, the Omnibus Budget Reconciliation Act of 1993, which contains a deficit reduction package, became law. Certain aspects of the Act directly affect the Company. Most significantly, the new law increased the maximum corporate federal income tax rate from 34% to 35% retroactive to January 1, 1993. This change required the Company to record additional deferred income tax expense of approximately $3.1 million to reflect the new tax rate's impact on net deferred income tax liability as of January 1, 1993. The higher corporate rate is not anticipated to significantly affect the Company's cash flow.
The Provision for Income Taxes for continuing operations consisted of the following ($ in millions):
Years Ended December 31, 1993 1992 1991 ---- ---- ----
Current income tax: Federal............. $23.6 $14.4 $ 9.4 State............... .9 1.6 1.0 Deferred income taxes. 31.9 21.4 20.4 ----- ----- ----- Provision for Income Taxes............... $56.4 $37.4 $30.8
The effective income tax rates for the years ended December 31, 1993, 1992 and 1991, were 38%, 34% and 32%, respectively. See Note 3 for the tax benefits associated with the extraordinary loss.
The items which gave rise to differences between the income taxes provided for continuing operations in the Consolidated Statements of Income and the income taxes computed at the statutory rate are summarized below ($ in millions):
Temporary differences between book and tax income arise because the tax effects of transactions are recorded in the year in which they enter into the determination of taxable income. As a result, the book provisions for taxes differ from the actual taxes reported on the income tax returns. The net results of such differences are included in Deferred Income Taxes in the Consolidated Balance Sheets.
The Company has an Alternative Minimum Tax ("AMT") carryforward credit of $.1 million at December 31, 1993. This excess of AMT over regular tax can be carried forward indefinitely to reduce future U.S. Federal income tax liabilities. At December 31, 1993, this credit was used to reduce the recorded deferred tax liability.
At December 31, 1993, the Company, for tax or financial statement reporting purposes, had no net operating loss carryovers.
Deferred Income Taxes consisted of the following ($ in millions):
December 31, ----------------------- 1993 1992
Deferred tax assets... $ 82.2 $ 114.4
Less: Valuation allowance. (2.2) (3.3)
Deferred tax assets, net of valuation allowance 80.0 111.1
Deferred tax liabilities. (259.5) (258.2) --------- --------- - - Deferred Income Taxes.... $ (179.5) $ (147.1)
The valuation allowance is comprised of the portion of state tax net operating loss carryforwards expected to expire before they are utilized and non-deductible expenses incurred with the previous merger of wholly-owned subsidiaries.
Major types of deferred tax assets are: reserves not yet deducted for tax purposes ($64.0 million) and safe harbor leases ($11.8 million). Major types of deferred tax liabilities are: accelerated depreciation ($206.2 million), land basis differences ($10.3 million) and debt marked to market ($2.1 million).
The Company and the Railroad have a tax sharing agreement whereby the Railroad's federal tax liability and combined state tax liabilities (if any) are the lesser of (i) the Railroad's separate consolidated liability as if it were not a member of the Company's consolidated group or (ii) the Company's consolidated liability computed without regard to any other subsidiaries of the Company. The Company and its financing/leasing subsidiaries have a tax sharing agreement whereby the subsidiary's federal income tax and state income tax liabilities are determined on a consolidated, or combined state income tax basis as if it were not a member of the Company's consolidated group, with no benefit for prior net operating losses or credit carryovers from prior years.
11. COMMON STOCK AND DIVIDENDS
The Company is authorized to issue 65,000,000 shares of Common Stock, par value $.001. At December 31, 1993, there were 42,614,566 shares of Common Stock outstanding. Each holder of Common Stock is entitled to one vote per share in the election of directors and on all matters submitted to a vote of stockholders. Subject to the rights and preferences of redeemable preferred stock, if any, each share of Common Stock is entitled to receive dividends as may be declared by the Board of Directors out of funds legally available and to share ratably in all assets available for distribution to stockholders upon dissolution or liquidation. No holder of Common Stock has any preemptive right to subscribe for any securities of the Company. No shares of preferred stock were outstanding at December 31, 1993 and 1992.
On February 4, 1992, the Board of Directors authorized a three-for-two stock split on Common Stock. The split was in the form of a stock dividend and was paid on February 28, 1992. Fractional shares were settled for cash. A total of 14,132,058 shares were issued from authorized but unissued shares. In 1992, the Board of Directors initiated a policy of quarterly dividends on the Common Stock of the Company. Future dividends may be dependent on the ability of the Railroad to pay dividends to the Company. Certain covenants of the Railroad's debt restrict the level of dividends it may pay to the Company. At December 31, 1993, approximately $76 million was free of such restrictions.
The Company awarded 25,000 shares and 150,000 shares of restricted stock to eligible employees of the Railroad in 1993 and 1992, respectively. No cash payments are required by the individuals. Shares awarded under the plans may not be sold, transferred, or used as collateral by the holders until the shares awarded become free of the restrictions. Restrictions lapse over a four-year period. All shares still subject to restrictions will be forfeited and returned to the plan if the employee's relationship with the Railroad is terminated. A total of 13,500 shares were forfeited in 1993. If the employee becomes disabled, or dies, or a change in control occurs during the vesting period, the restrictions will lapse at that time. The compensation expense resulting from the award of restricted stock is valued at the closing market price of the Company's Common Stock on the date of the award, recorded as a reduction of Stockholders' Equity, and charged to expense evenly over the service period. Compensation expense was $.8 million and $.5 million in 1993 and 1992, respectively.
In 1992, the Company awarded 200,000 shares to Mr. Moyers as well. Of this amount, 133,000 were vested upon his retirement in 1993. The remaining 67,000 were forfeited in 1993 when Mr. Moyers was employed by another Class I railroad. See Note 15.
12. COMPENSATION AND STOCK OPTIONS
Stock Purchase Plan. Under the Company's 1990 Stock Purchase Plan (the "Stock Plan"), 736,380 shares (post split) of Common Stock were made available from shares held by Prospect for sale to key employees and officers of the Company other than Mr. Moyers, as determined by the Company's Board of Directors. Shares so awarded were sold at a price of $.10 per share (post split)(which was Prospect's approximate original per share cost for such stock as adjusted for the 3 for 2 stock split in February 1992). In general, shares awarded pursuant to the Stock Purchase Plan are restricted for a period of four years and vest at a rate of 25% per year. At December 31, 1993, only 130,313 shares are restricted. All shares will vest prior to June 30, 1994, with 126,563 vesting on or before April 1, 1994. Unvested shares are subject to repurchase by the Company at a price of $.267 per share upon the termination of the participant's employment, other than as a result of death or permanent disability. The unawarded shares (63,270) and those repurchased in 1991 are now classified as Treasury Stock.
Long-Term Incentive Plan. Under the Company's 1990 Long-Term Incentive Plan (the "Long-Term Incentive Plan") shares of Common Stock are available for issuance upon the exercise of incentive options that may be awarded by the Compensation Committee to directors and selected salaried employees of the Company and its affiliates and to certain other individuals who possess the potential to contribute to the future success of the Company. The Compensation Committee also has the authority under the Long- Term Incentive Plan to award stock appreciation rights, restricted stock and restricted stock units, dividend equivalents and other stock-based awards, and to determine the consideration to be paid by the participant for any awards, any limits on transfer of awards, and, within certain limits, other terms of awards. In the case of options (other than options granted to directors who are not full-time employees of the Company ("Outside Directors"), as described below) granted under the Long-Term Incentive Plan, the Committee has the power to determine the exercise price of the option (which cannot be less than 50% of the fair market value on the date of grant of the shares subject to the option), the term of the option, the time and method of exercise and whether the options are intended to qualify as "incentive stock options" pursuant to Section 422A of the Internal Revenue Code.
Outside Directors of the Company also participate in the Long-Term Incentive Plan and are granted an option to purchase 15,000 shares of Common Stock upon initial appointment or election. In addition, Outside Directors as of November 1990 were granted options to purchase an additional 10,000 shares, which grants were approved at the 1991 Annual Meeting of Stockholders. Also on the date of each Annual Meeting, each Outside Director of IC who serves immediately prior to such date and who will continue to serve after such date (whether as a result of such director's re- election or by reason of the continuation of such director's term), will be granted an option to purchase 1,500 shares of Common Stock. Options granted to Outside Directors entitle such persons to purchase Common Stock at the fair market value of such Common Stock on the date the option was granted. Options held by Outside Directors expire 10 years from the date of grant, or, if earlier, one year following termination of service as a director for any reason other than death or disability. Such options become exercisable in full six months after their date of grant.
At the 1993 Annual Meeting, the stockholders authorized an additional one million shares to be available for issuance under the Long-Term Incentive Plan.
The following table summarizes the shares available for award under the Incentive Plan for the year ended December 31, 1993:
Reserved shares at beginning of year........... 904,000 Options exercised............ (49,500) Restricted stock awarded..... (25,000) (74,500) -------- -------- Subtotal.................. 829,500 Increase in authorized shares. 1,000,000 Shares of restricted stock forfeited.................... 80,500 Change in options outstanding during year.................. (482,500) --------- Shares available for award at end of year............... 1,427,500
The following table summarizes changes in shares under option for the year ended December 31, 1993:
Last Date Exercisable 4-21-2003 11-23-2003
The Compensation Committee awarded stock options to employees under the Long-Term Incentive Plan for the first time in 1993. Awards, all at fair market value, vest ratably over four years and expire 10 years from date of grant.
In 1993, Outside Directors exercised 7,500 options at $12.00 per share when the market price was $25.625 per share, 7,500 options at $12.00 per share when the market price was $27.875 per share and a total of 34,500 options at prices ranging from $8.000 per share to $27.750 per share when the market price was approximately $33.00 per share.
See Notes 11 and 15 for a discussion of the restricted stock issued under the Long-Term Incentive Plan.
13. CONTINGENCIES, COMMITMENTS AND CONCENTRATION OF RISKS
The Company has unconditionally guaranteed its finance subsidiary's $32.1 million obligations.
The Company is self-insured for the first $5 million of each loss. The Company carries $295 million of liability insurance per occurrence, subject to an annual cap of $370 million in the aggregate for all losses. This coverage is considered by the Company's management to be adequate in light of the Company's safety record and claims experience.
As of December 31, 1993, the Company had $4.0 million of letters of credit outstanding as collateral primarily for surety bonds executed on behalf of the Company. Such letters of credit expire in 1994 and are automatically renewable for one year. The letters of credit reduced the maximum amount that could be borrowed under the Revolver (see Note 8).
The Company has guaranteed repayment of certain indebtedness of a jointly owned company aggregating $7.8 million. The Company's primary share is $1.0 million; the remainder is a primary obligation of other unrelated owner companies.
There are various regulatory proceedings, claims and litigation pending against the Company. While the ultimate amount of liability that may result cannot be determined, in the opinion of the Company's management, based on present information, adequate provisions for liabilities have been recorded. See "Management's Discussion and Analysis - Other" for a discussion of environmental matters.
14. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and temporary cash investments. The carrying amount approximates fair value because of the short maturity of those instruments.
Investments. The Company has investments of $10.3 million in 1993 and $11.1 million in 1992 for which there are no quoted market prices. These investments are in joint railroad facilities, railroad terminal associations, switching railroads and other transportation companies. For these investments, the carrying amount is a reasonable estimate of fair value. The Company's remaining investments ($5.4 million in 1993 and $3.9 million in 1992) are accounted for by the equity method.
Long-term debt. The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities.
Fuel hedge agreements. The fair value of fuel hedging agreements is the estimated amount that the Company would receive or pay to terminate the agreements as of year end, taking into account the current credit worthiness of the agreement counterparties. At December 31, 1993 and 1992, the fair value was a liability of $4.6 million and less than $.1 million, respectively.
The estimated fair values of the Company's financial instruments at December 31, are as follows ($ in millions):
15. SPECIAL CHARGE
In 1992, the Company recorded a pretax special charge of $8.9 million as part of operating expense. The special charge reduced Net Income by $5.9 million or $.13 per share.
The special charge consisted of $7 million for various costs associated with the retirement of Mr. Moyers and the related organizational changes. The costs associated with Mr. Moyers' retirement include the present value of his pension, accelerated vesting of a portion of his restricted stock award and certain costs of a non- competition agreement. The remaining $1.9 million was for the disposition costs of railcars and a building and its adjacent land.
16. SELECTED QUARTERLY FINANCIAL DATA - (UNAUDITED)($ IN MILLIONS, EXCEPT SHARES DATA:
Per share amounts in 1991 have been restated to reflect the 3-for-2 stock split that occurred in February 1992.
- -----------------------
(a) Includes the special charge recorded in the fourth quarter of 1992, see Note 15.
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
--------------------
-----------------------------
F O R M 10-K
FINANCIAL STATEMENT SCHEDULES
SUBMITTED IN RESPONSE TO ITEM 14(a)
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
------------- -------------
I N D E X
T O FINANCIAL STATEMENT SCHEDULES SUBMITTED IN RESPONSE TO ITEM 14(a)
Schedules for the three years ended December 31, 1993:
II-Amounts receivable from related parties, and underwriters, promoters and employees other than related parties...
III-Condensed financial information........
V-Property, plant and equipment..........
VI-Accumulated depreciation and amortization of property, plant and equipment.......
VII-Guarantees of securities of other issuers...............................
VIII-Valuation and qualifying accounts......
Pursuant to Rule 5.04 of General Rules of Regulation S-X, all other schedules are omitted because they are not required or because the required information is set forth in the financial statements or related notes thereto.
------------- -------------
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
SCHEDULE II--AMOUNTS RECEIVABLE FROM RELATED PARTIES, AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES ($ in millions)
Balance at end of year Balance ----------- at begin- Non- Name of ning of Addi- Deduc- Curr- Curr- Debtor year tions tions ent ent - ------ --------- ----- ------ ---- ----- E. L. Moyers $.7 - - $.2 $.5
- -----------------
Pursuant to a four-year note dated May 15, 1992, bearing interest at the rate of 7.1%, Mr. Moyers became indebted to the Company in the principal amount of $1,000,000. In connection with Mr. Moyers' decision to retire and resign from the Board, Mr. Moyers repaid $238,500 of principal and interest and the Compensation Committee forgave an additional $200,000 principal amount of the loan. The May 15, 1992 note was cancelled in favor of a new note (the "Note") to be repaid in four annual installments of principal and interest, commencing on February 18, 1994. The Note provides that unpaid principal, including any accrued interest thereon, is to be accelerated in the event of a breach of the non-competition covenant contained in Mr. Moyers' consulting and non-competition agreement with the Company. The Note bears interest at a rate of 6.22% per annum and is prepayable in whole or in part at any time. Any unpaid principal, including any accrued interest thereon, is to be forgiven in the event of Mr. Moyers' death or disability.
The Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.
(a) Reflects 3-for-2 stock split in February 1992.
The Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.
(a) Reflects 3-for-2 stock split in February 1992.
The Notes to Consolidated Financial Statements beginning on page are an integral part of this schedule.
(1) Reclassification of properties from "Other Assets." (2) Reclassification of properties from "Assets Held For Disposition."
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
SCHEDULE VII--GUARANTEES OF SECURITIES OF OTHER ISSUERS
AS OF DECEMBER 31, 1993, 1992 AND 1991 ($ IN MILLIONS)
Column A Column B Column C Column D - -------- -------- -------- --------
Name of Title of Total Amount Nature of Issuer of Issue of Guaranteed Guarantee Securities Class of and Guaranteed Securities Outstanding by Person Guaranteed for Which Statement is Filed - ----------- ---------- ------------ --------
Terminal Refunding $7.8 Principal Railroad and and Association Improvement annual of St. Mortgage 4% interest Louis Bonds, St. Louis Series "C", due 7/1/2019
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
3.1 Articles of Incorporation of Illinois Central Railroad Company, as amended. (Incorporated by reference to Exhibit 3.1 to the Registration Statement of Illinois Central Railroad Company on Form S-1. (SEC File No. 33-29269))
3.2 By-Laws of Illinois Central Railroad Company, as amended. (Incorporated by reference to Exhibit 3.2 to the Registration Statement of Illinois Central Railroad Company on Form S-1. (SEC File No. 33-29269))
3.3 Restated Articles of Incorporation of Illinois Central Corporation. (Incorporated by reference to Exhibit 3.1 to the Quarterly Report of the Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))
3.4 By-Laws of Illinois Central Corporation, as amended. (Incorporated by reference to Exhibit 3.4 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1. (SEC File Nos. 33-36321 and 33-36321- 01))
3.5 Certificate of Retirement of Illinois Central Corporation (Incorporated by reference to Exhibit 3.3 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1, as amended. (SEC File No. 33- 40696 and Post-Effective Amendments to Registration Statement Nos. 33-36321 and 33-36321-01))
3.6 Certificate of Elimination of Illinois Central Corporation. (Incorporated by reference to Exhibit 3.2 to the Quarterly Report of the Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))
- --------------------
* Used herein to identify management contracts or compensation plans or arrangements as required by Item 14 of Form 10-K.
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
4.1 Form of 14-1/8% Senior Subordinated Debenture Indenture dated as of September 15, 1989 (the "Senior Subordinated Debenture Indenture") between Illinois Central Railroad Company and United States Trust Company of New York, Trustee (including the form of 14-1/8% Senior Subordinated Debenture included as Exhibit A therein). (Incorporated by reference to Exhibit 4.1 to the Registration Statement of Illinois Central Railroad Company on Form S-1, as amended. (SEC File No. 33- 29269))
4.2 Restated Articles of Incorporation of Illinois Central Corporation (included in Exhibit 3.3)
4.3 Form of the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Restated Revolving Credit Note, the Form of the Restated Term Note, the Form of the Intercreditor Agreement, the Form of the Security Agreement and the Form of the Bond Pledge Agreement included as Exhibits A, B, G, H and I, respectively, therein). (Incorporated by reference to Exhibit 4.1 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))
4.4 Amendment No. 1 dated as of February 28, 1992, to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Railroad Company and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Annual Report on Form 10-K for the year ended December 31, 1991, for the Illinois Central Railroad Company filed March 12, 1992. (SEC File No. 1-7092))
4.5 Form of Guaranty dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Corporation and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among the Illinois Central Railroad Company and the Banks named therein. (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))
4.6 Form of Pledge Agreement dated as of September 22, 1989, and amended and restated as of July 23, 1991, among Illinois Central Corporation and the Banks named therein that are or may become parties to the Amended and Restated Revolving Credit and Term Loan Agreement dated as of amended and restated as of July 23, 1991, among the Illinois Central Railroad Company and the Banks named therein and the Senior Note Purchasers that are parties to the Note Purchase Agreement dated as of July 23, 1991. (Incorporated by reference to Exhibit 4.4 to the Quarterly Report of Illinois Central Corporation on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-10720))
4.7 Form Supplemental Indenture dated July 23, 1991, between Illinois Central Railroad Company and Morgan Guaranty Trust Company of New York relating to First Mortgage Adjustable Rate Bonds, Series M. (Incorporated by reference to Exhibit 4.2 to the Quarterly Report of Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))
4.8 Form of Note Purchase Agreement dated as of July 23, 1991, among Illinois Central Railroad Company, as issuer, and Illinois Central Corporation, as guarantor, for 10.02% Guaranteed Senior Secured Series A Notes due 1999 and for 10.4% Guaranteed Senior Secured Series B Notes due 2001 (including the Form of Series A Note and Series B Note included as Exhibits A-1 and A-2, respectively, therein). (Incorporated by reference to Exhibit 4.3 to the Quarterly Report of the Illinois Central Railroad Company on Form 10-Q for the three months ended September 30, 1991. (SEC File No. 1-7092))
4.9 Form of the Loan and Security Agreement dated as of December 6, 1991, between IC Leasing Corporation I and Hitachi Credit America Corp. (including the Form of the Initial Funding Credit Note, the Form of the Refurbishing Credit Note, the Form of Assignment of Lease and Agreement, the Form of the Pledge Agreement between IC Financial Services Corporation and Hitachi Credit America Corp. and the Form of the Guaranty Agreement between Illinois Central Corporation and Hitachi Credit America Corp. included as Exhibits D, E, F, G and H, respectively, therein). (Incorporated by reference to Exhibit 4.9 to the Annual Report on Form 10-K for the year ended December 31, 1991, for the Illinois Central Corporation filed March 12, 1992. (SEC File No. 1-10720))
4.10 Form of the Trust Agreement dated as of March 30, 1993, between IC Leasing Corporation II and Wilmington Trust Company. (Incorporated by reference to Exhibit 4.10 to the Current Report of Illinois Central Corporation on Form 8- K dated May 7, 1993. (SEC File No. 1-10720))
4.11 Form of the Security Agreement and Mortgage dated as of March 30, 1993, between IC Leasing Trust II and UNUM Life Insurance Company of America (Including the Form of the Promissory Note between IC Leasing Trust II and UNUM Life Insurance Company of America included as Exhibit A, therein). (Incorporated by reference to Exhibit 4.11 to the Current Report of Illinois Central Corporation on Form 8- K dated May 7, 1993. (SEC File No. 1-10720))
4.12 Assignment of Lease and Conveyance dated March 30, 1993, between IC Leasing Corporation II and IC Leasing Trust II. (Incorporated by reference to Exhibit 4.12 to the Current Report of Illinois Central Corporation on Form 8- K dated May 7, 1993. (SEC File No. 1-10720))
4.13 Assignment of Lease and Conveyance dated March 30, 1993, between IC Leasing Trust II and UNUM Life Insurance Company of America. (Incorporated by reference to Exhibit 4.13 to the Current Report of Illinois Central Corporation on Form 8-K dated May 7, 1993. (SEC File No. 1- 10720))
4.14 Form of the Amended and Restated Demand Promissory Note between IC Leasing Corporation III and The First National Bank of Boston dated December 3, 1993, and amended and restated as of January 3, 1994.
4.15 Form of the Guaranty dated as of December 3, 1993, between Illinois Central Corporation and The First National Bank of Boston.
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
4.16 Security Agreement dated as of December 3, 1993, between IC Leasing Corporation III and The First National Bank of Boston and Amendment No. 1 to the Security Agreement dated as of January 3, 1994.
4.17 Form of the Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of the Competitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein). (Incorporated by reference to Exhibit 4.8 to the Annual Report on Form 10-K for the year ended December 31, 1993, for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))
4.18 Form of the Amended and Restated Revolving Credit Agreement dated as of October 27, 1993, among Illinois Central Railroad Company and the Banks named therein (including the Form of the Note, the Form of the Competitive Bid Request, Form of the Notice of Competitive Bid Request, Form of the Competitive Bid and Form of the Competitive Bid Accept/Reject Letter included as Exhibits A, B-1, B-2, B-3 and B-4, respectively, therein). (Incorporated by reference to Exhibit 4.8 to the Annual Report on Form 10-K for the year ended December 31, 1993, for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
4.19 Form of Commercial Paper Dealer Agreement between Illinois Central Railroad Company and Lehman Commercial Paper, Inc. dated as of November 19, 1993. (Incorporated by reference to Exhibit 4.10 to the Annual Report on Form 10-K for the year ended December 31, 1993 for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))
4.20 Form of Issuing and Paying Agency Agreement of the Illinois Central Railroad Company related to the Commercial Paper Program between Illinois Central Railroad Company and Bank America National Trust Company dated as of November 19, 1993, (including Exhibit A the Form of Certificated Commercial Paper Note included therein). (Incorporated by reference to Exhibit 4.11 to the Annual Report on Form 10-K for the year ended December 31, 1993 for Illinois Central Railroad Company filed March 16, 1994. (SEC File No. 1-7092))
10.1 * Form of supplemental retirement and savings plan. (Incorporated by reference to Exhibit 10C to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
10.2 * Form of management incentive compensation plan. (Incorporated by reference to Exhibit 10D to the Registration Statement of Illinois Central Transportation Co. on Form 10 filed on October 7, 1988, as amended. (SEC File No. 1- 10085))
10.3 Consolidated Mortgage dated November 1, 1949 between Illinois Central Railroad Company and Guaranty Trust Company of New York, Trustee, as amended. (Incorporated by reference to Exhibit 10.8 to the Registration Statement of Illinois Central Railroad Company on Form S-1, as amended. (SEC File No. 33- 29269))
10.4 Form of indemnification agreement dated as of January 29, 1991, between Illinois Central Corporation and certain officers and directors. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1990, for the Illinois Central Corporation filed on April 1, 1991. (SEC File No. 1-10720))
10.5 * Form of IC 1990 Stock Purchase Plan. (Incorporated by reference to Exhibit 10.6 to the Registration Statement of Illinois Central Corporation on Form 10 filed on January 5, 1990, as amended. (SEC File No. 1-10720))
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
10.6 * Form of IC Long-Term Incentive Option Plan. (Incorporated by reference to Exhibit 10.17 to the Registration Statement of Illinois Central Corporation and Illinois Central Railroad Company on Form S-1. (SEC File Nos. 33-36321 and 33- 36321-01))
10.7 * Amendments No. 1 and No. 2 to the IC Long-Term Incentive Plan. (Incorporated by reference to the Proxy Statement of Illinois Central Corporation in connection with its 1992 Annual Meeting of Stockholders. (SEC File No. 1- 10720))
10.8 Railroad Locomotive Lease Agreement between IC Leasing Corporation I and Illinois Central Railroad Company dated as of September 5, 1991. (Incorporated by reference to Exhibit 10.9 to the Annual Report on Form 10-K for the year ended December 31, 1991 for the Illinois Central Railroad Company filed March 12, 1992. (SEC File No. 1- 7092))
10.9 Railroad Locomotive Lease Agreement between IC Leasing Corporation II and Illinois Central Railroad Company dated as of January 14, 1993. (Incorporated by reference to Exhibit 10.6 to the Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Railroad Company filed March 5, 1993. (SEC File No. 1- 7092))
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
10.10 * Form of Consulting and Non- Competition Agreement between Illinois Central Corporation and Edward L. Moyers dated as of February 18, 1993. (Incorporated by reference to Exhibit 10.10 to Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Corporation filed March 5, 1993. (SEC File No. 1-10720))
10.11 * Form of the Note Agreement between the Illinois Central Corporation and Edward L. Moyers dated February 18, 1993. (Incorporated by reference to Exhibit 10.11 to Annual Report on Form 10-K for the year ended December 31, 1992, for the Illinois Central Corporation filed March 5, 1993. (SEC File No. 1- 10720))
10.12 * Form of a Supplemental Retirement Benefit Agreement dated as of August 20, 1992 between Illinois Central Corporation and Edward L. Moyers. (Incorporated by reference to Exhibit 10.3 to the Quarterly Report of the Illinois Central Corporation on Form 10-Q for the three month ended September 30, 1992. (SEC File No. 1-10720))
10.13 The Asset Sale Agreement between Allied Railcar Company and IC Leasing Corporation III dated December 3, 1993, (including the Bill of Sale Agreement and Assumption of Liabilities included as Exhibits C and D, respectively, therein).
ILLINOIS CENTRAL CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit Sequential No. Descriptions Page No. - ------- ------------ ----------
10.15 The Purchase Agreement between IC Leasing Corporation III and The First National Bank of Maryland dated December 29, 1993.
11 Computation of Income Per Common Share (Included at E-9) 21 Subsidiaries of Registrant (Included at E-10)
24.1 Consent of Arthur Andersen & Co. (A)
---------------------
(A) Included herein but not reproduced.
(1) Shares for 1991 restated to reflect February 1992 3 for 2 stock split. (2) Such items are included in primary calculation. Additional shares represent difference between average price of Common Stock for the period and the end of period price. | 859119 | 1993 |
|
Item 7. Management's Discussion and Analysis
The information called for by Item 7 appears in Management's Discussion and Analysis.
Item 8. | 78066 | 1993 |
|
Item 6. Selected Financial Data.
Selected Financial Data contained in the 1993 annual report to shareholders is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The Financial Review sections "Consolidated Results of Operations," "Group Operations" and "Financial Position and Cash Flow" contained in the 1993 annual report to shareholders are incorporated herein by reference.
Note M - Contingency, contained in the annual report to shareholders for the year ended December 31, 1993, is incorporated herein by reference.
Item 8. | 277509 | 1993 |
64908 | 1993 |
||
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Each of the Trusts was formed pursuant to a trust agreement between Capital Auto Receivables, Inc. (the "Seller") and Bankers Trust (Delaware), as Owner Trustee, and issued the following asset-backed notes and certificates. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for asset-backed notes and asset-backed certificates representing undivided interests in each of the Trusts. Each Trust's property includes a pool of retail instalment sale contracts for new and used automobiles and light trucks, certain monies due thereunder, security interests in the vehicles financed thereby and certain other property.
Retail Finance Date of Sale Receivables and Servicing Aggregate Asset-Backed Asset-Backed Trust Agreement Amount Notes Certificates - ---------- ----------------- --------- ---------------- ------------ (Millions) (Millions) (Millions) Capital December 17, 1992 $1,607.1 Class A-1 $ 657.7 $ 56.2 Auto Class A-2 $ 641.6 Receivables Class A-3 $ 251.6 Asset Trust 1992-1
Capital February 11, 1993 $2,912.9 Class A-1 $ 322.0 $ 101.9 Auto Class A-2 $ 225.0 Receivables Class A-3 $ 125.0 Asset Trust Class A-4 $ 478.0 1993-1 Class A-5 $1,147.0 Class A-6 $ 318.0 Class A-7 $ 196.0
Capital June 2, 1993 $2,009.3 Class A-1 $ 750.0 $ 58.6 Auto Class A-2 $ 100.0 Receivables Class A-3 $ 641.0 Asset Trust Class A-4 $ 403.0 1993-2
Capital October 21, 1993 $2,504.9 Class A-1 $ 430.0 $ 81.4 Auto Class A-2 $ 59.0 Receivables Class A-3 $ 63.0 Asset Trust Class A-4 $ 210.0 1993-3 Class A-5 $ 484.3 Class A-6 $1,177.2 (Private Placement)
General Motors Acceptance Corporation (GMAC), the originator of the retail receivables, continues to service the receivables for the aforementioned Trusts and receives compensation and fees for such services. Investors receive periodic payments of principal and interest for each class of notes and certificates as the receivables are liquidated.
____________________
II-1
ITEM 8. | 893958 | 1993 |
|
868482 | 1993 |
||
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
On August 23, 1985, the Partnership commenced an offering to the public of $100,000,000, subject to increase by up to $150,000,000, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. On January 17, 1986, the initial and final closing of the offering was consummated with the dealer manager of the public offering (an affiliate of which is a limited partner of one of the Associate General Partners of the Partnership), and 189,679 Interests were issued by the Partnership, from which the Partnership received gross proceeds of $189,679,000.
After deducting selling expenses and other offering costs, the Partnership had approximately $171,306,000 with which to make investments in income-producing commercial real property, to pay legal fees and other costs (including acquisition fees) related to such investments and for working capital reserves. A portion of such proceeds was utilized to acquire the properties described in Item 1 above.
At December 31, 1993, the Partnership had cash and cash equivalents of approximately $1,471,000. Such funds and short-term investments of approximately $21,966,000 are available for working capital requirements including the funding of the Partnership's share of releasing costs and capital improvements at the San Jose, California, New York, New York and Encino, California real property investments. The Partnership and its consolidated ventures have currently budgeted in 1994 approximately $4,271,000 for tenant improvements and other capital expenditures, not including the improvements or additions related to the renovation of Topanga Plaza to be funded through the existing loan as discussed below and in Note 3(c). Such budgeted amounts also exclude the Partnership's share of the January 17, 1994 earthquake repair costs at Topanga Plaza which are estimated to be approximately $2,100,000 (as discussed below and in Note 10(b)). The Partnership's share of such items and its share of similar items for its unconsolidated ventures in 1994 is currently budgeted to be approximately $3,056,000. Actual amounts expended in 1994 may vary depending on a number of factors including actual leasing activity, results of property operations, liquidity considerations and other market conditions over the course of the year. Due to these commitments, the Partnership has reduced the operating distribution beginning with the first quarter 1993. Additionally, as more fully described in Notes 5 and 8, distributions to the General Partners have been deferred in accordance with the subordination requirements of the Partnership agreement. The source of capital for such items and for both short-term and long-term future liquidity and distributions is expected to be through cash generated by the Partnership's investment properties and through the sale of such investments. To the extent that a property does not produce adequate amounts of cash to meet its needs, the Partnership may withdraw funds from the working capital reserve which it maintains. The Partnership's and its ventures' mortgage obligations are all non-recourse. Therefore, the Partnership and its Ventures are not obligated to pay mortgage indebtedness unless the related property produces sufficient net cash flow from operations or sale.
On January 30, 1992, the Partnership through JMB/Mid Rivers Mall Associates, sold its interest in Mid Rivers Mall located in St. Peters, Missouri to an affiliate of an unaffiliated joint venture partner. The Partnership received, in connection with the sale, after all fees, expenses, and joint venture participation, net cash of $13,250,000. See Note 6 for a further description of the transaction.
Overall cash flow returns at Broad Street for the next few years are expected to be lower than originally projected because an additional 13% of the space currently leased and occupied expires during the next two years. In addition, a tenant, occupying approximately 37,000 square feet (approximately 15% of the building), did not renew its lease when it expired in September 1993. However, subtenants occupying approximately 21,000 square feet whose leases also expired in September 1993 have held over while Broad Street continues to negotiate leases with them. Furthermore, Broad Street has renewed and expanded another tenant, effective July 1, 1993, whose lease was scheduled to expire in December 1994. This tenant has expanded from approximately 18,000 square feet to approximately 35,000 square feet at a market effective rental rate which is lower than its previous lease. The Partnership will continue its aggressive leasing program; however, the downtown New York City market remains extremely competitive due to the significant amount of space available primarily resulting from the layoffs, cutbacks and consolidations by financial service companies and related businesses which dominated this market. In addition to competition for tenants in the downtown Manhattan market from other buildings in the area, there is increasing competition from less expensive alternatives to Manhattan.
In order to enhance the building's competitive position in the marketplace, the joint venture partners have recently completed certain modest upgrades to the building's main lobby and elevators. Rental rates in the downtown market are currently at depressed levels and this can be expected to continue for the foreseeable future while the current vacant space is gradually absorbed. Little, if any, new construction is planned for downtown over the next few years and it is expected that the building will continue to be adversely affected by the lower than originally projected effective rental rates now achieved upon releasing of existing leases which expire over the next few years. Therefore, the JMB/Broad Street joint venture recorded a provision for value impairment at December 31, 1991 to reduce the net book value of 40 Broad Street to $30,000,000 due to the uncertainty of JMB/Broad Street joint venture's ability to recover the net carrying value of the investment property through future operations or sale. An additional provision for value impairment was recorded at December 31, 1992 to further reduce the net book value of the property to the then estimated valuation of $7,800,000. Reference is made to Notes 1 and 3(d) for further discussion of the current status of this investment property. During 1991, the JMB/Broad Street joint venture was required to pay approximately $1,800,000 in transfer taxes (and related amounts) relating to the original acquisition of this investment property. See Note 3(d).
In January 1992, the Partnership advanced $575,000 to the JMB/San Jose joint venture for the payment of certain other operating expenses. These monies were paid back to the Partnership by the end of 1992. The venture partners notified the tenants in and invitees to the complex that some of the buildings, particularly the 100-130 Park Center Plaza Buildings and the garage below them, could pose a life safety hazard under certain unusually intense earthquake conditions. While the buildings and the garage were designed to comply with the applicable codes for the period in which they were constructed, and there is no legal requirement to upgrade the buildings for seismic purposes, the venture partners are working with consultants to analyze ways in which such a potential life safety hazard could be eliminated. However, since the costs of both re-leasing space and any seismic program could be substantial, the Partnership has commenced discussions with the appropriate lender for additional loan proceeds to pay for all or a portion of these costs.
The Partnership is also continuing to discuss terms for a possible loan extension with the mortgage lender on the 150 Almaden and 185 Park Avenue buildings and certain parking areas as the mortgage loan secured by this portion of the complex matured on October 1, 1993 and was extended to December 1, 1993. However, the Partnership and the lender have not been able to agree upon mutually acceptable terms for a loan extension and the lender has accelerated the loan. Should an agreement not be reached and as the Partnership does not have its share of the outstanding loan balance in its reserves in order to retire the loan, it is possible that the lender would exercise its remedies and seek to acquire title to this portion of the complex. Furthermore, should lender assistance be required to fund significant costs at the 100-130 Park Center Plaza buildings but not be obtained, the Partnership has decided not to commit any additional amounts to this portion of the complex since the likelihood of recovering such funds through increased capital appreciation is remote. The result would be that the Partnership would no longer have an ownership interest in this portion of the complex.
As a result, there is uncertainty about the ability to recover the net carrying value of the property through future operations and sale and accordingly, the JMB/San Jose joint venture has made a provision for value impairment on the 150 Almaden and 185 Park Avenue buildings and certain parking areas of $15,549,935. Such provision at December 31, 1993 is recorded to reduce the net carrying value of these buildings to the then outstanding balance of the related non-recourse financing. Due to the uncertainty of the JMB/San Jose joint venture's ability to recover the net carrying value of those buildings within the investment property through future operations or sale, the JMB/San Jose joint venture had recorded a provision for value impairment at December 31, 1991 of $21,175,127 to reduce the net book value of the 100-130 Park Center Plaza buildings and a certain parking area to an amount equal to the then outstanding balance of the related non-recourse financing. Additionally, at December 31, 1992, the JMB/San Jose joint venture recorded a provision for value impairment of $8,142,152 on certain other portions of the complex to amounts equal to the then outstanding balances of the related non-recourse financing. In the event the lender on any portion of the complex exercised its remedies as discussed above, the result would likely be that JMB/San Jose joint venture would no longer have an ownership interest in such portion. See Note 3(b) for further discussion of this investment property. Tenants occupying approximately 110,000 square feet (approximately 26% of the buildings) of the Park Center Plaza investment property have leases that expire in 1995, for which there can be no assurance of renewals.
On January 17, 1994, an earthquake occurred in Los Angeles, California. The epicenter was located in the town of Northridge which is approximately 6 miles from Topanga Plaza Shopping Center. Consequently, the entire mall, including the 4 major department stores who own their own buildings, suffered some casualty damage. The approximately 360,000 sq. ft. of mall shops owned by the Topanga Partnership did not suffer major structural damage. The estimated cost of the repairs at Topanga for which the joint venture is responsible is approximately $8.8 million. The majority of this cost will be subject to recovery under the joint venture's earthquake insurance policy after payment of the required deductible. The deductible on the building improvements, furniture and fixtures, and business interruption coverages due to loss of rents is approximately $2.1 million. The Partnership anticipates that it will pay for its share of insurance deductibles from its reserves without any material effect on its projected operations for 1994. As of the date of this report, 97 of the malls 114 shops have opened, and the remaining shops are expected to open during the upcoming weeks as tenants complete their repairs. Only one of the four major department stores has been able to open and it may take several weeks or months before the entire center is open and operating. The earthquake will result in some adverse effect on the operations of the center in the near term; the extent and length of which is not presently determinable.
The Partnership and its joint venture partner completed a renovation at the Topanga Plaza Shopping Center during 1992 of approximately $40,000,000. In conjunction with this renovation and remerchandising, the Partnership secured an extension of the operating covenant for the Nordstrom's department store to the year 2000 from an original expiration date in 1994. In addition, the Broadway store has also committed to operate in the center until the year 2000. The Partnership and its joint venture partner have refinanced the existing mortgage notes with replacement financing from the existing mortgage holder in the aggregate amount of approximately $59,000,000 which was funded in four stages. See Note 4(b) for further discussion of the refinancing of this loan.
The Plaza Hermosa Shopping Center was developed with proceeds raised through a municipal bond financing. This financing is secured by a letter of credit facility which is ultimately secured by a deed of trust on the property. The letter of credit facility expired December 31, 1993; however, the Partnership signed an agreement with the holder of the letter of credit to extend its expiration date to June 30, 1994. The Partnership is currently evaluating its alternatives, including seeking an extension of the existing letter of credit, replacing the bond financing with a conventional mortgage or retiring the debt with current cash reserves. The existing bond financing is due and payable upon the expiration of the letter of credit, and accordingly, has been classified as a current liability at December 31, 1993. There can be no assurance that any such replacement financing will be secured. This property did not sustain any significant damage in connection with the January 17, 1994 Los Angeles earthquake.
In 1995, the leases of tenants occupying approximately 33,000 square feet (approximately 35% of the property) at the Plaza Hermosa Shopping Center expire. Although the Partnership has received indications that some of these tenants will renew, there can be no assurance that such renewals will take place.
In July 1993, at the First Financial Plaza office building, a tenant, Mitsubishi vacated its approximate 8,100 square feet prior to its lease expiration of January 1997 and continues to pay rent pursuant to its lease obligation. In 1994, leases representing approximately 20% of the leasable square footage are scheduled to expire. Although renewal discussions with the majority of these tenants have been favorable, there can be no assurance that these tenants will review their leases upon expiration. The Los Angeles office market in general and the Encino submarket in particular have become extremely competitive resulting in higher rental concession granted to tenants and flat or decreasing market rental rates. Furthermore, due to the recession in southern California and to concern regarding tenants' ability to perform under current lease terms, the venture has granted rent deferrals and other forms of rent relief to several tents including First Financial Housing, an affiliate of the unaffiliated venture partner. The property incurred minimal damage as a result of the earthquake in southern California on January 17, 1994.
There are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partners in an investment might become unable or unwilling to fulfill their financial or other obligations, or that such joint venture partners may have economic or business interests or goals that are inconsistent with those of the Partnership.
In response to the weakness of the economy and the limited amount of available real estate financing in particular, the Partnership is taking steps to preserve its working capital. Therefore, the Partnership is carefully scrutinizing the appropriateness of any discretionary expenditures, including the possible reduction of future distributions, particularly in relation to the amount of working capital it has available. By conserving working capital, the Partnership will be in a better position to meet future needs of its properties without having to rely on external financing sources.
RESULTS OF OPERATIONS
The increase in short-term investments, long-term debt and advances from affiliate and the decrease in construction costs payable and other long-term liabilities at December 31, 1993 as compared to December 31, 1992 is primarily due to the receipt of the funds advanced of approximately $735,000 by the joint venture partner at the Topanga Plaza and the receipt and use of the refinancing proceeds of the long-term debt related to the renovation at the Topanga Plaza as discussed above. The third funding of the refinancing of $18,400,000 was received on February 2, 1993, of which approximately $9,900,000 was used to payoff the other long-term liabilities and approximately $7,001,000 was used to paydown construction payables.
The increase in rents and other receivables at December 31, 1993 as compared to December 31, 1992 is primarily due to the timing of payment of certain tenant receivables of $292,000 at the Los Angeles, California investment property.
The increase in escrow deposits at December 31, 1993 as compared to December 31, 1992 is primarily due to the escrowing of funds for improvements as a result of a renewal and expansion of a certain tenant's space at 40 Broad Street. The increase in buildings and improvements at December 31, 1993 as compared to December 31, 1992 is primarily due to additions and expansion of a certain tenant's space of approximately $1,552,000 at 40 Broad Street, approximately $663,000 at the Topanga Plaza as a result of the renovation and re-merchandising of the property and approximately $430,000 at the First Financial Plaza.
The decrease in investment in unconsolidated ventures at December 31, 1993 as compared to December 31, 1992 and the decrease in the Partnership's share of operations of unconsolidated ventures for the twelve months ended December 31, 1993 as compared to the twelve months ended December 31, 1992 is primarily due to the JMB/San Jose joint venture recording at September 30, 1993 a provision for value impairment of $15,549,935 (of which the Partnership's share is $7,774,968) to reduce the net carrying value of the 150 Almaden and 185 Park Avenue buildings and certain parking areas to the then outstanding balance of the related non-recourse financing. The increase in the Partnership's share of operations of unconsolidated ventures for the twelve months ended December 31, 1992 as compared to the twelve months ended December 31, 1991 was primarily due to the Partnership's share of the provisions for value impairment recorded in 1991 at the San Jose, California investment property, partially offset in 1992 by the effect of an additional provision for value impairment recorded at December 31, 1992. See note 3(b).
The increase in accrued rents receivable at December 31, 1993 as compared to December 31, 1992 is primarily due to rents accrued ratably over the term of the lease rather than as paid at Topanga Plaza.
The increase in deferred expenses, and the corresponding increase of amortization of deferred expense for the twelve months ended and at December 31, 1993 as compared to December 31, 1992 is primarily due to the capitalization of certain expenses related to the renovation of Topanga Plaza.
The decrease in accrued interest at December 31, 1993 as compared to December 31, 1992 is primarily due to the new loan of $59,000,000 effective June 1, 1993 at the Topanga Plaza (see Note 3(c)).
The decrease in rental income for the twelve months ended December 31, 1993 as compared to the twelve months ended December 31, 1992 and 1991 is primarily due to decreased effective rents at the New York, New York investment property, lower occupancy at Plaza Hermosa and First Financial in 1993 and due to lower occupancy in 1992 at Topanga Plaza caused by the renovation as discussed in Note 3(c).
The decrease in interest income for the twelve months ended December 31, 1993 as compared to December 31, 1992 is primarily due to a decrease in the interest rates earned on U.S. Government obligations in 1993. Interest income increased for the twelve months ended December 31, 1992 as compared to the twelve months ended December 31, 1991 primarily due to the investment of the Mid Rivers sale proceeds in U.S. Government obligations in 1992.
Mortgage and other interest expense increased for the twelve months ended December 31, 1993 as compared to 1992 primarily due to the fundings by the Topanga mortgage lender of $16,000,000 in December 1992, $18,400,000 in February 1993 and $14,000,000 in June 1993 as more fully described in Note 4(b).
Depreciation expense increased for the twelve months ended December 31, 1993 as compared to 1992 due to the increase in building and improvements at 40 Broad Street, Topanga Plaza and First Financial Plaza. Depreciation expense decreased for the twelve months ended December 31, 1992 as compared to December 31, 1991 primarily due to the lower basis of assets at the New York, New York investment property due to the $28,870,198 provision for value impairment recorded at December 31, 1991.
Venture partners' share of consolidated ventures' operations decreased for the twelve months ended December 31, 1993 as compared to the twelve months ended December 31, 1992 primarily due to decreased earnings at the Topanga Plaza as a result of the renovation and re-merchandising as discussed above.
Partnership's share of gain on sale of interest in investment property of $5,655,876 decreased for the twelve months ended December 31, 1993 as compared to the twelve months ended December 31, 1992 due to the sale of the Partnership's interest in Mid Rivers in January, 1992 (see Note 6).
INFLATION
Due to the decrease in the level of inflation in recent years, inflation generally has not had a material effect on rental income or property operating expenses.
To the extent that inflation in future periods does have an adverse impact on property operating expenses, the effect will generally be offset by amounts recovered from tenants as many of the long-term leases at the Partnership's commercial properties have escalation clauses covering increases in the cost of operating and maintaining the properties as well as real estate taxes. Therefore, there should be little effect on operating earnings if the properties remain substantially occupied. In addition, substantially all of the leases at the Partnership's shopping center investments contain provisions which entitle the Partnership to participate in gross receipts of tenants above fixed minimum amounts.
Future inflation may also cause capital appreciation of the Partnership's investment properties over a period of time to the extent that rental rates and replacement costs of properties increase.
ITEM 8. | 765813 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA
The Selected Financial Data which appears as a part of Management's Discussion and Analysis of Financial Condition and Results of Operations on page 20 of Registrant's 1993 Annual Report to shareholders, is incorporated 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, which appears on pages 19 through 35 of Registrant's 1993 Annual Report to shareholders, is incorporated by reference in this Form 10-K Annual Report.
ITEM 8. | 351825 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth in the Corporation's 1993 Annual Report to Shareholders in the Financial Summary on page 17, in the Overview of 1993 results on pages 18 and 19, in the Significant events in 1993 on
ITEM 6. SELECTED FINANCIAL DATA (continued)
page 19, in note 1 of Notes to Financial Statements on pages 47 through 49, and in the Consolidated Balance Sheet -- Average Balances and Interest Yields/Rates on pages 76 and 77, which portions are 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 set forth in the Corporation's 1993 Annual Report to Shareholders in the Financial Review on pages 17 through 42 and in note 16 of Notes to Financial Statements on page 62, which portions are incorporated herein by reference.
ITEM 8. | 64782 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is set forth under the caption "Financial Review - Selected Financial Data and Comparative Statistics 1983-1993" in Pacific Enterprises' 1993 Annual Report to Shareholders filed as Exhibit 13.01 to this Annual Report. Such information 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 set forth under the caption "Financial Review - Management's Discussion and Analysis" in Pacific Enterprises' 1993 Annual Report to Shareholders filed as Exhibit 13.01 to this Annual Report. Such information is incorporated herein by reference.
ITEM 8. | 75527 | 1993 |
Item 6. Selected Financial Data
* Cable TV Fund 14-B's selected financial data includes 100 percent of the Cable TV Fund 14-A/B accounts on a consolidated basis.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
CABLE TV FUND 14-B
Results of Operations
The results of operations for Cable TV Fund 14-B ("Fund 14-B") are summarized below:
1993 Compared to 1992 -
Partnership owned -
Revenues in Fund 14-B's wholly-owned cable television systems increased $319,096, or approximately 3 percent, from $9,347,000 in 1992 to $9,666,096 in 1993. Basic service rate adjustments as well as increases in revenues from advertising sales and pay-per-view were primarily responsible for the increase in revenues. Such increases were offset, in part, by decreases in
premium service revenue. In addition, the increase in revenues would have been greater but for the reduction in basic rates due to new basic rate regulations issued by the FCC in May 1993 with which Fund 14-B complied effective September 1, 1993. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further.
Operating, general and administrative expenses increased $180,421, or approximately 4 percent, from $5,130,821 in 1992 to $5,311,242 in 1993. Operating, general and administrative expenses represented 55 percent of revenue in both 1993 and 1992. Increases in programming fees were primarily responsible for the increase in operating, general and administrative expense. No other individual factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from the General Partner increased $54,980, or approximately 4 percent, from $1,270,685 in 1992 to $1,325,665 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expense from the General Partner. Depreciation and amortization expense decreased $213,407, or approximately 3 percent, from $6,673,468 in 1992 to $6,460,061 in 1993. This decrease is due to the maturation of Fund 14-B's asset base.
Operating loss decreased $297,102, or approximately 8 percent, from $3,727,974 in 1992 to $3,430,872 in 1993. This decrease is due to the increase in revenues exceeding the increases in operating, general and administrative and management fees and allocated overhead from the General Partner as well as the decrease in depreciation and amortization expense. Operating income before depreciation and amortization expense increased $83,695, or approximately 3 percent, from $2,945,494 in 1992 to $3,029,189 in 1993 due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from the General Partner.
Interest expense decreased $164,771, or approximately 18 percent, from $923,922 in 1992 to $759,151 in 1993. This decrease is due to lower effective interest rates and lower outstanding balances on interest bearing obligations. Net loss decreased $471,996, or approximately 10 percent, from $4,673,447 in 1992 to $4,201,451 in 1993. These losses were primarily the result of the factors discussed above and are expected to continue in the future.
Venture owned -
In addition to its wholly owned systems, Fund 14-B owns an approximate 73 percent interest in the Venture.
Revenues of the Venture's Broward County System increased $1,856,065, or approximately 9 percent, from $20,212,867 in 1992 to $22,068,952 in 1993. Increases in basic and premium subscribers accounted for approximately 48 percent of the increase in revenue. Basic and premium subscribers increased 6 percent and 14 percent, respectively, during 1993. Advertising sales accounted for approximately 19 percent of the increase in revenues. Basic service rate adjustments accounted for approximately 15 percent of the increase in revenues. The increase in revenues would have been greater but for the reduction in basic rates due to the new basic rate regulations issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. No other individual factor significantly affected the increase in revenues.
Operating, general and administrative expense increased $1,287,088, or approximately 12 percent, from $11,052,427 in 1992 to $12,339,515 in 1993. Operating, general and administrative expenses represented 56 percent of revenue in 1993, compared to 55 percent in 1992. The increase in operating, general and administrative expenses was due primarily to increases in programming fees and marketing expenses. No other individual factor significantly affected the increase in operating, general and administrative expense. Management fees and allocated overhead from Jones Intercable, Inc. increased $219,910, or approximately 9 percent, from $2,481,658 in 1992 to $2,701,568 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $619,107, or approximately 6 percent, from $9,971,915 in 1992 to $9,352,808 in 1993. The decrease in depreciation and amortization expense is attributable to the maturation of the Venture's intangible asset base.
Operating loss decreased $968,164, or approximately 29 percent, from $3,293,133 in 1992 to $2,324,939 in 1993. This decrease is due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. as well as the decrease in depreciation and amortization expense. Operating income before depreciation and amortization expense increased $349,087, or approximately 5 percent, from $6,678,782 in 1992 to $7,027,869 in 1993 due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc.
Interest expense decreased $114,318, or approximately 4 percent, from $2,564,990 in 1992 to $2,450,672 in 1993 due to lower effective interest rates and lower outstanding balances on interest bearing obligations. Net loss decreased $1,472,607, or approximately 24 percent, from $6,186,107 in 1992 to $4,713,500 in 1993. The decrease was primarily attributable to the decrease in operating loss and the decrease in interest expense. These losses were primarily the result of the factors discussed above and are expected to continue in the future.
1992 Compared to 1991 -
Partnership owned -
Revenues in Fund 14-B's wholly-owned cable television systems increased $686,278, or approximately 8 percent, from $8,660,722 in 1991 to $9,347,000 in 1992. Service rate adjustments implemented in each of Fund 14-B's systems accounted for approximately 54 percent of the increase in revenues. Increases in basic subscribers accounted for approximately 19 percent of the increase in revenues. Increases in basic commercial customers accounted for approximately 11 percent of the increase in revenues. No other individual factor significantly affected the increase in revenues.
Operating, general and administrative expenses decreased $160,732, or approximately 3 percent, from $5,291,553 in 1991 to $5,130,821 in 1992. Operating, general and administrative expenses represented 55 percent of revenue in 1992 compared to 61 percent in 1991. The decrease in operating, general and administrative expense was due primarily to decreases in copyright fees and professional service fees. In 1991, the Partnership incurred fees relating to a Federal Trade Commission investigation initiated in May 1990, but no such fees were incurred in 1992. These decreases were partially offset by increases in personnel related costs and programming fees. No other individual factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from the General Partner increased $125,886, or approximately 11 percent, from $1,144,799 in 1991 to $1,270,685 in 1992 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expense from the General Partner. Depreciation and amortization expense increased $159,250, or approximately 2 percent, from $6,514,218 in 1991 to $6,673,468 in 1992. This increase in depreciation and amortization expense is attributable to additions in the depreciable asset base.
Operating loss decreased $561,874, or approximately 13 percent, from $4,289,848 in 1991 to $3,727,974 in 1992. This decrease was due to the increase in revenues and the decrease in operating, general and administrative expenses exceeding the increases in management fees and allocated overhead from the General Partner and depreciation and amortization expense. Operating income before depreciation and amortization expense increased $721,124, or approximately 32 percent, from $2,224,370 in 1991 to $2,945,494 in 1992 due to the increase in revenues and the decrease in operating, general and administrative expenses exceeding the increase in management fees and allocated overhead from the General Partner.
Interest expense decreased $351,475, or approximately 28 percent, from $1,275,397 in 1991 to $923,922 in 1992. This decrease was due to lower effective interest rates on interest bearing obligations. Net loss decreased $874,390, or approximately 16 percent, from $5,547,837 in 1991 to $4,673,447 in 1992. These losses were primarily the result of the factors discussed above.
Venture owned -
Revenues of the Venture's Broward County System increased $1,845,986, or approximately 10 percent, from $18,366,881 in 1991 to $20,212,867 in 1992. Basic service rate adjustments accounted for approximately 51 percent of the increase in revenues. Increases in basic commercial customers and customer late fees accounted for approximately 22 percent and 7 percent, respectively, of the increase in revenues. No other individual factor significantly affected the increase in revenues.
Operating, general and administrative expense increased $987,683, or approximately 10 percent, from $10,064,744 in 1991 to $11,052,427 in 1992. Operating, general and administrative expenses represented 55 percent of revenue in 1992 and 1991. The increase in operating, general and administrative expenses was due to increases in personnel related costs and programming fees, which were partially offset by decreases in marketing expenses. No other individual factor significantly affected the increase in operating, general and administrative expense. Management fees and allocated overhead from the General Partner increased $290,942, or approximately 13 percent, from $2,190,716 in 1991 to $2,481,658 in 1992 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from the General Partner.
Depreciation and amortization expense decreased $500,706, or approximately 5 percent, from $10,472,621 in 1991 to $9,971,915 in 1992. The decrease in depreciation and amortization expense was attributable to the maturation of the Venture's intangible asset base.
Operating loss decreased $1,068,067, or approximately 24 percent, from $4,361,200 in 1991 to $3,293,133 in 1992. This decrease was due to the increase in revenues exceeding the increases in operating, general and administrative expenses, management fees and allocated overhead from the General Partner, as well as the decrease in depreciation and amortization expense. Operating income before depreciation and amortization expense increased $567,361, or approximately 9 percent, from $6,111,421 in 1991 to $6,678,782 in 1992 due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from the General Partner.
Interest expense decreased $1,078,926, or approximately 30 percent, from $3,643,916 in 1991 to $2,564,990 in 1992 due to lower effective interest rates on interest bearing obligations. Net loss before minority interest in consolidated net loss decreased $1,852,613, or approximately 23 percent, from $8,038,720 in 1991 to $6,186,107 in 1992. The decrease was primarily attributable to the decrease in operating loss and the decrease in interest expense. These losses were primarily the result of the factors discussed above.
Financial Condition
In addition to the Surfside System and the Little Rock System owned exclusively by it, Fund 14-B owns an approximate 73 percent interest in the Venture. The accompanying consolidated financial statements include 100 percent of the accounts of Fund 14- B and those of the Venture reduced by Fund 14-A's 27 percent minority interest in the Venture. See discussion of the Venture's financial condition.
Fund 14-B expended approximately $1,638,000 on capital additions during 1993 in its Surfside System and Little Rock System. Approximately 32 percent of these expenditures were for the construction of cable plant extensions. Approximately 23 percent and 17 percent of the expenditures were for the construction of drops to subscribers homes and cable plant upgrades, respectively. The remainder of the expenditures were for various enhancements in Fund 14-B's cable television systems. Funding for these expenditures was provided by cash generated by operations. Anticipated capital expenditures for 1994 are approximately $1,500,000. Approximately 37 percent of these expenditures are expected to be used for new plant construction in Fund 14-B's systems. Approximately 21 percent are for service drops to homes. The remainder of these expenditures are for various enhancements in each of Fund 14-B's systems. The actual level of capital expenditures will depend, in part, upon the General Partner's determination as to the proper scope and timing of such expenditures in light of the FCC's announcement of a further rulemaking regarding the 1992 Cable Act on February 22, 1994 and Fund 14-B's liquidity position. Funding for these improvements will be provided by cash generated from operations and borrowings under Fund 14-B's credit facility.
Fund 14-B's credit agreement had an original commitment of $20,000,000. Such commitment consisted of a $10,000,000 reducing revolving credit facility and a $10,000,000 term loan. The reducing revolving credit commitment reduced to $9,500,000 on December 31, 1993, reduces to $8,500,000 on December 31, 1994 and is payable in full at December 31, 1995. At December 31, 1993, $5,600,000 was outstanding under this agreement, leaving $3,900,000 of borrowings available until December 31, 1994 for the needs of Fund 14-B. The $10,000,000 term loan is payable in quarterly installments which began March 31, 1993 and the term loan matures December 31, 1995. As of December 31, 1993, $9,750,000 was outstanding on this term loan due to installment payments made during 1993 totalling $250,000. Installments due during 1994 total $500,000. Currently, interest on the outstanding principal balance on each loan is at Fund 14-B's option of prime plus .20 percent, LIBOR plus 1.20 percent or CD rate plus 1.325 percent. The effective interest rates on amounts outstanding as of December 31, 1993 and 1992 were 4.71 percent and 4.98 percent, respectively. In January 1993, the Partnership entered into an interest rate cap agreement covering outstanding debt obligations of $8,000,000. The Partnership paid a fee of $77,600. The agreement protected the Partnership from interest rates that exceeded seven percent for three years from the date of the agreement. The General Partner believes that Fund 14-B has sufficient sources of capital to service its presently anticipated needs, subject to the regulatory matters discussed below.
As a result of the climate of the cable industry in recent years and the regulatory matters discussed below, the fair market values of Fund 14-B's cable television systems have declined on a per subscriber basis since acquired by Fund 14-B. Fund 14- B has no intention to sell the systems in the near term; however, it can not predict whether market conditions will improve in the future or whether the systems ultimately will appreciate in value.
Regulation and Legislation
On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act") which became effective on December 4, 1992. This legislation has effected significant changes to the regulatory environment in which the cable television industry operates. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. Under the 1992 Cable Act's definition of effective competition, nearly all cable television systems in the United States, including those owned and managed by the General Partner, are subject to rate regulation of basic cable services. In addition, the 1992 Cable Act allows the FCC to regulate rates for non-basic service tiers other than
premium services in response to complaints filed by franchising authorities and/or cable subscribers. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations, with which Fund 14-B complied, became effective on September 1, 1993. See Item 1 for further discussion of the provisions of the 1992 Cable Act.
Based on the General Partner's assessment of the FCC's rulemakings concerning rate regulation under the 1992 Cable Act, Fund 14-B reduced the rates it charged for certain regulated services. On an annualized basis, such rate reductions will result in an estimated reduction in Fund 14-B's revenue of approximately $700,000, or approximately 7 percent, and a decrease in operating income before depreciation and amortization of approximately $620,000, or approximately 13 percent. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. Based on the foregoing, the General Partner believes that the new rate regulations will have a negative effect on Fund 14-B's revenues and operating income before depreciation and amortization. The General Partner has undertaken actions to mitigate a portion of these reductions primarily through (a) new service offerings, (b) product re-marketing and re-packaging and (c) marketing efforts directed at non- subscribers. To the extent such reductions are not mitigated, the values of Fund 14-B's cable television systems, which are calculated based on cash flow, could be further adversely impacted.
The 1992 Cable Act contains new broadcast signal carriage requirements, and the FCC has adopted regulations implementing the statutory requirements. These new rules allow a local commercial broadcast television station to elect whether to demand that a cable system carry its signal or to require the cable system to negotiate with the station for "retransmission consent." Additionally, cable systems also are required to obtain retransmission consent from all "distant" commercial television stations (except for commercial satellite-delivered independent "superstations"), commercial radio stations and certain low-power television stations carried by the cable systems. The retransmission consent rules went into effect October 6, 1993. In the cable television systems owned by Fund 14-B, no broadcast stations withheld their consent to retransmission of their signal. Certain broadcast signals are being carried pursuant to extensions offered to the General Partner by broadcasters, including a one-year extension for carriage of the CBS station owned and operated by the CBS network in Los Angeles. The General Partner expects to conclude retransmission consent negotiations with those stations whose signals are being carried pursuant to extensions without having to terminate the distribution of any of those signals. However, there can be no assurance that such will occur . If any broadcast station currently being carried pursuant to an extension is dropped, there could be a negative effect on the system if a significant number of subscribers were to disconnect their service.
CABLE TV FUND 14-A/B VENTURE
Results of Operations
1993 Compared to 1992-
Revenues of the Venture's Broward County System increased $1,856,065, or approximately 9 percent, from $20,212,867 in 1992 to $22,068,952 in 1993. Increases in basic and premium subscribers accounted for approximately 48 percent of the increase in revenue. Basic and premium subscribers increased 6 percent and 14 percent, respectively, during 1993. Advertising sales accounted for approximately 19 percent of the increase in revenues. Basic service rate adjustments accounted for approximately 15 percent of the increase in revenues. The increase in revenues would have been greater but for the reduction in basic rates due to the new basic rate regulations issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. No other individual factor significantly affected the increase in revenues.
Operating, general and administrative expense increased $1,287,088, or approximately 12 percent, from $11,052,427 in 1992 to $12,339,515 in 1993. Operating, general and administrative expenses represented 56 percent of revenue in 1993, compared to 55 percent in 1992. The increase in operating, general and administrative expenses was due primarily to increases in programming fees and marketing expenses. No other individual factor significantly affected the increase in operating, general and administrative expense. Management fees and allocated overhead from Jones Intercable, Inc. increased $219,910, or approximately 9 percent, from $2,481,658 in 1992 to $2,701,568 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $619,107, or approximately 6 percent, from $9,971,915 in 1992 to $9,352,808 in 1993. The decrease in depreciation and amortization expense is attributable to the maturation of the Venture's tangible asset base.
Operating loss decreased $968,164, or approximately 29 percent, from $3,293,133 in 1992 to $2,324,939 in 1993. This decrease is due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. as well as the decrease in depreciation and amortization expense. Operating income before depreciation and amortization expense increased $349,087, or approximately 5 percent, from $6,678,782 in 1992 to $7,027,869 in 1993 due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc.
Interest expense decreased $114,318, or approximately 4 percent, from $2,564,990 in 1992 to $2,450, 672 in 1993 due to lower effective interest rates and lower outstanding balances on interest bearing obligations. Net loss decreased $1,472,607, or approximately 24 percent, from $6,186,107 in 1992 to $4,713,500 in 1993. The decrease was primarily attributable to the decrease in operating loss and the decrease in interest expense. These losses were primarily the result of the factors discussed above and are expected to continue in the future.
1992 Compared to 1991-
Revenues of the Venture's Broward County System increased $1,845,986, or approximately 10 percent, from $18,366,881 in 1991 to $20,212,867 in 1992. Basic service rate adjustments accounted for approximately 51 percent of the increase in revenues. Increases in basic commercial customers and customer late fees accounted for approximately 22 percent and 7 percent, respectively, of the increase in revenues. No other individual factor significantly affected the increase in revenues.
Operating, general and administrative expense increased $987,683, or approximately 10 percent, from $10,064,744 in 1991 to $11,052,427 in 1992. Operating, general and administrative expenses represented 55 percent of revenue in 1992 and 1991. The increase in operating, general and administrative expenses was due primarily to increases in personnel related costs and programming fees, which were partially off set by decreases in marketing expenses. No other individual factor significantly affected the increase in operating, general and administrative expense. Management fees and allocated overhead from Jones Intercable, Inc. increased $290,942, or approximately 13 percent, from $2,190,716 in 1991 to $2,481,658 in 1992 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $500,706, or approximately 5 percent, from $10,472,621 in 1991 to $9,971,915 in 1992. The decrease in depreciation and amortization expense was attributable to the maturation of the Venture's intangible asset base.
Operating loss decreased $1,068,067, or approximately 24 percent, from $4,361,200 in 1991 to $3,293,133 in 1992. This decrease was due to the increase in revenues exceeding the increase in operating, general and administrative expenses, management fees and allocated overhead from Jones Intercable, Inc. as well as the decrease in depreciation and amortization expense. Operating income before depreciation and amortization expense increased $567,361, or approximately 9 percent, from $6,111,421 in 1991 to $6,678,782 in 1992 due to the increase in revenues exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc.
Interest expense decreased $1,078,926, or approximately 30 percent, from $3,643,916 in 1991 to $2,564,990 in 1992 due to lower effective interest rates on interest bearing obligations. Net loss decreased $1,852,613, or approximately 23 percent, from $8,038,720 in 1991 to $6,186,107 in 1992. The decrease was primarily attributable to the decrease in operating loss and the decrease in interest expense. These losses were primarily the result of the factors discussed above.
Financial Condition
The Venture expended approximately $3,040,000 on capital additions during 1993. Cable television plant extensions accounted for approximately 27 percent of these expenditures. The construction of service drops to homes and the purchase of converters accounted for approximately 25 percent and 12 percent, respectively, of the expenditures. The remainder of these expenditures related to various enhancements in the Broward County System. These capital expenditures were funded from cash on hand and cash generated from operations. The Venture plans to expend approximately $3,125,000 for capital additions in 1994. Of this total, approximately 24 percent is for cable television plant extensions. Approximately 26 percent will relate to the construction of service drops to homes. Approximately 14 percent will relate to upgrades and rebuild of the Broward County System. The remainder of the anticipated expenditures are for various enhancements in the Broward County System. These capital expenditures are expected to be funded from cash on hand and cash generated from operations and, if necessary, borrowings under a renegotiated credit facility, as discussed below.
On December 31, 1992, the then outstanding balance of $46,800,000 on the Venture's revolving credit facility converted to a term loan. The balance outstanding on the term loan at December 31, 1993 was $43,290,000. The term loan is payable in quarterly installments which began March 31, 1993 and is payable in full by December 31, 1999. Installments paid during 1993 totalled $3,510,000. Installments due during 1994 total $3,510,000. Funding for these installments is expected to come from cash on hand and cash generated from operations. The General Partner is currently negotiating to reduce principal payments (to provide liquidity for capital expenditures) and to adjust certain leverage covenants. Interest is at the Venture's option of prime plus 1/2 percent, LIBOR plus 1-1/2 percent or CD rate plus 1-5/8 percent. The effective interest rates on amounts outstanding as of December 31, 1993 and 1992 were 5.0 percent and 5.48 percent, respectively. In January 1993, the Venture entered into an interest rate cap agreement covering outstanding debt obligations of $25,000,000. The Venture paid a fee of $246,250. The agreement protects the Venture from interest rates that exceeded 7 percent for three years from the date of the agreement.
Subject to regulatory matters discussed below and the General Partner's ability to successfully renegotiate the Venture's credit facility, the General Partner believes that the Venture has sufficient sources of capital to service its presently anticipated needs.
Regulation and Legislation
On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act") which became effective on December 4, 1992. This legislation has effected significant changes to the regulatory environment in which the cable television industry operates. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. Under the 1992 Cable Act's definition of effective competition, nearly all cable television systems in the United States, including those owned and managed by the General Partner, are subject to rate regulation of basic cable services. In addition, the 1992 Cable Act allows the FCC to regulate rates for non-basic service tiers other than premium services in response to complaints filed by franchising authorities and/or cable subscribers. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations, with which the Venture complied, became effective on September 1, 1993. See Item 1 for further discussion of the provisions of the 1992 Cable Act.
Based on the General Partner's assessment of the FCC's rulemakings concerning rate regulation under the 1992 Cable Act, the Venture reduced the rates it charged for certain regulated services. On an annualized basis, such rate reductions will result in an estimated reduction in the Venture's revenue of approximately $1,800,000, or approximately 8 percent, and a decrease in operating income before depreciation and amortization of approximately $1,100,000, or approximately 10 percent. In addition, on February 22, 1994, the FCC announced a further rulemaking which, when implemented, could reduce rates further. Based on the
foregoing, the General Partner believes that the new rate regulations will have a negative effect on the Venture's revenues and operating income before depreciation and amortization. The General Partner has undertaken actions to mitigate a portion of these reductions primarily through (a) new service offerings, (b) product re-marketing and re-packaging and (c) marketing efforts directed at non-subscribers. To the extent such reductions are not mitigated, the values of the Venture's cable television systems, which are calculated based on cash flow, could be adversely impacted. In addition, the FCC's rulemakings may have an adverse effect on the Venture's ability to renegotiate its credit facility.
Item 8. | 821480 | 1993 |
ITEM 6 - SELECTED FINANCIAL DATA
MC responds to this item by incorporating by reference the material appearing in the columns 1989 through 1993 under the caption "Selected Supplemental Financial Data" and accompanying footnote on page 43 of MC's Annual Report to Shareholders for the fiscal year ended December 31, 1993.
ITEM 7 | ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MC responds to this item by incorporating by reference the material under the section heading "Management's Analysis of the Results of Operations and Financial Condition" and the consolidated supplementary financial and statistical information on pages 16 through 43 and pages 71 through 75, respectively, of MC's Annual Report to Shareholders for the fiscal year ended December 31, 1993.
The FRB Agreement and the OCC Agreement referred to in "Regulatory Agreements" on page 42 of MC's Annual Report to Shareholders for the year ended December 31, 1993, were terminated in March 1994.
ITEM 8 | 793548 | 1993 |
Item 6. SELECTED FINANCIAL DATA
NEES ----
The information required by this item is incorporated herein by reference to page 21 of the NEES 1993 Annual Report.
NEP ---
The information required by this item is incorporated herein by reference to page 29 of the NEP 1993 Annual Report.
Mass. Electric --------------
The information required by this item is incorporated herein by reference to page 27 of the Mass. Electric 1993 Annual Report.
Narragansett ------------
The information required by this item is incorporated herein by reference to page 24 of the Narragansett 1993 Annual Report.
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
NEES ----
The information required by this item is incorporated herein by reference to pages 12 through 20 of the NEES 1993 Annual Report.
NEP ---
The information required by this item is incorporated herein by reference to pages 4 through 9 of the NEP 1993 Annual Report.
Mass. Electric --------------
The information required by this item is incorporated herein by reference to pages 4 through 10 of the Mass. Electric 1993 Annual Report.
Narragansett ------------
The information required by this item is incorporated herein by reference to pages 4 through 9 of the Narragansett 1993 Annual Report.
Item 8. | 63073 | 1993 |
Item 6. Selected Financial Data.
The "Consolidated Selected Financial Data" of the Corporation for the six years ended December 31, 1993 appears on pages 30 and 31 of the Corporation's 1993 Annual Report to Stockholders, which pages are included in Exhibit 13 hereto, and such information is hereby incorporated by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The information in response to this Item is included in "Management's Financial Review" on pages 32 through 51 of the Corporation's 1993 Annual Report to Stockholders, which pages are included in Exhibit 13 hereto, and such information is hereby incorporated by reference.
Item 8. | 36672 | 1993 |
879209 | 1993 |
||
ITEM 6. SELECTED FINANCIAL DATA.
The following represents selected financial data for the Fund for the years ended December 31, 1993, 1992, 1991, 1990 and 1989. The data should be read in conjunction with the consolidated financial statements included elsewhere herein. This data is not covered by the independent auditors' report.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This Item should be read in conjunction with Consolidated Financial Statements and other Items contained elsewhere in this Report.
RESULTS OF OPERATIONS
In 1993, some of the Fund's properties experienced an improvement in operations as a result of slight increases in the rental and lease rates due, in part, to improvements in the local economies in which the properties operate. However, the operating results of certain of the Fund's properties continue to be affected by highly competitive market conditions combined with the continued sluggish economy. Markets in some areas remained depressed due, in part, to overbuilding which continued to depress rental rates at some of the Fund's properties. Markets in which the Fund's properties are located are discussed below:
Phoenix The Phoenix economy remains stable. It is anticipated that several companies will be relocating to the area causing increased economic growth.
Construction continues to decline, allowing absorption of vacant apartment units and rental rate increases. Occupancy increased and rental revenue improved at Greenspoint Apartments due to selective rental rate increases. Occupancy and revenue remained stable at Sandspoint Apartments.
St. Petersburg/Tampa The recession still lingers within the St. Petersburg/Tampa economy. The defense cutbacks and the partial closing of MacDill Airforce Base have kept job growth to a minimum. However, job growth is expected to come from corporate relocations to the area due to lower rents and cost of living. The apartment market is competitive, resulting in stable occupancy and operations at Sunrunner Apartments.
Dallas The Dallas economy is relatively diversified; however, the recession still lingers where continued defense cutbacks have slowed the growth in employment. These job losses were partially offset by major corporations relocating to the area near the Dallas/Fort Worth International Airport causing a recent increase in economic growth in certain submarkets. The apartment market remains competitive due to affordability of new single family homes and recent job losses as described above. Occupancy at McMillan Place Apartments remained stable and selective rental rate increases were implemented during the year due, in part, to a strong submarket.
Atlanta Atlanta's economy appears to be recovering although it remains very weak. Relocating corporations, the 1996 Summer Olympic Games, health services and the Fighter contract awarded to Lockheed are expected to be major sources of job growth. In addition, UPS has relocated its headquarters to Atlanta. The apartment market remains competitive due to oversupply of available rental units. However, curtailment of apartment construction and continued corporate migration combined with a decline in single family home construction are expected to increase occupancy in the next year. The Partnership's properties operate in competitive submarkets. However,
occupancy and rental revenue were relatively stable at Wood Lake, Plantation Forest, Plantation Crossing and Wood Ridge Apartments.
Charlotte The economy is slowly recovering due to job losses in the dominant manufacturing industry. However, these job losses were offset, in part, by job growth in health care and financial services industries as Charlotte continues its transition from a manufacturing economy to a service economy.
Abatement of construction in some areas has allowed occupancy to stabilize.
However, the market remains competitive and rental concessions are common. Occupancy and operations at Misty Woods Apartments have remained stable.
1993 Compared to 1992
Loss before extraordinary item decreased $5,624,000 in 1993 compared to 1992 primarily due to the $3,846,000 provision for impairment of value and loss on sale recognized in 1992 and to a decrease in interest, operating and depreciation expenses, offset, in part, by decreased rental revenues, due to the sale of Parkside Village Apartments and the foreclosure of The Cove Apartments in 1993, and the sale of the Shadow Lake Apartments in December 1992. The decrease in rental revenue was offset, in part, by the increased rental revenue at certain of the Fund's properties due to increased occupancy. In addition, the decrease in interest expense is also due to lower interest rates obtained from the replacement financing of the Sandspoint and Greenspoint Apartments in June 1992 and Wood Lake, Wood Ridge and Plantation Crossing Apartments in June 1993 which is offset, in part, by the prepayment penalties paid in connection with the Wood Lake, Wood Ridge and Plantation Crossing Apartments refinancing. General and administrative expenses increased due to financing costs incurred in 1993 on refinancings which were not finalized. The gain on sale of property of $576,000 relates to the sale of Parkside Village Apartments and the loss on sale of $44,000 relates to the foreclosure of The Cove Apartments.
1992 Compared to 1991
Loss before extraordinary item increased $3,053,000 in 1992 compared to 1991 primarily due to the $1,694,000 and $1,895,000 provisions for impairment of value recognized in 1992 on The Cove Apartments and Parkside Village Apartments, respectively, and the $257,000 loss on sale of Shadow Lake Apartments recognized in 1992. Rental revenues, operating expenses and interest expenses decreased, in part, as a result of cessation of recording the operating results of Shadow Lake and The Cove Apartments since these properties were placed into receivership in 1992; however, operating expenses increased at most of the remaining properties. Depreciation expense decreased due to depreciation no longer being recorded on Shadow Lake and The Cove Apartments when a receiver was placed on the properties. Interest and other income decreased due to a decrease in interest rates and cash available for investments.
The $7,022,000 extraordinary item - gain on extinguishment of debt recognized in 1992 relates to the debt -forgiveness by the lenders from the sale of Shadow Lake Apartments and the refinancing on Sandspoint and Greenspoint Apartments in 1992.
FUND LIQUIDITY AND CAPITAL RESOURCES
Introduction
The results of project operations are determined by rental revenues less operating expenses (exclusive of depreciation and amortization) and debt service (see Item 2, Properties). Seven of the Fund's ten properties operating during all or part of 1993 generated positive project operations while Parkside Village, McMillan Place and Misty Woods Apartments experienced negative project operations. The Fund, after taking into account results of project operations, interest and other income and general and administrative expenses, incurred negative results from operations for the period, as defined herein. Negative results are also anticipated to occur in 1994. Cash distributions from operations were suspended since 1987. It is anticipated that cash distributions will remain suspended in 1994.
Net project operations should not be considered as an alternative to net loss (as presented in the consolidated financial statements) as an indicator of the Fund's operating performance or to cash flows as a measure of liquidity. As presented in the Consolidated Statement of Cash Flows, cash was used by operating activities. Cash was provided by investing activities from proceeds from sale of rental property and used for additions and improvements to rental properties, an increase in restricted cash and cost of sale of rental property. Cash was used by financing activities primarily for notes payable principal payments and repayments of notes payable to affiliate of the general partner and provided primarily by notes payable proceeds on the refinancing of Wood Lake, Wood Ridge and Plantation Crossing Apartments. As a result of scheduled pay rate increases in 1990 in accordance with the Greenspoint and Sandspoint Apartments debt modification agreements, the Fund approached the lender on these notes requesting further debt relief or a discounted prepayment on the loans. The Fund received approval from the lender for discounted prepayments. The discounted prepayments were contingent upon receiving proceeds from replacement financing on the properties, which the Fund obtained in June 1992, as discussed in Note 7 to the consolidated financial statements.
The Fund had been negotiating debt modification or a discounted payoff with the lender of the loan on Shadow Lake Apartments but was unsuccessful. In an effort to obtain debt modification, the Fund did not make the June 1992 debt service payment. The lender issued a notice of default and placed a receiver on the property on July 31, 1992. As discussed in Note 7 to the consolidated financial statements, the property was sold in December 1992. The net loss on sale was $257,000. The total consideration for the property was $11,724,000, including mortgage financing of $8,000,000 when acquired in November 1983.
The Fund approached the lender on McMillan Place Apartments requesting an extension of the modification agreement which expired in October 1991 and, as discussed in Note 4 to the consolidated financial statements, finalized an agreement in July 1992.
The Fund borrowed an additional $291,000 in 1993 from an affiliate of the general partner to provide cash for working capital needs. The Fund repaid $1,309,000 in principal and $86,000 in interest to an affiliate of the general partner in 1993. As of December 31, 1993 the Partnership had outstanding borrowings of $370,000 from an affiliate of the general partner as discussed in Note 5 to the consolidated financial statements.
The Fund had been attempting to refinance the Wood Lake, Wood Ridge and Plantation Crossing Apartments loans in the amount of $6,850,000, $6,371,000 and $4,361,000, respectively, due in 1993 and 1994. As discussed in Note 4 to the consolidated financial statements, the Fund finalized an agreement with a new lender for replacement financing in June 1993. The new financing has a variable interest rate and matures in 1998. A wholly owned subsidiary was formed in October 1992 into which the properties were transferred in June 1993 as a condition of the refinancing.
The Fund had not made the debt service payments since July 1992 on The Cove Apartments note payable. Consequently, the lender issued a notice of default and placed a receiver on the property on September 1, 1992. As discussed in Note 8 to the consolidated financial statements, the property was acquired through foreclosure by the first lender in July 1993. The net loss on property disposition after the $1,694,000 provision for impairment of value recognized in 1992 was $44,000. The total consideration for the property was $23,732,000, including mortgage financing of $14,546,000 when acquired in December 1984.
The Fund placed Parkside Village Apartments, located in Aurora, Colorado, on the market for sale due to working capital needs for the Fund and continued improvement in the Denver market. As a result, as discussed in Note 8 to the consolidated financial statements, the Fund sold the property in May 1993 for $11,259,000. Net gain on the sale after the provision for impairment of value of $1,895,000 recognized in 1992 was $576,000. A substantial portion of the proceeds received from this sale was used to replenish working capital reserves, pay down the notes due to an affiliate of the general partner and pay down $500,000 on the Sunrunner Apartments note payable which was a condition of the sale of Parkside Village Apartments. The total consideration for the Parkside Village Apartments was $17,262,000, including mortgage financing of $10,000,000 when acquired in November 1983.
The two remaining letters of credit on Misty Woods Apartments were scheduled to expire in June 1993. However, the Fund obtained a one year extension to June 1994. Upon expiration the lender will re-evaluate the requirements for such letters of credit, but could determine that all or part of these amounts be drawn to pay down the loan. As discussed in Note 3 to the consolidated financial statements, the Fund has cash reserved for this purpose should payment be required by the lender.
The Fund approached the lender of the $5,804,000 first loan on Misty Woods Apartments for debt modification and an extension of the May 1996 maturity date. The lender is currently reviewing the proposal.
The Fund has a balloon payment on McMillan Place Apartments of $10,800,000 due in December 1994. To meet this obligation, the Fund is currently negotiating with the lender for debt modification.
In October 1993, Greenspoint Apartments sustained flood damage as a result of heavy rainfall. The Fund incurred $45,000 in damage, which was paid for by the Fund's insurance carrier.
As discussed in Note 9 to the consolidated financial statements, in February 1994 the Fund sold Plantation Forest Apartments for $2,450,000. The estimated loss on the sale was $149,000 which will be recognized in the first quarter of 1994. Total consideration paid for the property was $3,429,000 including mortgage financing of $1,760,000 when acquired in June
1984. Net proceeds realized from the sale were, in part, used to fully repay the demand notes held by an affiliate of the general partner.
In 1993, the Fund spent $658,000 on additions and improvements to properties, the majority of which was spent at Sandspoint, Sunrunner and Wood Ridge Apartments. In 1994, the Fund anticipates spending approximately $781,000 on property additions and improvements, the majority of which will be spent at Sandspoint, Wood Lake, Wood Ridge and McMillan Place Apartments. However, due to the limited cash available only improvements necessary to maintain occupancy or to meet safety requirements will be made in 1994.
Conclusion
At this time, it appears that the investment objective of capital growth will not be attained and that a significant portion of invested capital will not be returned to investors. The extent to which invested capital is returned to investors is dependent upon the success of the Fund's strategy as set forth herein, as well as upon significant improvement in the performance of the Fund's remaining properties and the markets in which such properties are located and on the sales price of the remaining properties. In this regard, the remaining properties will be held longer than originally expected. The ability to hold and operate these properties is dependent on the Fund's ability to obtain additional financing, refinancing, or debt restructuring as required.
Since January 1991, the Fund's working capital reserves have been depleted and insufficient funds have been available to meet ongoing operating requirements. Subsequently, after periodically notifying the general partner of the Fund's need for capital to maintain operations, short-term loans have been obtained from an affiliate of the general partner. A substantial portion of the proceeds received from the sale of Parkside Village Apartments was used to pay down these borrowings.
In order to meet capital and operating requirements and to hold and operate its properties, the Fund sold Parkside Village Apartments in May 1993 and Plantation Forest in February 1994 and obtained refinancing on the Wood Lake, Wood Ridge and Plantation Crossing Apartments. Proceeds received from the sale were used to replenish working capital reserves, pay off the notes payable to an affiliate of the general partner and pay down the Sunrunner Apartments note payable. If the Fund is unable to obtain additional debt modification or refinancing, the Fund may be required to dispose of additional properties now operating at a deficit or with significant balloon payments, through sale or transfer to lenders. The Fund believes this strategy, combined with cash generated from the Fund's properties with positive operations, will allow the Partnership to meet its capital and operating requirements.
Although inflation impacts the Fund's expenses, the Fund has the ability to attempt to offset expense increases through rent increases. It is impossible to predict the future impact of inflation on the operations of the Fund's properties, the Fund's ability to successfully pass increased costs through to tenants or the impact of inflation on the ultimate sales price of remaining properties.
ITEM 8. | 705752 | 1993 |
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Omitted under the reduced disclosure format pursuant to General Instruction J(2)(a) of Form 10-K.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Abbreviated pursuant to General Instruction J(2)(a) of Form 10-K).
HIGHLIGHTS
SUMMARY American's net income in 1993 was $23 million. The 1993 results reflect the negative impact of a five-day strike by the union representing American's flight attendants in November. The results also include a $125 million charge ($79 million after tax) for the retirement of certain DC-10 aircraft and a positive $115 million adjustment to revenues ($67 million net of related commission expense and taxes) for a change in estimate related to certain earned passenger revenues. In 1992, American recorded a net loss of $735 million. The loss for 1992, before the effect of the adoption of two new mandatory accounting standards, was $274 million. The Company's 1993 operating income was $564 million, compared to an operating loss of $77 million in 1992.
In the first quarter of 1993, AMR created and began implementing a new strategic framework, known as the Transition Plan. The Plan has three parts, each intended to improve results. First, make AMR's core airline business bigger and stronger where economically justified. Second, and conversely, shrink the airline where it cannot compete profitably. Third, reallocate resources and effort to AMR and American's growing information and management services businesses which are more profitable than the airline.
Major events relating to the Transition Plan in 1993 included:
. The SABRE Technology Group -- later renamed The SABRE Group -- was formed during the second quarter of 1993.
. American announced its decision to retire 42 widebody DC-10 jets to reduce the airline's capacity and lower operating expenses.
. American shifted domestic capacity to its major hubs in Dallas/Fort Worth and Miami. The AMR Eagle carriers added or increased service in certain other markets as American reduced or withdrew jet service.
. American significantly reduced service at San Jose, California.
. To provide increased value to business customers, American expanded its successful three-class transcontinental service to new markets, added more frequent flights on business routes such as Dallas/Fort Worth - Chicago, and added more first class seats on some narrowbody aircraft.
. American increased capacity in Latin America by 17.5 percent over 1992.
American's 1993 results benefited from strengthened domestic revenues in comparison to 1992. American's 1992 domestic revenues suffered from competitive fare reductions below the levels American established in its Value Pricing Plan in April 1992. European revenues, however, were negatively impacted in 1993 by aggressive fare discounting by competitors, weak European economies and a stronger U.S. dollar.
The Company's 1993 results also reflect the dramatic adverse impact of a five-day strike by American's flight attendants' union in November. The strike's after-tax impact on fourth quarter results, estimated at $190 million, offset earnings generated earlier in the year.
With the downsizing of unprofitable operations, American's workforce began to decline following years of double-digit percentage increases. In 1993, American provided $25 million for employee severance, primarily management/specialist and operations employees.
REVENUES 1993 COMPARED TO 1992 American's operating revenues increased 8.4 percent to $14.7 billion in 1993, compared to $13.6 billion in 1992. Passenger revenues rose 8.4 percent, $1.0 billion, primarily as a result of an 8.8 percent increase in passenger yield (the average amount one passenger pays to fly one mile), partially offset by a 0.3 percent decline in passenger traffic.
American's passenger yield in 1993 increased to 13.28 cents, primarily as a result of a very weak comparison base of 1992, when revenues were negatively impacted by competitors' drastic discounting of domestic fares. For the year, domestic yield increased 13.5 percent. International yield was mixed, increasing 13.9 percent in the Pacific, unchanged in Latin America and declining 10.1 percent in Europe. In 1993, American derived 73.8 percent of its passenger revenues from domestic operations and 26.2 percent from international operations.
Although American's system capacity, as measured by available seat miles (ASMs), increased 5.2 percent, its traffic, as measured by revenue passenger miles (RPMs), decreased 0.3 percent. The drastic fare discounting drove traffic up to record levels in 1992. Traffic suffered in 1993 from American's inability to carry passengers during the flight attendants' union strike in November and the adverse effect of the strike on passenger demand during the month of December. American's domestic traffic decreased 3.5 percent, to 69.7 billion RPMs, while domestic capacity grew 2.9 percent. International traffic grew 9.1 percent, to 27.5 billion RPMs on capacity growth of 12.1 percent. The increase in international traffic was led by a 14.7 percent increase in Latin America on capacity growth of 17.5 percent, and a 7.4 percent increase in Europe on capacity growth of 10.8 percent.
Cargo revenues increased 10.4 percent, $60 million, driven by a 22.5 percent increase in American's domestic and international cargo volumes, partially offset by decreasing yields brought about by strong price competition resulting from excess industry capacity.
Other revenues, consisting of service fees, liquor revenues, duty-free sales, tour marketing and miscellaneous other revenues, increased 5.2 percent, $26 million, primarily as a result of increased traffic.
Information Services Group revenues increased 7.3 percent, $79 million, primarily due to increased booking fees resulting from growth in booking volumes and average fees collected from participating vendors.
EXPENSES 1993 COMPARED TO 1992 Operating expenses increased 3.8 percent, $515 million. American's capacity increased 5.2 percent, to 160.9 billion ASMs, due primarily to the addition of new aircraft. American's Passenger Division cost per ASM decreased by 2.0 percent, to 8.25 cents.
Wages, salaries and benefits rose 5.1 percent, $237 million, due to wage and salary adjustments for existing employees and rising health-care costs. In addition, during the fourth quarter, American recorded a $25 million severance provision in conjunction with layoffs and voluntary terminations of management/specialist and operations personnel.
Aircraft fuel expense decreased 2.4 percent, $44 million, due to a 4.9 percent decrease in the average price per gallon, partially offset by a 2.7 percent increase in gallons consumed. The average price per gallon decreased from $0.65 per gallon in 1992 to $0.62 per gallon in 1993. American consumed an average of 245 million gallons of fuel each month. A one-cent decline in fuel prices saves approximately $2.5 million per month.
Commissions to agents increased 10.3 percent, $130 million, due principally to increased passenger revenues and increased incentives for travel agents.
Depreciation and amortization increased 16.4 percent, $157 million, primarily due to the addition of 44 owned jet aircraft and other capital equipment.
Food service cost was flat, reflecting the 9.1 percent increase in international traffic, where food costs are greater, offset by the 3.5 percent decrease in domestic traffic.
Maintenance materials and repairs expense decreased 8.9 percent, $53 million, due principally to the retirement of older aircraft and increased operational efficiencies.
Other operating expenses (including crew travel expenses, booking fees, purchased services, communications charges, credit card fees and advertising) increased 2.4 percent, $54 million, primarily due to the increase in capacity and an increase in fees paid to affiliates for passengers connecting with American flights.
Interest capitalized decreased 50.0 percent, $49 million, as a result of the decrease in the average balance during the year of purchase deposits for flight equipment and the decline in interest rates.
Miscellaneous - net for 1993 includes a $125 million charge related to the retirement of 31 DC-10 aircraft. Included in Miscellaneous - net for 1992 is a $14 million provision for a cash payment representing American's share of a multi-carrier antitrust settlement.
OTHER INFORMATION
DEFERRED TAX ASSETS As of December 31, 1993, the Company had deferred tax assets aggregating approximately $2.0 billion, including approximately $337 million of alternative minimum tax (AMT) credit carryforwards. The Company believes substantially all the deferred tax assets, other than the AMT credit carryforwards, will be realized through reversal of existing taxable temporary differences. The Company anticipates using its AMT credit carryforwards, which are available for an indefinite period of time, against its future regular tax liability within the next 10 years for several reasons. Although the Company incurred net losses in 1990 through 1993, it recorded substantial income before taxes and taxable income during the seven-year period 1983 through 1989 of approximately $3.2 billion and $1.8 billion, respectively. The Company is aggressively pursuing revenue enhancement and cost reduction initiatives to restore profitability. The Company has also substantially curtailed its planned capital spending program, which will accelerate the reversal of depreciation differences between financial and tax income, thus increasing taxable income.
ENVIRONMENTAL MATTERS American has been notified of potential liability with regard to several environmental cleanup sites. At sites where remedial litigation has commenced, potential liability is joint and several. American's alleged volumetric contributions at the sites are minimal. American does not expect these actions, individually or collectively, to have a material impact on its financial condition, operating results or cash flows.
DISCOUNT RATE Due to the decline in interest rates during 1993, the discount rate used to determine the Company's pension obligations as of December 31, 1993 and the related expense for 1994, has been reduced. The impact on 1994 pension expense of the change in the discount rate will be substantially offset by the significant appreciation in the market value of pension plan assets experienced during 1993.
PROPOSED SETTLEMENT OF LITIGATION During 1992, American and certain other carriers agreed to settle various class action claims, subject to approval by the U.S. District Court for the Northern District of Georgia. Under the terms of the agreement, the carriers paid a total of approximately $50 million in cash and will jointly issue and distribute approximately $408 million in face amount of certificates for discounts of approximately 10 percent on future air travel on any of the carriers. A liability has not been established for the certificate portion of the settlement since American expects that, in the aggregate, future revenues received upon redemption of the certificates will exceed the related cost of providing the air travel. American anticipates that the share of the certificates redeemed on American may represent, but is not limited to, American's 26 percent market share among the carriers. The ultimate impact of the settlement on American's revenues, operating margins and earnings is not reasonably estimable since both the portion of certificates to be redeemed on American and the stimulative or depressive effect of the certificate redemption on revenues is not known.
OUTLOOK FOR 1994
During 1993, AMR completed a comprehensive review of the competitive realities of its businesses and determined that it must change significantly in order to generate sufficient earnings. The fundamental problems of the airline -- increasing competition from low- cost, low-fare carriers, its inability to reduce labor costs to competitive levels, and the changing values of its customers -- demand new solutions. As an initial response to that need, AMR created and began implementing a new strategic framework known as the Transition Plan. The plan has three parts, each intended to improve AMR's results. First, make the core airline business bigger and stronger where economically justified. Second, and conversely, shrink the airline where it cannot compete profitably. Third, reallocate resources and effort to the growing information and management services businesses, which are more profitable than the airline.
An integral part of the Transition Plan is the expansion of the business activities of The SABRE Group. The SABRE Group was formed as a business unit during 1993, integrating reporting relationships among American's STIN, SCS and SDS divisions and AMR's other information technology businesses. AMR plans to more fully develop and market its distinct information technology expertise through The SABRE Group and continues to investigate opportunities for further expanding its information technology businesses. These opportunities may include the combination of marketing and/or developmental functions of The SABRE Group businesses and/or a formal reorganization of The SABRE Group into one or more subsidiaries of AMR. This formal reorganization, if concluded, would likely involve the transfer to AMR, by means of a dividend, of American's STIN, SCS and SDS divisions. In addition, a formal reorganization would also result in the Company's compliance with a recent directive from the European Community Council of Ministers that, in effect, requires that a CRS operating in the European Community have a legal status that is separate and apart from its affiliated airline.
Further, the Transition Plan recognizes the unfavorable and uncertain economics which have characterized the core airline business in recent years, acknowledges the airline cost problem and seeks to maximize the contribution of the Company's more profitable businesses. In 1994, AMR will continue the course of change initiated in 1993 under the Transition Plan. Over the long term, AMR will continue its best efforts to reduce airline costs and to restore the airline operations to profitability. Based on the success or failure of those efforts, AMR will make ongoing determinations as to the appropriate degree of reallocation of resources from the airline operations to its other businesses, which may include, if the airline cannot be run profitably, the disposition or termination, over the long term, of a substantial part or all of the airline operations.
AIR TRANSPORTATION GROUP During 1993, American closed its hub and dramatically reduced operations at San Jose, California, and expanded its Dallas/Fort Worth and Miami hubs. The airline will continue to reduce or eliminate service where it cannot operate profitably. American's regional airline affiliates, subsidiaries of AMR Eagle, have added turboprop service on some routes where jet service has been canceled, and they will continue to pursue these opportunities in 1994.
In 1993, American removed 21 McDonnell Douglas DC-10 and 28 Boeing 727 aircraft from service. In 1994, an additional 14 DC- 10s and 31 727s will be retired. As a result, in 1994 American's available seat miles are expected to decrease by almost five percent. Domestic capacity will drop by almost seven percent, while international capacity will increase slightly. The capacity reduction will be the first at American since 1981.
Aircraft retirements have necessitated the furlough of about 3,700 American employees since late 1992. The Company anticipates further workforce reductions in 1994 and, accordingly, made a provision for the cost of these reductions in 1993. Fewer aircraft deliveries will also translate into lower capital spending.
American's revenue plan for 1994 reflects continued emphasis on producing premium yields by attracting more full fare passengers than its competitors. As part of this plan, American will expand its successful three-class domestic transcontinental service, add more first class seats on some narrowbody aircraft and increase frequencies in business-oriented markets. In addition, American will seek to grow its cargo revenues again in 1994.
In 1993, American's Passenger Division cost per available seat mile declined by 2.0 percent, largely due to a 4.9 percent drop in the cost of jet fuel. In 1994, though American will continue its rigorous program of cost control, it expects units costs, excluding fuel, to rise modestly. This increase will be driven by higher unit labor costs due to pay scale and average seniority escalations.
On August 10, 1993, the Omnibus Budget Reconciliation Act was signed into law, imposing a new 4.3 cents per gallon tax on commercial aviation jet fuel for use in domestic operations. The new tax will become effective October 1, 1995, and is scheduled to continue until October 1, 1998. American estimates the resulting annual increase in fuel taxes will be approximately $90 million.
AMR instituted a program in the latter half of 1993 to reduce interest costs. At year-end interest rates, the Company anticipates that this program, which involves such things as interest rate swaps, will produce significant interest cost savings. This savings is expected to largely offset the additional interest cost of new financings in 1994.
In November 1993, American endured a five-day strike by its flight attendants' union; the strike ended when both sides agreed to binding arbitration. The arbitration process is expected to be complex and will likely not be decided for several months. While the ultimate outcome is uncertain, the new contract will likely result in higher unit labor costs in 1994.
American's labor contract with its pilots' union becomes amendable in August 1994. The Company and the union leadership are pursuing opportunities to streamline the negotiation and settlement process. The ultimate outcome of these negotiations cannot be estimated at this time.
INFORMATION SERVICES GROUP The integration of AMR's information services businesses will continue in 1994 with the integration of American Airlines Decision Technologies, which is a subsidiary of AMR, SDS and other units in The SABRE Group into SABRE Decision Technologies (SDT). SDT will develop and market The SABRE Group's expanding array of information systems products and services to a growing list of airline and other customers throughout the world.
STIN will seek to sustain its revenue growth through continued geographical expansion of the SABRE computerized reservation system and the sale of its leading-edge automated reservations products such as SABRExpress, SABRExpress Ticketing and SABRE TravelBase, a new travel agency accounting system.
ITEM 8. | 4515 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The information required by Item 6 is incorporated by reference from pages A-24 and A-25 of the Appendix to the Company's 1994 Annual Meeting Proxy Statement under the caption "Eleven-year Financial Summary" but only for the years 1989-1993, inclusive, and then only with respect to the information set forth for each of such years under the following captions: "Sales and revenues," "Profit (loss) before effects of accounting changes(1)" (including the footnote indicated), "Effects of accounting changes (note 2)" (including the note indicated), "Profit (loss)," "Profit (loss) per share of common stock: (1) (2) Profit (loss) before effects of accounting changes(1)" (including the footnotes indicated), "Profit (loss) per share of common stock:(1) (2) Effects of accounting changes (note 2)" (including the footnotes and note indicated), "Profit (loss) per share of common stock:(1) (2) Profit (loss)" (including the footnotes indicated), "Dividends declared per share of common stock," "Total assets: Machinery and Engines," "Total assets: Financial Products," "Long-term debt due after one year: Machinery and Engines," and "Long-term debt due after one year: Financial Products."
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required by Item 7 is incorporated by reference from under the caption "Management's Discussion and Analysis" on pages A-26 through A-35 of the Appendix to the Company's 1994 Annual Meeting Proxy Statement.
ITEM 8. | 18230 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
Note: This table should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements and Supplementary Schedules.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following sections should be read in conjunction with Note (14) of Notes to Consolidated Financial Statements for Segment and Geographical Information.
RESULTS OF OPERATIONS
1993 COMPARED TO 1992
Net sales of $6,899 million in 1993 were 2%, or $145 million, below 1992 sales. Life Sciences sales were slightly higher than in 1992, but sales declined in all other operating segments.
Chemicals segment sales were lower than 1992 as increased volumes were offset by lower selling prices as a result of continued overcapacity. Fibers and Film segment sales declined from 1992 as reduced export volumes and selling prices were slightly offset by improved domestic volumes. Textile Fibers sales were level compared to 1992. Higher acetate filament sales volumes and prices reflect continuing strength in the fashion industry. These improvements were offset by lower volumes in North American polyester filament and lower selling prices for polyester staple that resulted from increased competitive pressures. In Technical Fibers, sales volumes and prices were lower than in 1992 as filter product shipments to the Far East decreased and overall selling prices declined due to excess worldwide capacity and the strengthening of the dollar in Europe. Tire and MRG (mechanical rubber goods) volumes were lower as a result of the weak European economy, while increased spunbond sales reflected a stronger domestic roofing market.
Polyester Resins and Films sales increased marginally over 1992 as packaging resin volumes increased due to higher demand, particularly in the Mexican market. After adjusting for the disposition of the high density polyethylene ("HDPE") business in 1992, Specialties and Advanced Materials sales improved as increased volumes offset lower selling prices. Specialty Chemicals sales were virtually unchanged as reduced selling prices, due to worldwide competitive pressures, and lower volumes, primarily in fine chemicals and printing products, were offset by increased selling prices and improved product mix for pigments and improved volumes for surfactants, electronic products, waxes, and superabsorbent materials. Within Advanced Materials, sales were higher as volumes increased for both high performance polymers and engineering thermoplastics due to general economic growth in their end use markets. Life Sciences sales were slightly higher as both price and volume improvements in crop protection and animal health, in part the result of new product introductions, offset lower full year pharmaceutical volumes. Fourth quarter pharmaceutical sales were higher than the prior 1993 quarters due to wholesaler purchases that normally would have occurred in the first quarter of 1994.
Selling, General and Administrative expenses ("SG&A") for 1993 remained virtually the same as 1992 as improvements in Chemicals, Specialty Chemicals, and Advanced Materials offset unfavorable expenses in Fibers and Film. In addition, Fibers and Film SG&A includes a $50 million receipt in settlement of a litigation. Research and Development expenses of $258 million were slightly lower than in 1992.
During 1993, the Company charged $29 million to operating income for restructuring (principally Mexican chemical operations), $19 million of which related to the write-down of property, plant and equipment. As part of an ongoing Fibers and Film Segment North American strategy, the company restructured its North American polyester fibers operations. During 1992, the Company charged $87 million to operating income for restructuring, $34 million of which related to the write-down of property, plant and equipment. An additional $15 million was charged to operations in 1992 for restructuring and regionalization of certain other businesses.
Operating income of $360 million was $38 million, or 10%, lower than 1992. Improvements in the Fibers and Film and the Specialty and Advanced Materials segments were offset by lower Chemicals and Life Sciences segments operating income. Chemicals segment operating income declined from $210 million in 1992 to $88 million in 1993 due to several nonrecurring items. Operating income from continuing operations improved as manufacturing costs and product mix were favorable compared to the prior year. Operating income was reduced, however, due to 1993 restructuring charges and costs associated with a toxic tort suit involving the Pampa, Texas plant. Also, during 1992, Chemicals segment recorded income of $68 million related to the settlement of its Pampa insurance claims. Fibers and Film operating income improved by $117 million from $298 million in 1992 to $415 million in 1993. Textile Fibers operating income was relatively flat compared to 1992 as an increase in sales volume was offset by higher manufacturing costs. Technical Fibers operating income was lower than in 1992 primarily due to reduced shipments and lower selling prices of filter products. The decrease in Polyester Resins and Films operating income was due to increased manufacturing costs and higher raw material costs principally in Mexico. In addition, Fibers and Film 1993 operating income includes a $50 million receipt in settlement of a litigation while 1992 operating income included $87 million in restructuring costs. The Specialties and Advanced Materials segment operating income improved from $26 million to $58 million primarily due to higher volumes and lower selling and marketing expenses. Specialty Chemicals operating income was lower primarily due to increased manufacturing costs. Operating income increased significantly for Advanced Materials due to improved volumes and favorable manufacturing costs resulting from higher efficiencies and reduced maintenance expenses. Operating income in Life Sciences declined from $60 million in 1992 to $17 million in 1993 primarily due to reduced pharmaceutical sales and to research and development expenditures associated with strategic initiatives within the pharmaceuticals business.
Beginning in 1993, the Company has segregated sales and costs associated with the Advanced Technology segment from segment sales and operating income of its operating segments. The Advanced Technology segment represents research and development costs to seed and develop new businesses. Prior to 1993 this group was included in the Specialties and Advanced Materials segment.These costs and results have not been borne by any operating group. When projects and/or businesses become viable, they are transferred to the appropriate operating segment.
Equity in Net (Loss) Earnings of Affiliates declined by $12 million compared to 1992 primarily due to lower earnings by Japanese and German affiliates which reflect the continued sluggish economic conditions in those countries.
Interest expense decreased $5 million, or 6%, primarily due to lower interest rates, particularly in Mexico. Interest and Other Income, net, was $22 million lower than in 1992 primarily due to lower interest income in 1993, the result of lower interest rates. In 1992, Interest and Other Income included a gain on the sale of the HDPE facility.
The effective tax rate decreased to 35% in 1993 compared to 47% in 1992. The decrease is mainly attributable to the accounting change required by the Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109").
The Company implemented Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"), effective January 1, 1992, and FAS 109 and Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits" (FAS 112), January 1, 1993. FAS 106, requires the Company to accrue the current cost of those benefits and resulted in a net after-tax cumulative charge of $141 million in the first quarter of 1992. FAS 109, which requires the asset and liability method of accounting for income taxes and the calculation of deferred taxes using enacted tax rates, resulted in a net after-tax cumulative charge of $31 million in 1993. In addition, by applying FAS 109, pre-tax operating income was reduced by $40 million due to the increase in depreciation and amortization expense resulting from the increased carrying amounts of assets and liabilities acquired in a purchase business combination. The increase in operating expense was offset by a lower deferred tax provision. FAS 112 requires recognition of postemployment benefits on an accrual basis and resulted in a net after-tax cumulative charge of $8 million in 1993. The effect of this change on 1993 earnings before the cumulative effect of accounting changes was not material.
On November 11,1993, the Company purchased 52.96% of the outstanding shares of Copley Pharmaceutical, Inc. ("Copley") for approximately $546 million. Copley develops, manufactures and markets a broad range of off-patent prescription and over-the-counter pharmaceuticals. The acquisition was accounted for under the purchase method of accounting. Accordingly, the purchase price will be allocated to the assets acquired and liabilities assumed based on their estimated respective fair values as of the date of acquisition. The allocation of the purchase price will be finalized during 1994. The excess of cost over net assets acquired was approximately $510 million and is being amortized over its estimated life. The Company financed the acquisition through a revolving credit agreement with its parent, Hoechst Corporation. Copley's results of operations have been included in the Company's consolidated financial statements as of the date of acquisition. Copley's operations are not material in relation to the Company's consolidated financial statements and pro forma financial information, therefore, has not been presented. Copley is included in the Life Sciences segment.
The following discussions and analyses of "1992 Compared to 1991" and "1991 Compared to 1990" have been restated to reflect Advanced Technology as a separate segment.
1992 COMPARED TO 1991
Net sales of $7,044 million for 1992 represented an increase of 3.7%, or $250 million, over 1991. Improvements in the Fibers and Film, Specialties and Advanced Materials and Life Sciences segments more than offset a decline in the Chemicals segment.
Chemicals segment sales declined due to continued unfavorable selling prices, principally methanol and ethylene glycol/oxide, partially offset by domestic and export volume improvements, mostly acrylates and vinyl acetate monomer. In the Fibers and Film segment, 1992 full year sales increased due to improved volumes and, to a lesser extent, higher selling prices. Textile fibers sales were higher due to an increase in polyester staple, acetate filament and polyester textile filament prices. Volume improvements, primarily in polyester staple and spunbond, were partially offset by unfavorable acetate filament export volumes. Spunbond prices were lower due to increased
competitive pressures. Strong fourth quarter sales contributed to 1992 increases in Technical Fibers. The improvement is attributable to higher sales volumes from filter products and the polyester high denier industrial fibers business units resulting from increased market demands. In Film and Fiber Intermediates, sales increased as a result of favorable pricing and higher volumes in polyethylene terephthalate film and packaging resins. Specialties and Advanced Materials segment sales were slightly higher, primarily due to volume improvements in superabsorbents, dyes and pigments, the last two increasing due to stronger apparel and automotive markets. Advanced Materials sales increased due to higher volumes in engineering thermoplastics and high performance polymers, the result of a general strengthening of the U.S. economy. These volume increases were partially offset by unfavorable selling prices due to competitive pressures. Life Sciences segment sales increased due to a strong fourth quarter. The heavy sales volumes were the result of significant wholesaler purchases which normally would have occurred in the first quarter of 1993. New product introductions in the crop protection and animal health area also contributed to the increase.
Selling, general and administrative expenses were $946 million, an increase of $56 million, or 6.3%, from 1991. Selling, general and administrative expenses were higher as increased expenses within Life Sciences were partially offset by declines in the Fibers and Film and Specialties and Advanced Materials segments. Life Sciences expenses increased due to a field force expansion and higher costs to support new marketing programs. Research and Development expenses of $262 million were flat across all segments and unchanged from 1991 levels.
The Company is restructuring its North American polyester fibers operations. As part of an ongoing North American strategy, Hoechst Celanese will install additional staple fiber capacity within Celanese Mexicana, S.A. This expansion should not result in a net increase in North American staple fiber capacity. The realignment of other polyester facilities in Canada and the United States is currently being studied. During 1992, $87 million has been charged to Fibers and Film operating income for restructuring, $34 million of which related to the write-down of property, plant and equipment. An additional $15 million has been established for restructuring and regionalization of certain other businesses.
Operating income was $398 million, a decrease of $75 million, or 15.9%, from 1991. Excluding the effects of restructuring costs, all business areas within the Fibers and Film segment showed improvements in operating income and offset a decline in the Chemicals segment operating income. The favorability in operating income experienced by Textile Fibers was mainly due to sales improvements. Technical Fibers registered a modest improvement in operating income from increased sales. Film and Fiber Intermediates operating income was higher due to substantially improved sales volumes and, to a lesser extent, favorable raw materials costs (paraxylene and ethylene glycol). Although raw material costs were somewhat lower, Chemicals segment operating income declined as competitive pressures in the commodity chemicals market continued to have an adverse impact on selling prices and profit margins. Specialties and Advanced Materials segment operating income improved primarily due to higher sales volumes. In Specialty Chemicals, strong sales volumes were the main contributor to improved operating income. Improvements were also realized in Advanced Materials, which was aided by a strengthening in the automotive and electronics markets. Life Sciences segment operating income was relatively flat as fourth quarter sales volume improvements were offset by higher selling, general and administrative expenses. In addition to higher volumes of Trental(R) (pentoxifylline), Diabeta (R)(glyburide) and Altace(TM) (ramipril), earnings benefited from improved performance in the animal health and crop protection businesses.
Equity in Net Earnings of Affiliates was $4 million, a decline of $14 million from the comparable 1991 period. The reduction is due, in part, to start up costs related to the Company's participation in a joint venture to manufacture and market bulk ibuprofen. In addition, lower volumes and increased price competition contributed to lower earnings by Japanese and German affiliates reflecting continued sluggish economic conditions in those countries.
Interest expense declined $13 million to $81 million due primarily to lower interest rates, particularly in Mexico. Interest and other income, net, rose slightly to $74 million. The increase is predominantly due to gains realized on the sale of the HDPE facility and certain other cost investments, partially offset by lower 1992 interest income, the result of lower interest rates.
The effective tax rate was 47.1% and 47.4% for 1992 and 1991, respectively.
In November 1987, an explosion and fire caused severe damage resulting in the shutdown of the Chemical segment's Pampa, Texas plant. Rebuilding of the plant production facilities was completed in April 1989 with ancillary and support facilities completed in June of 1991. In 1989, the Company established a valuation allowance for any potential shortfall between the insurance claims and the ultimate insurance settlement. During the fourth quarter of 1992, the Company agreed to a settlement with its insurance carriers covering the explosion and business interruption claims. As a result of the settlement, approximately $68 million was credited to operating income.
Effective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits Other than Pensions" ("FAS 106") which decreased net income by $141 million, net of tax. See Note (12) of Notes to Consolidated Financial Statements.
In the following discussion and analysis of "1991 Compared to 1990," 1990 is presented on a pro forma basis as if Celmex had been consolidated at January 1, 1990.
1991 COMPARED TO PRO FORMA 1990 FOR THE INCLUSION OF CELMEX
Net sales of $6,794 million for 1991 increased $262 million, or 4%, from 1990 net sales. Sales increased in the Chemicals and Life Sciences segments, but were flat in the Fibers and Film and Specialties and Advanced Materials segments.
Chemical segment sales improved due to higher selling prices and strong export sales volumes. However, sales prices have generally declined throughout the year, influenced by the decline in prices for purchased hydrocarbon feedstocks. Full year sales volumes were level as export volume improvement offset a decline in the domestic area. In the Fibers and Film segment, sales increased marginally as higher volumes offset lower selling prices. In Textile Fibers, polyester staple and filament volumes increased versus the prior year reflecting improved market conditions. Acetate filament and Trevira(R) Spunbond polyester geotextile and roofing products continued to operate at capacity levels. However, polyester staple selling prices were lower due to competitive and recessionary market conditions. Technical Fibers sales were level as higher filter products sales were offset by reductions in other product lines, particularly tire yarn and fabrics. Filter products sales improved in 1991 as strong worldwide demand for cigarette tow and acetate flake resulted in both higher sales prices and volumes. Although pricing improved marginally, sales volumes were lower for tire yarn and fabrics due to the continued sluggish economy, particularly in the automotive sector. In Film and Fiber Intermediates, higher volumes for polyester intermediates and packaging resins were offset by lower volumes for polyester film. Prices were lower for both film and intermediates. Specialty and Advanced Materials 1991 segment sales increased primarily due to increased sales in Specialty Chemicals. Specialty Chemicals experienced strong demand for fiber reactive dyes, superabsorbent materials and specialty and paper chemicals. Advanced Materials sales were slightly higher than the prior year due to higher sales of fluoropolymers. This increase was partially offset by slightly lower Engineering Plastics sales resulting from a weak domestic economy especially in the depressed automotive, electrical/electronics and housing industries. Life Sciences segment sales increased due predominantly to the continued strong sales of Diabeta(R) (glyburide), Trental(R) (pentoxifylline) and Claforan(R) (cefotaxime sodium) as well as sales from new products Altace/TM/ (ramipril) and Prokine/TM/ (sargramostim).
Selling, general and administrative expenses (including research and development) were $1,151 million, an increase of $94 million, or 8.9%, from the comparable 1990 period. Selling, general and administrative expenses increased in all segments, but predominantly within Life Sciences and Specialties and Advanced Materials. Life Sciences expenses increased due to higher advertising and marketing expenses related to new products, Altace/TM /and Prokine/TM/, as well as additional personnel costs to support higher sales levels. Specialty and Advanced Materials segments expenses increased due to new business development and higher development costs.
Operating income was $473 million, an increase of $37 million, or 8.5%, from the comparable 1990 period. Operating income improved significantly for the Chemicals and Life Sciences segments, remained flat for the Fibers and Film segment and declined in the Specialties and Advanced Materials segment. Chemicals segment operating
income increased as higher sales and lower hydrocarbon feedstock costs more than offset higher manufacturing costs. Fibers and Film segment operating income was virtually unchanged from the prior year as improvement in the Celmex fibers and film businesses offset declines in the domestic businesses. Textile Fibers operating income declined as higher sales revenue was offset by higher manufacturing costs. Technical Fibers operating income was off slightly as unfavorable tire yarn results and higher manufacturing costs offset improvements in the filter products business. Film and Fiber Intermediates operating income improved due principally to lower hydrocarbon feedstock costs. Specialty and Advanced Materials segment operating income declined due to increased manufacturing costs. Life Sciences segment operating income improved as net sales more than offset increased selling, general and administrative and manufacturing costs.
Equity in Net Earnings of Affiliates ($18 million) was virtually unchanged from 1990. Interest expense decreased $8 million to $94 million due primarily to a decline in Celmex's debt. Interest and other income, net, of $69 million represents a decrease of $62 million from 1990. The decrease resulted predominantly from a $20 million gain on the sales of businesses recognized during 1990 and a $28 million decrease in Celmex interest income in 1991.
The effective tax rate for the full year 1991 was 47.4% compared to 45.8% for the comparable 1990 period.
ENVIRONMENTAL
In 1993, combined worldwide expenditures, including third party and divested sites, for compliance with environmental regulations and internal Company initiatives totaled $294 million of which $149 million was for capital projects. In both 1994 and 1995 total annual environmental expenditures are expected to be approximately $300 million of which $125 million is for capital projects. It is anticipated that stringent environmental regulations will continue to be imposed on the Company and the industry in general. Although the Company cannot predict expenditures beyond 1995, management believes that the current spending trends will continue.
In 1993, 1992 and 1991 the total environmental costs charged to operations for remediation efforts amounted to $34 million, $46 million and $24 million, respectively. As of December 31, 1993 and 1992 the Company's total environmental liability recognized in the financial statements is $149 million and $156 million, respectively. The amounts are neither reduced for anticipated insurance recovery nor discounted from the anticipated payment date.
In the opinion of management, environmental expenditures will not have a material adverse effect upon the Company's competitive position.
INFLATION
In recent years, inflation has not had a material impact on the Company's costs due principally to price competition among suppliers of raw materials. However, in certain segments of the Company's businesses, changes in the prices of raw materials, particularly petroleum derivatives, could have a significant impact on the Company's costs, which the Company may not be able to reflect fully in its pricing structure.
RATIO OF EARNINGS TO FIXED CHARGES
Ratio of earnings to fixed charges for 1993 was 3.6 compared to 4.0 for 1992. The ratio declined due to the decrease in operating income. For the purpose of calculating the ratio of earnings to fixed charges, earnings consist of earnings from operations before fixed charges, minority interests, income taxes and cumulative effect of accounting changes. Fixed charges consist of interest and debt expense, capitalized interest, interest on obligations under capital leases, the estimated interest portion of rents under operating leases and the majority-owned preferred stock dividend requirement.
LIQUIDITY AND CAPITAL RESOURCES OF THE COMPANY
Cash and cash equivalents of $171 million at December 31, 1993 represented a decrease of $42 million from 1992. The decrease primarily resulted from net cash used in investing activities of $978 million, partially offset by net cash provided by operating and financing activities of $537 million and $400 million, respectively.
Investing activities in 1993 included expenditures for capital projects of $556 million compared with $592 million in 1992. In addition, as discussed above, the Company acquired 52.96% of the outstanding shares of Copley for approximately $546 million. The Company funded the purchase price with a loan under a revolving credit agreement with Hoechst Corporation ("Parent").
In 1993, the Company increased its commercial paper program from $250 million to $600 million to provide an additional source of financing flexibility. At December 31, 1993, there was no commercial paper outstanding. The Company has $600 million of committed domestic credit facilities, all of which were unused at December 31, 1993. These credit lines provide backup to the Company's commercial paper program. The Company also has a $750 million revolving credit agreement with its Parent. At December 31, 1993, the outstanding balance on this credit facility was $679 million, primarily the result of the Copley acquisition. In addition, the Company prepaid its 13% senior promissory notes and 8% notes in the amounts of $15 million and $7 million, respectively.
In February 1993, the Company paid its Parent an $85 million dividend. The Company also declared a 1993 dividend of $70 million which was paid during the first quarter of 1994. The Company intends to continue its practice of paying a dividend to its Parent at the discretion of the Company's Board of Directors.
On January 10, 1994, the Securities and Exchange Commission declared effective the Company's registration statement covering the offer and sale from time to time of its unsecured debt securities at an aggregate initial public offering price of not more than $650 million. On January 26, 1994, the Company issued $250 million of 6-1/8% Notes due February 2004. In March 1994, the Company also sold $100 million of its medium-term notes. The net proceeds from these transactions were used to repay a portion of the amount borrowed by the Company from its Parent. The Company may sell from time to time up to an additional $300 million of medium-term notes. The proceeds from any medium-term notes to be sold will be used for general corporate purposes.
The Company expects that its capital expenditures, investments and working capital requirements will continue to be met primarily from internally generated funds from operations. However, the Company may, due to the timing of funding requirements or investments supplement its liquidity from external or affiliated sources. Such sources include the Company's medium-term note shelf registration, its commercial paper program or loans from its Parent or Hoechst AG and affiliates.
ITEM 8. | 812427 | 1993 |
Item 6. Selected Financial Data.
The required information is set forth on pages 18 and 19 of the accompanying 1993 Annual Report, which material is incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The required information is set forth on pages 16 through 23 of the accompanying 1993 Annual Report, which material is incorporated herein by reference.
Item 8. | 68813 | 1993 |
ITEM 6 SELECTED FINANCIAL DATA
Pages 1 and 2 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1993 included herein as exhibit 13 is incorporated herein by reference.
ITEM 7 | ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pages 2 through 17 inclusive in the Registrant's Annual Report to Shareholders for the year ended December 31, 1993 included herein as exhibit 13 are incorporated herein by reference.
ITEM 8 | 352510 | 1993 |
Item 6. Selected Financial Data
The information required by this item is included under "Selected Consolidated Financial Data" on page 16 of the Company's 1993 Annual Report to Shareholders.
Item 7. | Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition
The information required by this item is included under "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 17-22 of the Company's 1993 Annual Report to Shareholders.
Item 8. | 701811 | 1993 |
Item 6. SELECTED FINANCIAL DATA.
The following summary of certain consolidated financial information of Credco was derived from audited financial statements for the five years ended December 31, 1993. 1993 1992 1991 1990 1989 ---- ---- ---- ---- ---- (dollars in millions) Income Statement Data Revenues 1,282 1,605 2,070 2,131 1,731
Interest expense 599 728 946 1,022 898 Provision for doubtful accounts, net of recoveries 475 661 855 811 565 Income tax provision 64 70 87 99 71
Extraordinary charge net of taxes 22 - - - -
Net income 115 138 174 191 190
Balance Sheet Data
Accounts receivable 12,968 11,699 12,220 13,068 10,733
Reserve for doubtful accounts (542) (603) (731) (719) (550)
Total assets 14,943 13,631 14,127 14,222 12,610
Short-term debt 9,738 7,581 7,918 7,450 5,506
Current portion of long-term debt 692 969 768 823 771
Long-term debt 1,776 2,303 3,136 3,403 3,795
Shareholder's equity 1,662 1,672 1,784 1,610 1,422
Dividends
Cash Dividends 125 250 - - -
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Liquidity and Capital Resources
Credco's receivables portfolio consists of charge card receivables, participation interests in charge card receivables and extended payment plan receivables purchased without recourse from American Express Travel Related Services Company, Inc. and certain of its subsidiaries ("TRS") throughout the world. At December 31, 1993 and 1992, respectively, Credco owned $11.8 billion and $10.6 billion of charge card receivables and participations in charge card receivables, representing 91.2 percent and 90.4 percent of the total receivables owned, and $1.1 billion of extended payment plan receivables, representing 8.8 percent and 9.6 percent of the total receivables owned.
At December 31, 1993 and 1992, $2 billion of variable rate loans made to American Express Centurion Bank ("Centurion Bank") were outstanding, which are secured by Optima receivables owned by Centurion Bank. The loan agreements require Centurion Bank to maintain, as collateral, Optima receivables equal to the outstanding loan balance plus an amount equal to three times the receivable reserve as applicable to such Optima receivables.
Credco's assets are financed through a combination of short-term debt, long- term senior notes, equity capital and retained earnings. Daily funding requirements are met primarily by the sale of commercial paper. Credco has readily sold the volume of commercial paper necessary to meet its funding needs as well as to cover the daily maturities of commercial paper issued. The average amount of commercial paper outstanding was $8.7 billion for 1993 and $7.7 billion for 1992.
An alternate source of borrowing consists of committed credit line facilities. The aggregate commitment of these facilities is generally maintained at 50 percent of short-term debt, net of short-term investments and cash equivalents. At December 31, 1993 and 1992, Credco, through its wholly-owned subsidiary, American Express Overseas Credit Corporation Limited ("AEOCC"), had outstanding borrowings of $58.4 million and $9.7 million, respectively, under these committed lines of credit. In addition, Credco, through AEOCC, had short-term borrowings under uncommitted lines of credit totalling $65 million and $37.2 million at December 31, 1993 and 1992, respectively.
During 1993, Credco issued $606 million of medium- and long-term debt. The proceeds were used to reduce short-term debt incurred primarily in connection with the purchase of Cardmember receivables. During 1993, 1992 and 1991, the average long-term debt outstanding was $2.8 billion, $3.7 billion and $4.0 billion, respectively. At December 31, 1993, Credco had $810 million of medium- and long-term debt which may be issued under shelf registrations filed with the Securities and Exchange Commission.
Credco has realigned its long-term debt financing strategy to better match its its liabilities with its assets. In connection with this realigned strategy, during 1993 Credco reduced its high coupon long-term debt through the defeasance of $498 million of long-term debt and the retirement of an additional $153.8 million of long-term debt through a series of open market purchases. These transactions resulted in an extraordinary charge net of income tax, of $22 million. In addition, Credco canceled an interest rate swaption resulting in additional interest expense of $13 million.
Credco paid dividends to TRS of $125 million and $250 million in December, 1993 and 1992, respectively.
Results of Operations
Credco purchases Cardmember receivables without recourse from TRS. Non-interest-bearing Cardmember receivables are purchased at face amount less a specified discount agreed upon from time to time, and interest-bearing Cardmember receivables are purchased at face amount. Non-interest-bearing receivables are purchased under Receivables Agreements that generally provide that the discount rate shall not be lower than a rate that yields earnings of at least 1.25 times fixed charges on an annual basis. The ratio of earnings to fixed charges was 1.34, 1.29 and 1.28 in 1993, 1992 and 1991, respectively. The ratio of earnings to fixed charges in 1993 calculated in accordance with the Receivables Agreements after the impact of the extraordinary charge was 1.28. The Receivables Agreements also provide that consideration will be given from time to time to revising the discount rate applicable to purchases of new receivables to reflect changes in money market interest rates or significant changes in the collectibility of receivables. Pretax income depends primarily on the volume of Cardmember receivables purchased, the discount rates applicable thereto, the relationship of total discount to Credco's interest expense and the collectibility of the receivables purchased. The average life of Cardmember receivables was 43 days for each of the years ended December 31, 1993, 1992 and 1991.
During 1993 and 1992 Credco sold participation interests in a portion of its receivables to an affiliate. These transactions were partly responsible for the decreased revenues from purchased Cardmember receivables which was offset by decreased interest expense and provision for doubtful accounts.
Credco's operating results for the year ended December 31, 1993 include a $6 million one-time benefit from the change in the U.S. federal income tax rate (from 34 percent to 35 percent) in Credco's deferred tax assets.
The following is an analysis of the (decrease) increase in key revenue and expense accounts (in millions): - ----------------------------------------------------------------------------- 1993 1992 1991 - ----------------------------------------------------------------------------- Revenue earned from purchased accounts receivable-changes attributable to: Volume of receivables purchased $ 24 $ (89) $ (50) Discount rate (334) (333) (29) - ----------------------------------------------------------------------------- Total $(310) $(422) $ (79) - ----------------------------------------------------------------------------- Interest income from affiliates-changes attributable to: Average loan $ (7) $ 19 $ 28 Interest rates (14) (51) (49) - ----------------------------------------------------------------------------- Total $ (21) $ (32) $ (21) - ----------------------------------------------------------------------------- Interest income from investments-changes attributable to: Average investments $ 14 $ 34 $ 65 Interest rates (11) (40) (27) - ----------------------------------------------------------------------------- Total $ 3 $ (6) $ 38 - ----------------------------------------------------------------------------- Interest expense-changes attributable to: Average debt $ 24 $ 1 $ 88 Interest rates (153) (219) (164) - ----------------------------------------------------------------------------- Total $(129) $(218) $ (76) - ----------------------------------------------------------------------------- Provision for doubtful accounts-changes attributable to: Volume of receivables purchased $ 9 $ (57) $ (27) Provision rates and volume of recoveries (195) (137) 71 - ----------------------------------------------------------------------------- Total $(186) $(194) $ 44 - -----------------------------------------------------------------------------
Item 8. | 4969 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The Selected Eleven-Year Financial Data in the 1993 Annual Report to Shareholders provides the required data, and is hereby incorporated by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information presented under Management's Discussion and Analysis of the 1993 Annual Report to Shareholders is hereby incorporated by reference.
ITEM 8. | 91767 | 1993 |
ITEM 6 SELECTED CONSOLIDATED FINANCIAL INFORMATION
The following table summarizes selected consolidated financial information and should be read in conjunction with the Consolidated Financial Statements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". CONSOLIDATED INCOME STATEMENT DATA (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED BALANCE SHEET DATA (IN THOUSANDS)
ITEM 7 | ITEM 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
On June 19, 1992, the Company completed a transaction with Selex, which resulted in a change in control of the Company. Under the transaction, Selex loaned the Company $3,000,000 collateralized by a first mortgage on certain of the Company's property in its St. Augustine Shores, Florida community (the "First Selex Loan"). The First Selex Loan initially bears interest at the rate of 10% per annum with a term of four years and payment of interest deferred for the first 18 months. Accrued interest due under the First Selex Loan in the amount of $604,312 (including $463,562 due December 31, 1993) was unpaid and in default as of August 31, 1994.
In conjunction with the First Selex Loan: (i) Empire sold Selex its 2,220,066 shares of the Company's Common Stock and assigned Selex its $1,000,000 Note from the Company, with $225,000 of interest accrued thereon; (ii) Maurice A. Halperin, Chairman of the Board of Empire and former Chairman of the Board of the Company, forgave payment of the $200,000 salary due him for the period of April, 1990 through April, 1991, which was in arrears; and (iii) certain changes occurred in the composition of the Company's Board of Directors. Namely, the six directors serving on the Company's Board who were previously designated by Empire resigned and four Selex designees (Messrs. Marcellus H.B. Muyres, Antony Gram, Cornelis van de Peppel and Cornelis L.J.J. Zwaans) were elected to serve as directors in their stead. Marcellus H.B. Muyres was appointed Chairman of the Board and Chief Executive Officer of the Company. These directors, as well as Leonardus G.M. Nipshagen, a Selex designee, were then elected as directors at the Company's 1992 Annual Meeting and re-elected at the Company's 1993 Annual Meeting.
As part of the Selex transaction, Selex was granted an option, approved by the holders of a majority of the outstanding shares of the Company's Common Stock at the Company's 1992 Annual Meeting, to convert the Selex Loan, or any portion thereof, into a maximum of 850,000 shares of the Company's Common Stock at a per share conversion price equal to the greater of (i) $1.25 or (ii) 95% of the market price of the Company's Common Stock at the time of conversion, but in no event greater than $4.50 per share (the "Option"). However, on September 14, 1992, Selex formally waived and relinquished its right to exercise the Option as to 250,000 shares of the Company's Common Stock to enable the Company to settle certain litigation involving the Company through the issuance of approximately 250,000 shares of the Company's Common Stock to the claimants, without jeopardizing the utilization of the Company's net operating loss carryforward. On February 17, 1994, Selex exercised the remaining full 600,000 share Option at a conversion price of $1.90 per share, such that $1,140,000 in principal was repaid under the First Selex Loan through such conversion. As a consequence of such conversion, Selex holds 2,820,066 shares of the Company's Common Stock (43.1% of the outstanding shares of Common Stock of the Company based upon the number of shares of the Company's Common Stock outstanding as of March 18, 1994.
Pursuant to the Selex transaction, $1,000,000 of the proceeds from the First Selex Loan was used by the Company to acquire certain commercial and multi-family properties at the Company's St. Augustine Shores community at their net appraised value, from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres. Namely, (i) $416,000 was used to acquire 48 undeveloped condominium units (twelve 4 unit building sites) and 4 completed (and rented) condominium units from Conquistador, in which Messrs. Zwaans and Muyres serve as directors, as well as President and Secretary/Treasurer, respectively; (ii) $485,000 was used to acquire 4 commercial lots from Swan, in which Messrs. Zwaans and Muyres also serve as directors, as well as President and Secretary, respectively; and (iii) approximately $99,000 was used to reacquire, from Mr. Muyres, all of his rights, title and interest in that certain contract with the Company for the purchase of a commercial tract in St. Augustine Shores, Florida. None of the commercial land and multi-family property acquired by the Company from Mr. Muyres and certain entities affiliated with Messrs. Zwaans and Muyres collateralizes the First Selex Loan. In March, 1994, Conquistador exercised its right to repurchase certain of the multi-family property
from the Company (which right had been granted in connection with the June, 1992 transaction) at a price of $312,000, of which $260,000 was paid in cash to the Company and $52,000 was applied to reduce interest due to Selex under the Third Selex Loan.
In December, 1992, Mr. Gram, a director of the Company and beneficial owner of the Common Stock of the Company held by Selex, acquired all of the Company's outstanding bank debt and then assigned same to Yasawa, of which Mr. Gram is also the beneficial owner. Yasawa simultaneously completed a series of transactions with the Company which involved the transfer of certain assets to Yasawa or its affiliated companies, the acquisition by Yasawa of 289,637 shares of the Company's Common Stock through the exercise of warrants previously held by the banks, the provision of a $1,500,000 line of credit to the Company and the restructuring of the remaining debt as a $5,106,000 Yasawa Loan. Principal repayments aggregating $341,000 were made in 1993 and 1994 to reduce the Yasawa Loan to $4,765,000. On April 30, 1993, Selex loaned the Company an additional amount of $1,000,000 pursuant to the Second Selex Loan and since July 1, 1993 made further loans to the Company aggregating $4,400,000 under the Third Selex Loan. Principal of $33,000 had been repaid under the Second Selex Loan through August 31, 1994. As of August 31, 1994, Yasawa has loaned the Company an additional sum of $l,200,000 pursuant to the Second Yasawa Loan. As a consequence of these transactions, the Company had loans outstanding from Selex, Yasawa and their affiliates on August 31, 1994 in the aggregate amount of approximately $17,976,000, including interest. The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company. See Note 5 to Consolidated Financial Statements.
The Company has stated in previous filings with the Commission that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As stated above, during the last six months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements.
On March 10, 1994, the Company was advised that Selex filed Amendment No. 2 dated February 17, 1994 to its Schedule 13D (the "Amendment") with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates, were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.
Inasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its escrow obligations to the Division pursuant to the Company's 1992 Consent Order, its obligation under its lease for its corporate offices and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid certain real estate taxes which are approximately $1,549,000 at August 31, 1994 and is also subject to certain pending litigation by former employees and others, which may adversely affect the financial condition of the Company. See "Legal Proceedings."
The Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of
the Company. There can be no assurance, however, that any such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including but not limited to filing under the federal bankruptcy laws. Alternatively, the Company could be subject to the filing of an involuntary bankruptcy proceeding in the event it is unable to resolve and settle pending litigation, satisfy settlement commitments and other unpaid creditor claims. See "Business: Recent Developments", "Legal Proceedings" and Notes 1, 5 and 8 to Consolidated Financial Statements.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1993 AND DECEMBER 25, 1992
REVENUES
Total revenues were $12,099,000 for 1993 compared to $12,217,000 for 1992. Included in 1992 revenues is a third quarter gain of $448,000 from the sale of the administration building at the Company's Citrus Springs community.
Gross land sales were $3,170,000 for 1993 versus $2,515,000 for 1992. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) increased to $2,432,000 for 1993 from $2,092,000 for 1992. The modest increase in sales reflects the introduction of the Company's marketing program which was delayed until the third quarter of the year.
Retail land sales increased to $3,057,000 from $2,289,000, a 33.5% increase. The Company had a 90.6% increase in retail land sales contracts entered into in 1993 over 1992. This increase was due to the third quarter introduction of the Company's marketing program and reflects increased spending on advertising and promotional programs to strengthen the Company's marketing organization, rebuild its retail land sales business and re-enter the single-family home business.
Bulk land sales were $113,000 in 1993 as compared to bulk land sales of $226,000 in 1992. In light of the Company's diminished bulk land sales inventory and the properties transferred to the Company's lenders on October 11, 1991, it is anticipated that 1994 will also produce a low volume of bulk land sales. See "Liquidity and Capital Resources: Mortgages and Similar Debt".
The Company re-entered the single-family housing business in December, 1992. Since revenues are not recognized from housing sales until the completion of construction and passage of title, no significant housing revenues will be recognized in 1994. The Company recognized revenues from housing sales of $344,000 for 1993, primarily during the fourth quarter of the year, and had a backlog of housing sales of $899,000 as of December 31, 1993.
The following table reflects the Company's real estate product mix for 1993 and 1992 (in thousands):
- - -------------------- * New retail land sales contracts entered into, including deposit sales on which the Company has received less than 20% of the sales price, net of cancellations, for the years ended December 31, 1993 and December 25, 1992 were $4,106,000 and $2,154,000, respectively. Such contracts are not included in retail land sales until the applicable rescission period has expired and the Company has received payments totalling 20% of the contract sales prices. See Note 1 to the Consolidated Financial Statements.
Improvement revenues result from the recognition of revenue deferred from prior period sales. Recognition occurs as development work proceeds on previously sold property. Improvement revenues totalled $4,725,000 in 1993 as compared to $2,404,000 for 1992. The increase was due to the Company's resumption of development work in the third quarter of 1992.
Interest income was $1,197,000 for 1993 compared to $3,584,000 for 1992. This decrease is the result of lower contracts receivable balances.
Other revenues were $3,401,000 for 1993 compared to $4,137,000 in 1992. Included in other revenues for 1992 is the previously mentioned gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community, as well as revenues from the Company's Sunny Hills golf and country club which was sold in the first quarter of 1993.
COSTS AND EXPENSES
Costs and expenses were $20,871,000 for 1993 compared to $18,935,000 in 1992. Cost of sales totalled $6,441,000 for 1993 versus $4,605,000 for 1992, primarily due to the resumption of development work in the third quarter of 1992. Gross profit margins decreased from 46.7% to 40.9%
The 1993 results include a provision for contract cancellations of $2,400,000. Included in the provision is $1,400,000 for contracts sold in prior years to third parties which the Company is obligated to repurchase.
Commissions, advertising and other selling expenses totalled $6,008,000 for 1993 versus $3,917,000 for 1992. Advertising and promotional expenditures increased from $580,000 in 1992 to $1,521,000 in 1993, reflecting the Company's implementation of its marketing program.
General and administrative expenses were $3,790,000 in 1993 versus $5,844,000 for 1992. General and administrative expenses have decreased primarily due to overhead reductions, as part of the Company's efforts to stabilize its liquidity situation.
Interest expense was $1,257,000 for 1993, as compared to $3,356,000 for 1992, or a 62.5% decrease. Total interest costs (including capitalized interest) were $1,421,000 and $3,456,000 for 1993 and 1992, respectively. The decrease in interest cost is due to lower debt balances.
NET INCOME
The Company reported a net loss of $8,772,000 for 1993, compared to a net income of $7,336,000 for 1992. The 1993 results include a provision for contract cancellations of $2,400,000. The 1992 results include a gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community, as well as a $10,161,000 extraordinary gain from debt restructuring and a $3,983,000 extraordinary gain from the settlement related to the Company's Marco refund obligation.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 25, 1992 AND DECEMBER 27, 1991
REVENUES
Total revenues were $12,217,000 for 1992 compared to $10,784,000 for 1991. Included in 1992 revenues is a third quarter gain of $448,000 from the sale of the administration building at the Company's Citrus Springs community.
Gross land sales were $2,515,000 for 1992 versus $1,539,000 for 1991. Net land sales (gross land sales less estimated uncollectible installment sales and contract valuation discount) increased to $2,092,000 for 1992 from $1,154,000 for 1991. Retail land sales contracts written increased $851,000 from $1,438,000 in 1991 to $2,289,000 in 1992, a 60% increase. The increase in sales is primarily due to the resale, during the first quarter of 1992, of property which was the subject of a previously cancelled contract; however, sales for the year reflected the economic slowdown and the Company's inability to bolster marketing efforts due to its liquidity situation. Bulk land sales were $226,000 in 1992 as compared to bulk land sales of $101,000 in 1991. See "Liquidity and Capital Resources: Mortgages and Similar Debt".
Although the Company re-entered the single-family housing business in December, 1992, since revenues are not recognized from housing sales until the completion of construction and passage of title, no housing revenues were expected to be recognized until late 1993.
The following table reflects the Company's real estate product mix for 1992 and 1991 (in thousands):
Improvement revenues result from the recognition of revenue deferred from prior period sales. Recognition occurs as development work proceeds on previously sold property. Improvement revenues totalled $2,404,000 in 1992 as compared to $-0- for 1991. The increase was due to the Company's resumption of development work in the third quarter of 1992.
Interest income was $3,584,000 for 1992 compared to $5,270,000 for 1991. This decrease is the result of lower contracts receivable balances.
Other revenues were $4,137,000 for 1992 compared to $4,240,000 in 1991. Included in other revenues is the previously mentioned gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community.
COSTS AND EXPENSES
Costs and expenses were $18,935,000 for 1992 compared to $30,313,000 in 1991. Included in costs and expenses for 1991 was a provision of $8,900,000 caused by an addition to the allowance for uncollectible contracts for previously recognized sales of $12,200,000. Cost of sales totalled $4,605,000 for 1992 versus $2,599,000 for 1991, primarily due to the resumption of development work in the third quarter of 1992. Gross profit margins decreased from 53.1% to 46.7%.
Commissions, advertising and other selling expenses totalled $3,917,000 for 1992 versus $4,107,000 for 1991. Advertising expenditures increased from $259,000 in 1991 to $580,000 in 1992, reflecting the Company's efforts to stimulate sales and implement its marketing program. Additional working capital was expected to be allocated during the year for advertising and promotional purposes to strengthen the Company's marketing organization, rebuild its retail land sales business and re-enter the single-family home business.
General and administrative expenses were $5,844,000 in 1992 versus $6,165,000 for 1991. General and administrative expenses decreased primarily due to overhead reductions, as part of the Company's efforts to stabilize its liquidity situation.
Interest expense was $3,356,000 for 1992, as compared to $6,896,000 for 1991, or a 51% decrease. Total interest costs (including capitalized interest) were $3,456,000 and $6,896,000 for 1992 and 1991, respectively. The decrease in interest cost is due to substantially lower debt balances, as well as lower prime rates of interest charged by the Company's lenders.
NET INCOME
The Company reported net income of $7,336,000 for 1992, compared to a net loss of $26,629,000 for 1991. The 1992 results include a gain of $448,000 on the sale of the administration building at the Company's Citrus Springs community, as well as a $10,161,000 extraordinary gain from debt restructuring and a $3,983,000 extraordinary gain from the settlement related to the Company's Marco refund obligation. The 1991 results included a provision of approximately $8,900,000 related to a $12,200,000 addition to the allowance for uncollectible contracts, as well as a $7,100,000 extraordinary loss from debt restructuring related to the Sixth Restatement. Exclusive of the extraordinary items, the loss from operations for 1992 was $6,808,000, as compared to the prior year's loss of $19,529,000.
REGULATORY DEVELOPMENTS WHICH MAY AFFECT FUTURE OPERATIONS
In Florida, as in many growth areas, local governments have sought to limit or control population growth in their communities through restrictive zoning, density reduction, the imposition of impact fees and more stringent development requirements. Although the Company has taken such factors into consideration in its master plans, the increased regulation has lengthened the development process and added to development costs.
On a statewide level, the Florida Legislature adopted and implemented the Florida Growth Management Act of 1985 (the "Act") to aid local governments efforts to discourage uncontrolled growth in Florida. The Act precludes the issuance of development orders or permits if public facilities such as transportation, water and sewer services will not be available concurrent with development. Development orders have been issued for, and development has commenced in, the Company's existing communities (with development being virtually completed in certain of these communities). Thus, such communities are less likely to be affected by the new growth management policies than future communities. Any future communities developed by the Company will be strongly impacted by new growth management policies. Since the Act and its implications are consistently being re-examined by the State, together with local governments and various state and local governmental agencies, the Company cannot further predict the timing or the effect of new growth management policies, but anticipates that such policies may increase the Company's permitting and development costs.
In addition to Florida, other jurisdictions in which the Company's properties are offered for sale have recently strengthened, or are considering strengthening, their regulation of subdividers and subdivided lands in order to provide further assurances to the public, particularly given the adverse publicity surrounding the industry which existed in 1990. The Company has attempted to take appropriate steps to modify its marketing programs and registration applications in the face of such increased regulation, but has incurred additional costs and delays in the marketing of certain of its properties in certain states and countries. For example, the Company has complied with regulations of certain states which require that the Company sell its properties to residents of those states pursuant to a deed and mortgage transaction, regardless of the amount of the down payment. The Company intends to continue to monitor any changes in statutes or regulations affecting, or anticipated to affect, the sale of its properties and intends to take all necessary and reasonable action to assure that its properties and its proposed marketing programs are in compliance with such regulations, but there can be no assurance that the Company will be able to timely comply with all regulatory changes in all jurisdictions in which the Company's properties are presently offered for sale to the public.
LIQUIDITY AND CAPITAL RESOURCES
MORTGAGES AND SIMILAR DEBT
Indebtedness under various purchase money mortgages and loan agreements is collateralized by substantially all of the Company's assets, including stock of certain wholly-owned subsidiaries.
The following table presents information with respect to mortgages and similar debt (in thousands):
Included in Mortgage Notes Payable is the $3,000,000 First Selex Loan ($1,860,000 as of August 31, 1994), the $1,000,000 Second Selex Loan ($967,000 as of August 31, 1994) the $4,384,000 Third Selex Loan and the
$4,900,000 Yasawa Loan ($4,765,000 as of August 31, 1994). Other loans include the $1,000,000 Empire note and the $1,500,000 Scafholding Loan.
These mortgage notes payable and other loans are in default as of August 31, 1994 due to the non-payment of interest and principal. The lenders have not taken any action as a result of these defaults.
On June 19, 1992, the Company completed a transaction with Selex whereby, among other things, Selex loaned the Company $3,000,000 (the First Selex Loan). The First Selex Loan is collateralized by a first mortgage on certain of the Company's property in its St. Augustine Shores, Florida community. The Loan matures on June 15, 1996 and provides for principal to be repaid at 50% of the net proceeds per lot for lots requiring release from the mortgage, with the entire unpaid balance becoming due and payable at the end of the four year term. It initially bears interest at the rate of 10% per annum, with payment of interest deferred for the initial eighteen months of the Loan and interest payments due quarterly thereafter. On February 17, 1994, principal in the amount of $1,140,000 was repaid under the First Selex Loan when Selex exercised its previously described Option to convert a portion of the Loan into 600,000 shares of the Company's Common Stock at a conversion price of $1.90 per share. Accrued interest in the amount of $604,300 (including $463,600 due December 31, 1993) was unpaid and in default under the First Selex Loan as of August 31, 1994.
The Company had defaulted on its bank debt in the third quarter of 1990, and was engaged in negotiating the repayment and restructuring of such debt through 1991 and the first half of 1992. As of December 27, 1991, the Company's bank debt had been reduced by the assignment of mortgages receivables and, on October 11, 1991, the transfer of certain properties to its principal lending banks pursuant to a Conveyance Agreement with such lenders. The Conveyance Agreement not only provided for the partial repayment of the bank debt, but also encompassed an agreement in principle providing for the restructuring and repayment of the remaining bank debt.
On June 18, 1992, the Company completed the restructuring of its bank debt by entering into the Sixth Amended and Restated Credit and Security Agreement (the "Sixth Restatement") with its lenders. The terms of the Sixth Restatement provided for the Company's remaining debt in the principal amount of approximately $25,300,000 to be repaid by June 30, 1997, with specified interim repayments and benchmarks to be achieved. Among other things, the Sixth Restatement provided for: (i) interest to accrue on the remaining debt at Citibank's alternate base rate ("ABR") plus 4% per annum, subject to a minimum interest rate of 11% per annum and a maximum interest rate of 14% per annum, with no interest payments due until June 30, 1996; (ii) accrued, but unpaid interest on $10,000,000 of the restructured debt to be forgiven provided that the principal balance outstanding on the restructured debt as of June 30, 1996 was less than $9,000,000; and (iii) the issuance to the lenders of warrants to acquire up to 277,387 shares of the Company's Common Stock at a price of $1.00 per share.
In conjunction with the completion of the Sixth Restatement, the lenders released or subordinated their lien on certain assets of the Company, to enable the Company to complete the First Selex Loan, to complete the $13,500,000 sale of contracts receivable described below, to enter into the 1992 Consent Order with the Division, and to secure working capital needed to pay real estate taxes which were, at the time, delinquent and meet its customer obligations for improvement work at certain of the Company's communities. During the third quarter of 1992, the lenders also released their lien on certain other contracts receivable to allow the Company to complete a sale of such receivables, which generated $600,000 in proceeds. These proceeds were, in turn, paid to the lenders, with the lenders allowing the Company $1,000,000 in debt reduction credit, and resulting in an extraordinary gain of $400,000.
During the 1991 second quarter, the Company incurred extraordinary expenses of $3,500,000 for debt restructuring, based upon the transfer value of the assets involved in the first phase of its debt restructuring. During the fourth quarter of 1991, the Company provided for an additional $3,600,000 of extraordinary expenses for debt restructuring based upon the Company's assessment of the ultimate costs that would result from the
restructuring of its debt pursuant to the Sixth Restatement. The fourth quarter addition included the anticipated professional fees, bank charges and other costs related to the Sixth Restatement, as well as the loss on the sale of contracts receivable discussed below. The completion of the Sixth Restatement was dependent upon the completion of the sale of contracts receivable; therefore, the loss on such sale was included as an extraordinary item.
On December 2, 1992 the Company entered into various agreements relating to certain of its assets and the restructuring of its debt with Yasawa. The consummation of these agreements was conditioned upon the acquisition by Mr. Gram of the bank debt under the Sixth Restatement (the "Bank Loan") described above. On December 4, 1992, Gram acquired the Bank Loan of approximately $25,150,000 (including interest and fees) for a price of $10,750,000, as well as the warrants which the lenders held. Immediately thereafter, Gram transferred all of his interest in the Bank Loan, including the warrants, to Yasawa. See Notes 5 and 10 to Consolidated Financial Statements.
On December 11, 1992 the Company consummated the December 2, 1992 agreements with Yasawa. Under these agreements, Yasawa, its affiliates and the Company agreed as follows: (i) the Company sold certain property at its Citrus Springs community to an affiliate of Yasawa in exchange for approximately $6,500,000 of debt reduction credit; (ii) an affiliate of Yasawa and the Company entered into a joint venture agreement with respect to the Citrus Springs property, providing for the Company to market such property and receive an administration fee from the venture (in March, 1994, the Company and the affiliate agreed to terminate the venture); (iii) the Company sold certain contracts receivable at face value to an affiliate of Yasawa for debt reduction credit of approximately $10,800,000; (iv) the Company sold the Marco Shores Country Club and Golf Course to an affiliate of Yasawa for an aggregate sales price of $5,500,000, with the affiliate assuming an existing first mortgage of approximately $1,100,000 and the Company receiving debt reduction credit of $2,400,000, such that the Company obtained cash proceeds from this transaction of $2,000,000, which amount was used for working capital; (v) an affiliate of Yasawa agreed to lease the Marco Shores Country Club and Golf Course to the Company for a period of approximately one year; (vi) an affiliate of Yasawa and the Company agreed to amend the terms of the warrants to increase the number of shares issuable upon their exercise from 277,387 shares to 289,637 shares and to adjust the exercise price to an aggregate of approximately $314,000; (vii) Yasawa exercised the warrants in exchange for debt reduction credit of approximately $314,000; (viii) Yasawa released certain collateral held for the Bank Loan; (ix) an affiliate of Yasawa agreed to make an additional loan of up to $1,500,000 to the Company, thus providing the Company with a future line of credit (all of which was drawn and outstanding as of August 31, 1994); and (x) Yasawa agreed to restructure the payment terms of the remaining $5,106,000 of the Bank Loan as a loan from Yasawa.
The Yasawa Loan bears interest at the rate of 11% per annum, with payment of interest deferred until December 31, 1993, at which time only accrued interest became payable. Commencing January 31, 1994, principal and interest became payable monthly, with all unpaid principal and accrued interest being due and payable on December 31, 1997. A portion of the proceeds from a March, 1993 sale of contracts receivable was applied to reduce the Yasawa Loan to $4,900,000 during the first quarter of 1993 and the assignment of a mortgage receivable to Yasawa reduced the Yasawa Loan to $4,764,000 as of August 31, 1994. Accrued interest due under the Yasawa Loan in the amount of $355,196 was unpaid and in default as of August 31, 1994.
In February, 1994, Yasawa loaned the Company an additional amount of $437,500 at an interest rate of 8% per annum (the "Second Yasawa Loan"). As of August 31, 1994, a total of $1,200,000 had been advanced under the Loan.
On April 30, 1993 Selex loaned the Company an additional $1,000,000 collateralized by a first mortgage on certain of the Company's property in its Marion Oaks, Florida community (the "Second Selex Loan"). The Second Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. The Second Selex Loan provides for principal to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994
to be due and payable on April 30, 1994. Although Selex had certain conversion rights under the Second Selex Loan in the event the Company sold any Common Stock or Preferred Stock prior to payment in full of all amounts due to Selex under the Second Selex Loan, such rights were voided as of December 31, 1993 since the regulations set forth in proposed Treasury Decision CO-18-90 relative to Section 382 of the Internal Revenue Code were not adopted by such date. As of August 31, 1994, $33,000 in principal had been repaid under the Second Selex Loan, but accrued interest of $93,344 due under the Loan as of August 31, 1993 remained unpaid and in default.
From July 9, 1993 through December 31, 1993, Selex loaned the Company an additional $4,400,000 collateralized by a second mortgage on certain of the Company's property on which Selex and/or Yasawa hold a first mortgage pursuant to a Loan Agreement dated July 14, 1993 and amendments thereto (the "Third Selex Loan"). The Third Selex Loan bears interest at 11% per annum, with interest deferred until December 31, 1993. Principal is to be repaid at $3,000 per lot for lots requiring release from the mortgage, with the entire unpaid principal balance and interest accruing from January 1, 1994 to April 30, 1994 becoming due and payable on April 30, 1994. As of August 31, 1994 accrued interest of $466,837 due under the Third Selex Loan was unpaid and in default.
Interest due to Selex, Yasawa and their affiliates in the aggregate amount of $2,300,000 remained unpaid and in default as of August 31, 1994. From January 1, 1994 through August 31, 1994, $24,000 in principal was repaid under the Second Selex Loan and $1,140,000 in principal was repaid under the First Selex Loan through the exercise of the above described Option. After giving effect to such repayments of principal, the Company had loans outstanding from Selex, Yasawa and their affiliates on August 31, 1994 in the amount of approximately $17,976,000 including interest, of which approximately $9,867,000 is owed to Selex, (10% per annum on the First Selex Loan, 11% per annum on the Second and Third Selex Loans and 12% per annum on the $1,000,000 Empire Note assigned to Selex); approximately $6,349,000 is owed to Yasawa, including accrued and unpaid interest of approximately $384,500 (11% per annum on the Yasawa Loan and 8% per annum on the Second Yasawa Loan); and approximately $1,759,000 is owed to an affiliate of Yasawa, including accrued and unpaid interest of approximately $259,500 (12% per annum). The loans from Selex, Yasawa and their affiliates are secured by substantially all of the assets of the Company.
On March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D filed with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.
The Company has stated in previous filings with the Commission that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As stated above, during the last six months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program could not be realized in 1993 and the Company was unable to secure financing in 1994 to meet its ongoing working capital requirements.
Inasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its escrow obligations to the Division pursuant to the
Company's 1992 Consent Order, its obligation under its lease for its corporate offices and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid certain real estate taxes which aggregate approximately $1,549,000 as of August 31, 1994 and is also subject to certain pending litigation from former employees and others, which may adversely affect the financial condition of the Company. See "Legal Proceedings."
The Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that any such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position including but not limited to protection under federal bankruptcy laws. Alternatively, the Company could be subject to the filing of an involuntary bankruptcy proceeding in the event it is unable to resolve and settle pending litigation, satisfy settlement commitments and other unpaid creditor claims. See "Business: Recent Developments", "Legal Proceedings" and Notes 1, 5 and 8 to Consolidated Financial Statements.
CONTRACTS AND MORTGAGES RECEIVABLE SALES
In December, 1992, as described above, the Company sold $10,800,000 of contracts and mortgages receivable to an affiliate of Yasawa at face value, applying the proceeds therefrom to reduce the Bank Loan acquired by Yasawa.
In June, 1992, the Company completed a new financing through a $13,500,000 sale of contracts and mortgages receivable which generated approximately $8,000,000 in net proceeds to the Company and the creation of a holdback account in the amount of $3,100,000. The anticipated costs of this transaction were included in the extraordinary loss from debt restructuring for 1991. In conjunction with this sale, the February, 1990 sale described below and certain prior sales of receivables, the Company granted the purchaser a security interest in certain additional contracts receivable of approximately $2,700,000 and conveyed all of its rights, title and interest in the property underlying such contracts to a collateral trustee. Upon compliance with the conditions of the agreement with the purchaser, funds from the holdback account and property held by the collateral trustee will be released to the Company.
In February, 1990, the Company completed a sale of $17,000,000 of receivables, generating approximately $13,900,000 in net proceeds and a loss of approximately $600,000. This transaction, as well as the June, 1992 sale described above, among other things, requires that the Company replace or repurchase any receivable that becomes 90 days delinquent upon the request of the purchaser. Such requirement can be satisfied from contracts in which the purchaser holds a security interest (approximately $1,200,000 as of August 31, 1993). The Company believes that it has established adequate reserves and guarantees in the event such replacement or repurchase becomes necessary.
In addition to the above, the Company transferred $1,600,000 in contracts and mortgages receivable in March, 1993, to a third party generating $1,100,000 in proceeds to the Company and the creation of a holdback account in the amount $150,000.
The Company was the guarantor of approximately $29,265,000 of contracts receivable sold or transferred as of December 31, 1993 and had $1,992,000 on deposit with the purchaser of the receivables as security to assure collectibility as of such date. The Company has been in compliance with all receivable transactions since the consummation of the June, 1992 sale.
The Company anticipates that it will be necessary to complete additional sales and financings of a portion of its receivables in 1994 and 1995. There can be no assurance, however, that such sales and/or financings can be accomplished.
OTHER OBLIGATIONS
As a result of the delays in completing the land improvements to certain property sold in certain of its Central and North Florida communities, the Company fell behind in meeting its contractual obligations to its customers. In connection with these delays, the Company, in February, 1980, entered into a Consent Order with the Division which provided a program for notifying affected customers. The Consent Order, which was restated and amended, provided a program for notifying affected customers of the anticipated delays in the completion of improvements (or, in the case of purchasers of unbuildable lots in certain areas of the Company's Sunny Hills community, the transfer of development obligations to core growth areas of the community); various options which may be selected by affected purchasers; a schedule for completing certain improvements; and a deferral of the obligation to install water mains until requested by the purchaser. Under an agreement with Topeka, Topeka's utility companies have agreed to furnish utility service to the future residents of the Company's communities on substantially the same basis as such services were provided by the Company. The Consent Order also required the establishment of an improvement escrow account as assurance for completing such improvement obligations. In June, 1992, the Company entered into the 1992 Consent Order with the Division, which replaced and superseded the original Consent Order, as amended and restated. Among other things, the 1992 Consent Order consolidated the Company's development obligations and provided for a reduction in its required monthly escrow obligation to $175,000 from September, 1992 through December, 1993. Beginning January, 1994 and until development is completed or the 1992 Consent Order is amended, the Company is required to deposit $430,000 per month into the escrow account. To meet its current escrow and development obligations under the 1992 Consent Order, the Company is required to deposit into escrow $5,160,000 in 1994 and $3,519,000 in 1995. As part of the assurance program under the 1992 Consent Order, the Company and its lenders granted the Division a lien on certain contracts receivable (approximately $8,915,000 as of December 31, 1993) and future receivables. As previously stated, the Company is in default of its escrow obligations, and in accordance with the 1992 Consent Order, the collections on such receivables have been escrowed for the benefit of purchasers since March 1, 1994. At August 31, 1994, the amount collected on fully paid-for lots was approximately $1,340,000. Pursuant to the 1992 Consent Order, the Company has limited the sale of single-family lots to lots which front on a paved street and are ready for immediate building. Because of the Company's default, the Division could also exercise other available remedies under the 1992 Consent Order, which remedies entitle the Division, among other things, to halt all sales of registered property.
As of December 31, 1993, the Company had estimated development obligations of approximately $2,825,000 on sold property, an estimated liability to provide title insurance costing $951,000 and an estimated cost of street maintenance, prior to assumption of such obligations by local governments, of $3,852,000, all of which are included in deferred revenue. The total cost, including the previously mentioned obligations, to complete improvements at December 31, 1993 to lots subject to the 1992 Consent Order and to lots in the St. Augustine Shores community was estimated to be approximately $18,574,000. The Company has in escrow approximately $1,664,000 specifically for land improvements at certain of its Central and North Florida communities.
The Company's continuing liquidity problems have precluded the timely payment of the full amount of its 1992 and 1993 real estate taxes. The Company has paid real estate taxes on all properties sold on which it is solely obligated to pay real estate taxes and on all properties which are presently available for sale. On properties where customers have contractually assumed the obligation to pay into a tax escrow maintained by the Company, the Company has and will continue to pay real estate taxes as monies are collected from customers. Delinquent real estate taxes on certain of the Company's properties, none of which are presently being marketed, aggregated approximately $1,549,000 as of August 31, 1994.
The Company's corporate performance bonds to assure the completion of development at its St. Augustine Shores community expired in March and June, 1993. Such bonds cannot be renewed due to a change in the policy of the Board of County Commissioners of St. Johns County which precludes allowing any developer to secure the performance of development obligations by the issuance of corporate bonds. In the event that St. Johns County elects to undertake and complete such development work, the Company would be obligated with respect to 1,000 improved lots at St. Augustine Shores in the amount of approximately $6,200,000. The Company intends to submit an alternative assurance program for the completion of such development and improvements to the County for its approval.
On September 30, 1988, the Company entered into an agreement with Citrus County, Florida to establish the procedure for transferring final maintenance responsibilities for roads in the Company's Citrus Springs subdivision to Citrus County. The agreement obligated the Company to complete certain remedial work on previously completed improvements within the Citrus Springs subdivision by June 1, 1991. The Company was unable to complete this work by the specified date and is negotiating with Citrus County for the transfer of final maintenance responsibility for the roads to the County.
Following the consummation of the Sixth Restatement, the Company conveyed certain properties to the landlord in satisfaction of its outstanding lease obligations for its executive office building in Miami, Florida. The Company also entered into a modification of its lease agreement, providing for a reduction of its rental expenses through June 30, 1994, at which time the Company would have the option of acquiring the leased premises or reinstating the lease according to its original terms. Should the landlord sell the leased premises to a third party at any time that the lease, or any modification thereof, is in effect, then the lease with the Company would be cancelled. In December, 1993, the landlord filed suit against the Company alleging that the Company defaulted in its obligation to make rental payments under the lease and seeking to accelerate lease payments. See "Business: Recent Developments" and "Legal Proceedings".
The Company had placed certain properties in trust to meet its refund obligations to customers affected by the 1976 denial by the U.S. Army Corps of Engineers of permits to complete the development of the Company's Marco Island community and had provided in its financial statements for such obligations. Following the September, 1992 court approval of a settlement of certain class action litigation instituted by customers affected by the Marco permit denials, the Company, among other things, conveyed more than 120 acres of multi-family and commercial land that had been placed in trust to the trustee of the 809 member class, and listed 250,000 shares of restricted Common Stock of the Company to be issued to the class members. At December 31, 1993, $2,886,000 remained in the allowance for Marco permit costs, including $554,000 relating to interest accrued on such obligations. Based upon the Company's experience with affected customers, the Company believes that its total obligations to the remaining 1.3% of its affected customers will not materially exceed the amount provided for in its financial statements. See Note 9 to Consolidated Financial Statements.
LIQUIDITY
Since 1986, the Company has directed its marketing efforts to rebuilding retail land sales in an attempt to obtain a more stable income stream and achieve a balanced growth of retail land sales and bulk land sales. Retail land sales typically have a higher gross profit margin than bulk land sales and the contracts receivable generated from retail land sales provide a continuing source of income. However, retail land sales also have traditionally produced negative cash flow through the point of sale. This is because the marketing and selling expenses have generally been paid prior to or shortly after the point of sale, while the land is generally paid for in installments. The Company's ability to rebuild retail land sales has been substantially dependent on its ability to sell or otherwise finance contracts receivable and/or secure other financing sources to meet its cash requirements.
To alleviate the negative cash flow impact arising from retail land sales while attempting to rebuild its sales volume, the Company implemented several new marketing programs which, among other things, adjusted the method of commission payments and required larger down payments. However, the nationwide economic recession, which has been especially pronounced in the real estate industry, adverse publicity surrounding the industry which existed in 1990, the resulting, more stringent regulatory climate, and worldwide economic uncertainties have severely depressed retail land sales beginning in mid-1990 and continuing thereafter, resulting in a continuing liquidity crisis.
Because of this severe liquidity crisis, the Company ceased development work late in the third quarter of 1990 and did not resume development work until the third quarter of 1992. From September 29, 1990 through the fourth quarter of 1991, when the Company ceased selling undeveloped lots, sales of undeveloped lots were accounted for using the deposit method. Under this method, all payments were recorded as a customer deposit liability. In addition, because of the increasing trend in delinquencies during 1990, since the beginning of 1991, the Company has not recognized any sale until 20% of the contract sales price has been received. As a result, the reporting and recognition of revenues and profits on a portion of the Company's retail land sales contracts is being delayed. See Note 1 to Consolidated Financial Statements.
The continued economic recession and the increasing adverse effects of such recession on the Florida real estate industry not only resulted in the Company's sales remaining at depressed levels, but caused greater contract cancellations in 1991, particularly in the second half of the year, than were anticipated. Such cancellations required the Company to record an additional provision to its allowance for uncollectible sales of approximately $12,200,000 in the 1991 third quarter, impacting net income by approximately $8,900,000. While the Company is making every effort to reduce its cancellations, should this trend continue, the Company could be required to record additional provisions in the future.
The Company had defaulted on its bank debt in the third quarter of 1990, and was engaged in negotiating the repayment and restructuring of such debt through 1991 and the first half of 1992. On October 11, 1991, as described above, the Company completed the first phase of the restructuring of its bank debt by conveying to the lenders certain real estate assets which had been held for future development or bulk sales purposes, and on June 18, 1992, the Company finalized the restructuring of its remaining bank debt by entering into the Sixth Restatement.
In December, 1992, such bank debt was acquired by Mr. Gram and assigned to Yasawa. Through the sale of certain assets to Yasawa and its affiliates, including certain contracts receivable, and the exercise of the warrants by Yasawa, the Company was able to reduce such remaining debt from approximately $25,150,000 (including interest and fees) to approximately $5,106,000. During 1993, the Yasawa Loan was reduced to $4,900,000. The agreement with Yasawa also provided the Company with a future line of credit of $1,500,000, all of which was drawn and outstanding as of August 31, 1994. During 1993, Selex loaned the Company an additional $5,400,000 pursuant to the Second and Third Selex Loans, of which $5,351,000 was outstanding as of August 31, 1994, and Yasawa loaned the Company an additional $1,200,000 in 1994 pursuant to the Second Yasawa Loan. The loans from Selex, Yasawa and their affiliates are collateralized by substantially all of the Company's assets.
On March 10, 1994, the Company was advised that Selex filed an Amendment to its Schedule 13D with the Commission. In the Amendment, Selex reported that it, together with Yasawa and their affiliates, were uncertain as to whether they would provide any further funds to the Company. The Amendment further stated that Selex, Yasawa and their affiliates were seeking third parties to provide financing for the Company and that as part of any such transaction, they would be willing to sell or restructure all or a portion of their loans and Common Stock in the Company.
The Company has stated in previous filings with the Commission and elsewhere herein that the obtainment of additional funds to implement its marketing program and achieve the objectives of its business plan is essential
to enable the Company to maintain operations and continue as a going concern. Since December, 1992, the Company has been dependent on loans and advances from Selex, Yasawa and their affiliates in order to implement its marketing program and assist in meeting its working capital requirements. As previously stated, during the last six months of 1993, Selex, Yasawa and their affiliates loaned the Company an aggregate of $4,400,000 pursuant to Third Selex Loan. Funds advanced under the Third Selex Loan enabled the Company to commence implementation of the majority of its marketing program in the third quarter of 1993. The full benefits of the program were not realized in 1993 and the Company was unable to secure financing in 1994 to meet its working capital requirements.
Inasmuch as funding is not presently available to the Company from external sources and, as stated in their Amendment, Selex, Yasawa and their affiliates have not determined whether they will provide any further funds to the Company, the Company is facing a severe cash shortfall. As a consequence of its liquidity position, the Company has defaulted on certain obligations, including its previously described escrow obligations to the Division pursuant to the Company's 1992 Consent Order, its obligation under its lease for its corporate offices and its obligation to make required interest payments under loans from Selex, Yasawa and their affiliates. Furthermore, the Company has not paid certain real estate taxes which aggregate approximately $1,549,000 as of August 31, 1994 and is also subject to certain pending litigation from former employees and others, which may adversely affect the financial condition of the Company. See "Legal Proceedings."
The Company is continuing to seek third parties to provide financing. As part of any such transaction, Selex, Yasawa and their affiliates have indicated that they are willing to sell or restructure all or a portion of their loans and Common Stock in the Company. They have also indicated that they are willing to sell their interests in the Company at a significant discount. Consummation of any such transaction may result in a change in control of the Company. There can be no assurance, however, that such transaction will result or that any financing will be obtained. Accordingly, the Company's Board of Directors is also considering other appropriate action given the severity of the Company's liquidity position. Alternatively, the Company could be subject to the filing of an involuntary bankruptcy proceeding in the event it is unable to resolve and settle pending litigation, satisfy settlement commitments and other unpaid creditor claims. See "Business: Recent Developments", "Legal Proceedings" and Notes 1, 5 and 8 to Consolidated Financial Statements.
ITEM 8 | 27984 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The company's summary of selected financial data and related notes for the years 1989 through 1993 are incorporated in this Form 10-K by reference to pages 54 through 56 of the Stockholders' Report.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's discussion and analysis of 1991 to 1993 results is incorporated herein by reference to pages 22 through 31 of the Stockholders' Report. These items should be read in conjunction with the consolidated financial statements presented on pages 34 through 53 of the Stockholders' Report.
ITEM 8. | 84792 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The information that follows is being provided in lieu of the information called for by Item 6 of Form 10-K, in accordance with General Instruction J.(2)(a) to Form 10-K.
The following table sets forth selected consolidated financial information regarding the Company's financial position and operating results which has been extracted from the Company's consolidated financial statements for the five years ended December 31, 1993. The information should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and accompanying footnotes included elsewhere in this report (dollar amounts in millions):
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following management's narrative analysis of the results of operations is provided in lieu of management's discussion and analysis, in accordance with General Instruction J.(2)(a) to Form 10-K.
Results of Operations
REVENUE - Total revenue for the year ended December 31, 1993 increased $359.0 million (11%), compared with the year ended December 31, 1992. The components of the increase were as follows:
Finance charges increased $316.0 million (11%), primarily caused by an increase in average net finance receivables outstanding, which was partially offset by a decrease in average revenue rates. Average net finance receivables outstanding were $24.4 billion and $21.0 billion for the years ended December 31, 1993 and 1992, respectively, a 16% increase. Total net finance receivables increased by approximately $3.5 billion (15%) from December 31, 1992 to December 31, 1993. Of the total growth, 23% was in the residential real estate-secured portfolio, 20% was in the direct installment and credit card portfolios, 19% was in the manufactured housing and other portfolios, 23% was in the heavy-duty truck portfolio and 15% was in the industrial equipment portfolio. The growth was due, in part, to the acquisitions of finance businesses or finance receivables of Allied Finance Company (April 1993), and Mack Financial Corporation and Great Western Financial Corporation (September 1993) as described in NOTE 3 to the consolidated financial statements. The average revenue rates on aggregate net receivables were 13.4% and 14.1% for the years ended December 31, 1993 and 1992, respectively. The decline in the average revenue rates was principally due to changes in market conditions, including lower prevailing market rates affecting yields on new business and variable and adjustable rate loans, and a shift in the loan portfolio mix toward a higher percentage of commercial loans, which generally have lower yields than consumer loans.
Insurance premiums increased $32.3 million (15%) as a result of increased sales of insurance products, primarily in the credit life and credit accident and health insurance programs.
Investment and other income increased $10.7 million (6%), due to an increase in fee-based financial services revenue, which was partially offset by a decrease in interest income from loans to former foreign subsidiaries of First Capital as a result of decreased balances outstanding, and a general decrease in the interest rates on investments.
EXPENSES - Total expenses for the year ended December 31, 1993 increased $213.6 million (8%), compared with the year ended December 31, 1992. The components of the increase were as follows:
Interest expense increased $59.1 million (5%). This change was caused by an increase in average outstanding debt ($186.7 million) attributable to higher net finance receivables outstanding, which was partially offset by a decrease in average interest rates ($127.6 million). The annual average interest rates on total debt, including amortization of discount and issuance expense, were as follows:
Year Ended December 31 1993 1992
Short-term Debt 3.11% 3.68% Long-term Debt 8.03 8.78 Total Debt 5.94 6.55
The net interest margin was 7.92% and 7.98% for the years ended December 31, 1993 and 1992, respectively.
Operating expenses increased $176.1 million (21%), primarily as a result of increased salaries, employment benefits and other operating expenses generally related to increased volumes of business, including acquisitions.
The provision for loan losses decreased by $36.5 million (7%), primarily due to decreased losses. Net credit losses, measured in dollars and as a percent of average net finance receivables, declined during the twelve-month period ended December 31, 1993, compared to the same period ended December 31, 1992. The allowance for losses increased $109.7 million (16%) to $808.9 million at December 31, 1993 from $699.2 million at December 31, 1992. The increase primarily relates to the growth in net finance receivables. The allowance for losses, measured as a percent of net finance receivables, remained at a relatively constant level at December 31, 1993 (3.07%) compared to December 31, 1992 (3.06%). The allowance for losses is maintained at a level which considers, among other factors, historical loss experience, possible deviations from historical loss experience and varying economic conditions.
Insurance benefits paid or provided increased $14.9 million (15%) in 1993, primarily due to an increase in property and casualty insurance claims.
EARNINGS BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - As a result of the aforementioned changes, earnings before provision for income taxes and cumulative effect of changes in accounting principles increased $145.4 million (24%) during 1993.
PROVISION FOR INCOME TAXES - The provision for income taxes represented 37.5% and 35.2% of earnings before provision for income taxes for the years ended December 31, 1993 and 1992, respectively. The increase in the effective tax rate is primarily related to an increase in the Federal statutory rate and the method of computing state taxes as described in NOTE 8 to the consolidated financial statements.
EARNINGS BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - Earnings before cumulative effect of changes in accounting principles increased $76.9 million (20%) during 1993.
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES - In 1992, the Company recorded a one-time charge of $10.4 million relating to the adoption of two new accounting standards. See NOTE 2 to the consolidated financial statements for additional information.
NET EARNINGS - As a result of the aforementioned changes, net earnings increased $87.3 million (23%) during 1993.
Liquidity/Capital Resources
The following sets forth liquidity and capital resources for First Capital and its subsidiaries other than Associates and its subsidiaries.
First Capital's primary sources of funds have been (i) borrowings from both commercial banks and the public and (ii) borrowings and dividends from Associates. The amount of dividends which may be paid by Associates is limited by certain provisions of its outstanding debt and revolving credit agreements. A restriction contained in one series of debt securities maturing August 1, 1996, generally limits payments of cash dividends on Associates Common Stock in any one year to not more than 50% of Associates consolidated net earnings for such year, subject to certain exceptions, plus increases in contributed capital and extraordinary gains. Any such amounts available for the payment of dividends in such fiscal year and not so paid, may be paid in any one or more of the five subsequent fiscal years. In accordance with this provision, at December 31, 1993, $221.9 million was available for dividends. A restriction contained in certain revolving credit agreements requires Associates to maintain a minimum tangible net worth, as defined, of $1.5 billion. At December 31, 1993, Associates tangible net worth was approximately $2.9 billion. A debt agreement of Associates limits the total of all affiliate-related receivables, as defined, to 7% of the aggregate gross receivables owned by Associates. An affiliate within the meaning of affiliate-related receivables includes First Capital, its parent corporation, and any corporation, other than Associates and its subsidiaries, of which First Capital or its parent corporation owns or controls at least 50% of its stock. The net total of all affiliate-related receivables which Associates owned at December 31, 1993 and 1992, amounted to 1.5% and 1.2%, respectively, of its aggregate gross receivables as of those dates.
At December 31, 1993, First Capital had contractually committed bank lines of credit of $75.0 million, and revolving credit facilities of $250.0 million, none of which was in use. During 1993, First Capital raised $209.3 million through public and private offerings of medium- and long-term debt.
The following sets forth liquidity and capital resources for Associates:
Associates endeavors to maximize its liquidity by diversifying its sources of funds, which include: (i) its operations; (ii) the issuance of commercial paper; (iii) the issuance of unsecured intermediate-term debt in the public and private markets; (iv) borrowings available from short-term and revolving credit facilities with commercial banks; and (v) receivables purchase facilities.
Issuance of Short- and Intermediate-Term Debt
Commercial paper, with maturities ranging from 1 to 270 days, is the primary source of short-term debt. The average commercial paper interest rate incurred during 1993 was 3.11%.
Associates issues intermediate-term debt publicly and privately in the domestic and foreign markets. During the year ended December 31, 1993, Associates raised $3.6 billion through public and private offerings at a weighted average effective interest rate and a weighted average term of 5.64% and 6.5 years, respectively.
Credit Facilities and Related Borrowings
Associates policy is to maintain bank credit facilities in support of its net short-term borrowings consistent with market conditions. Bank credit facilities provide a means of refinancing maturing commercial paper obligations as needed. At December 31, 1993, short-term bank lines and revolving credit facilities with banks totaled $8.2 billion, none of which was in use at that date. These facilities represented 80% of net short-term borrowings outstanding at December 31, 1993. Bank lines and revolvers may be withdrawn only under certain standard conditions. Associates pays fees or maintains compensating balances or utilizes a combination of both to maintain the availability of its bank credit facilities. Fees are .05% to .25% of 1% per annum of the amount of the facilities.
At December 31, 1993 and 1992, Associates short-term debt, as defined, as a percent of total debt was 52%. Short-term debt, for purposes of this computation, includes the current portion of long-term debt but excludes short-term investments. See NOTES 5, 6 and 7 to the consolidated financial statements for a description of credit facilities, notes payable and long- term debt, respectively.
Recent Accounting Pronouncements
Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 112, "Employers' Accounting for Postretirement Benefits" and SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". The adoption of these standards was not significant to the Company's consolidated financial statements.
The Financial Accounting Standards Board has issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" effective 1995, SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" effective 1994, and SFAS No. 116, "Accounting for Contributions Received and Contributions Made" effective 1995. Adoption of these pronouncements is not expected to be significant to the Company's consolidated financial statements.
ITEM 8. | 7974 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The table entitled "Selected Financial Data" on pages 6465 of the Annual Report is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The section entitled "Financial Review" on pages 34-45 of the Annual Report is incorporated herein by reference.
ITEM 8. | 10427 | 1993 |
Item 6: Selected Financial Data
THE PITTSTON COMPANY AND SUBSIDIARIES SELECTED FINANCIAL DATA
(a) For purposes of computing net income (loss) per common share and book value per share for Pittston Services Group ("Services Group") and Pittston Minerals Group ("Minerals Group") for the periods prior to July 1, 1993, the number of shares of Pittston Services Group Common Stock ("Services Stock") are assumed to be the same as the total corresponding number of shares of The Pittston Company's (the "Company") common stock. The number of shares of Pittston Minerals Group Common Stock ("Minerals Stock") are assumed to equal one-fifth of the number of shares of the Company's common stock (Note 9).
The initial dividends on the Services Stock and Minerals Stock were paid on September 1, 1993. Dividends paid by the Company prior to September 1, 1993, have been attributed to the Services and Minerals Groups in relation to the initial dividends paid on the Services Stock and Minerals Stock.
(b) As of January 1, 1992, Brink's Home Security, Inc. elected to capitalize categories of costs not previously capitalized for home security installations to more accurately reflect subscriber installation costs. The effect of this change in accounting principle was to increase income (loss) before extraordinary credit and cumulative effect of accounting changes and net income of the Company and the Services Group by $2,435,000 or $.07 per share of Services Stock in 1993 and by $2,596,000 or $.07 per share of Services Stock in 1992.
(c) Calculated based on the number of shares outstanding at end of the period excluding shares outstanding under the Company's Employee Benefits Trust (Note 9).
PITTSTON SERVICES GROUP SELECTED FINANCIAL DATA
The following Selected Financial Data reflects the results of operations and financial position of the businesses which comprise Pittston Services Group ("Services Group") and should be read in connection with the Services Group's financial statements. The financial information of the Services Group and Pittston Minerals Group ("Minerals Group") supplements the consolidated financial information of The Pittston Company and Subsidiaries (the "Company") and, taken together, includes all accounts which comprise the corresponding consolidated financial information of the Company.
(a) For purposes of computing net income per common share and book value per share for the Service Group for the periods prior to July 1, 1993, the number of shares of Pittston Services Group Common Stock ("Services Stock") are assumed to be the same as the total corresponding number of shares of the Company's common stock. The initial dividend on Services Stock was paid on September 1, 1993. Dividends paid by the Company prior to September 1, 1993, have been attributed to the Services Group in relation to the initial dividend paid on the Services Stock. Book value per share is calculated based on the number of shares outstanding at the end of the period excluding 3,853,778 and 3,951,033 shares outstanding under the Company's Employee Benefits Trust at December 31, 1993 and 1992, respectively. Shares outstanding under the Company's Employee Benefits Trust are evaluated for inclusion in the evaluation of net income per share and have no dilutive effect (Note 1).
(b) As of January 1, 1992, Brink's Home Security, Inc. ("BHS") elected to capitalize categories of costs not previously capitalized for home security installations to more accurately reflect subscriber installation costs. The effect of this change in accounting principle was to increase income before extraordinary credit and cumulative effect of accounting changes and net income of the Services Group by $2,435,000 or $.07 per share of Services Stock in 1993 and by $2,596,000 or $.07 per share of Services Stock in 1992.
PITTSTON MINERALS GROUP SELECTED FINANCIAL DATA
The following Selected Financial Data reflects the results of operations and financial position of the businesses which comprise Pittston Minerals Group ("Minerals Group") and should be read in connection with the Minerals Group's financial statements. The financial information of Minerals Group and Pittston Services Group ("Services Group") supplements the consolidated financial information of The Pittston Company and Subsidiaries (the "Company") and, taken together, includes all accounts which comprise the corresponding consolidated financial information of the Company.
-2-
(a) For purposes of computing net income per common share and book value per share for the Minerals Group for the periods prior to July 1, 1993, the number of shares of Pittston Minerals Group Common Stock ("Minerals Stock") are assumed to equal one-fifth of the number of shares of the Company's common stock. The initial dividend on Minerals Stock was paid on September 1, 1993. Dividends paid by the Company prior to September 1, 1993 have been attributed to the Minerals Group in relation to the initial dividend paid on the Minerals Stock. Book value per share is calculated based on the number of shares outstanding at the end of the period excluding 770,301 and 790,207 shares outstanding under the Company's Employee Benefits Trust at December 31, 1993 and 1992, respectively. Shares outstanding under the Company's Employee Benefits Trust are evaluated for inclusion in the calculation of net income per share and have no dilutive effect (Note 1).
Item 7: | Item 7: Management's Discussion and Analysis of Results of Operations and Financial Condition
THE PITTSTON COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS Net income for 1993 was $14.1 million compared with $49.1 million for 1992. Operating profit totalled $26.1 million for 1993 compared with $89.5 million for 1992. Net income and operating profit for 1993 included restructuring and other charges of $48.9 million and $78.6 million, respectively, impacting Coal and Mineral Ventures operations. Consequently, these operations each reported operating losses for 1993, while each of The Pittston Company's (the "Company") services businesses, which include the operations of Burlington Air Express Inc. ("Burlington"), Brink's, Incorporated ("Brink's") and Brink's Home Security, Inc. ("BHS"), reported improved operating earnings compared with 1992. Net income and operating profit for 1992 were positively impacted by a pension credit of $7.0 million and $11.1 million, respectively, relating to the amortization of the unrecognized initial net pension asset at the date of adoption of Statement of Financial Accounting Standards ("SFAS") No. 87, "Employers' Accounting for Pensions", which was recognized over the estimated remaining average service life of the Company's employees since the date of adoption which expired at the end of 1992.
In 1991, the Company had a net loss of $151.9 million and an operating loss of $33.9 million. The operating loss in 1991 included restructuring charges in the Coal segment of $115.2 million. Excluding the 1991 restructuring charges, operating profit in the Coal segment increased $5.8 million in 1992 compared with 1991. The combined operating profit of the Company's services businesses increased $3.3 million for the same period, with increased results for home security operations partially offset by decreased results for air freight operations. As of January 1, 1992, BHS elected to capitalize categories of costs not previously capitalized for home security installations to more accurately reflect subscriber installation costs. The effect of this change in accounting principle was to increase net income in 1992 by $2.6 million.
The net loss for 1991 was due to the coal restructuring charges and to the net effect of two accounting changes adopted in 1991. The Company adopted the provisions of SFAS No. 109, "Accounting for Income Taxes" and SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". The cumulative effect of SFAS No. 109 increased net income by $10.1 million in 1991, while the cumulative effect of SFAS No. 106 decreased net income by $133.1 million in 1991.
BURLINGTON Operating profit of Burlington increased $22.9 million to $38.0 million in 1993 from $15.1 million in 1992. Worldwide revenues increased $97.8 million or 11% to $998.1 million in 1993 from $900.3 million in 1992. The increase in revenues primarily reflects volume increases only partially offset by lower average yields (revenues per pound). Total weight shipped worldwide for 1993 increased 14% to 1,020.4 million pounds from 893.0 million pounds in 1992. Operating expenses increased $76.2 million in 1993, while selling, general and administrative expenses decreased $.5 million in 1993 compared with the prior year. Selling, general and administrative expenses in 1992 were adversely affected by charges for costs related to organizational downsizing in both domestic and foreign operations. Higher operating expenses resulting from the increased volume of business in 1993 were, however, favorably impacted by increased efficiency in private fleet operations achieved as a result of a fleet upgrade to DC8-71 aircraft replacing B707 aircraft, accomplished by lease transactions at year-end 1992 and in early 1993. Two additional DC8-71's were added to the fleet during the fourth quarter of 1993, replacing less fuel efficient DC8-63 freighters. These aircraft meet Stage III noise regulations and provide the company with a significant increase in its lift capacity. During the 1993 fourth quarter Burlington also completed a 30% expansion of its airfreight hub in Toledo, Ohio. This expansion assists in achieving continuing efficiency gains, including higher average weight shipped per container.
The increase in operating profit for 1993 compared with 1992 is attributable to increased Americas' operating profit of $22.0 million and increased foreign operating profit of $.9 million. The increase in Americas' operating profit was largely due to increased domestic and export volume and lower transportation costs per pound, partially offset by decreased average yields. Intra-Americas' volume increases resulted from strong electronics industry shipments as well as increased shipments from the health care industry, retail businesses and local accounts. While average yields decreased in 1993 compared with 1992 reflecting a highly competitive pricing environment, market improvement was evident during the last quarter of the year as load factors reached record levels throughout the industry.
Burlington's operating profit decreased $4.7 million to $15.1 million in 1992 from $19.8 million in 1991 even though worldwide revenues increased $69.4 million or 8%. The increase in revenues reflected significant company-wide volume increases occurring principally during the latter part of 1992, offset by weaker average yields. The 1992 volume gains reflected recovering economic conditions. Yield declines resulted from a change in customer mix, due to a loss of high-yielding business with volume gains in lower-yielding accounts, and a change in product mix to an increased proportion of second-day business. The decline in operating profit, resulting from increased operating expenses which exceeded increased revenues is principally attributable to decreased Americas' operating profit of $8.3 million, which was only partially offset by increased foreign operating profit of $3.6 million.
Americas' operating profit was adversely affected by decreased yields in 1992, only partially offset by volume gains. Operating profit of foreign subsidiaries increased $3.6 million in the aggregate to $12.5 million from $8.9 million in 1991 as improved results in the Far East more than offset declines in Europe. Operating profit in the Far East benefitted from volume increases despite pressures on yields. Operating profit in Europe was adversely impacted by the weakening in foreign currencies in relation to the U.S. dollar. However, margins in local currencies were maintained due to strong volumes, despite lower yields. In 1991, although operating expenses were adversely affected by $2.8 million of costs related to the move of Burlington's freight sorting hub from Fort Wayne, Indiana to Toledo Express Airport in Ohio, station costs and corporate support group costs were positively impacted by productivity gains.
BRINK'S Operating profit of Brink's totalled $35.0 million in 1993 compared with $30.4 million in 1992. Worldwide operating revenues increased 9% or $37.9 million to $481.9 million with increased operating expenses and selling, general and administrative expenses of $31.7 million. Revenues increased for North American operations largely as a result of new business, but were partially offset by weak securities volumes for U.S. air courier operations. Operating expenses increased largely as a result of new business expansion, while selling, general and administrative expenses increased only slightly compared with the prior year. Other operating income decreased $1.5 million in 1993 almost entirely due to a $1.2 million decrease in equity earnings of foreign affiliates.
Improved operating results from North American ground operations, air courier operations and international subsidiaries in 1993 compared with 1992 were partially offset by decreased equity earnings of foreign affiliates. North American ground operations had a 25% or $3.6 million operating profit improvement in 1993 compared with 1992 with increases in ATM, armored car and coin wrapping results, partially offset by a decrease in currency processing results. Air courier results increased $.5 million in 1993 largely due to high volume of precious metals exports, foreign currency shipments and new money shipments, which more than offset lower diamond and jewelry margins and the continued decline in the domestic securities business. Operating results for international subsidiaries increased $1.2 million compared with 1992, while equity earnings of foreign affiliates, included in operating profit decreased $1.2 million to $6.9 million in 1993 from $8.1 million in 1992. The increased results for international subsidiaries were largely attributable to earnings reported for operations in Brazil, partially offset by decreased results
from a U.K. subsidiary. Operations in Brazil reported a $1.4 million operating profit in 1993 compared with a $.3 million operating loss in 1992. Although results were positive during 1993, operational and inflationary problems caused by the Brazilian economy make it uncertain as to whether this favorable trend in earnings will continue. Results in the U.K. were affected by competitive price pressures and recessionary pressures and were impacted by the cost of a labor settlement which will reduce future labor rates. In 1993, equity earnings of foreign affiliates were negatively impacted by substantially lower earnings of a 20% owned affiliate in Mexico. Operations in Mexico have been affected by a recessionary economy, new competitive pressures, losses from new business ventures and severance costs incurred in streamlining the work force.
In 1992, Brink's operating profit increased $.4 million to $30.4 million from $30.0 million in 1991. Worldwide operating revenues increased 7% or $28.7 million to $444.0 million with increased operating expenses and selling, general and administrative expenses of $27.3 million and decreased other operating income of $1.0 million. Revenues increased for domestic operations as a result of new business, expansion of service with existing customers and increased specials work as a result of Hurricane Andrew. U.S. revenue increases were partially offset by decreases from Canada as a result of competitive pricing pressures as well as recessionary pressures. Operating costs increased as a result of providing new and expanded service for domestic customers, rising foreign labor costs and costs incurred for expansion in foreign markets. These operating cost increases were partially offset by benefits gained from domestic operating efficiencies. Increased operating results from foreign and North American ground operations of $2.2 million and $.3 million, respectively, were offset by a $2.1 million reduction in air courier profits. Operating profit of North American ground operations in 1992 increased 2% to $14.3 million from $14.0 million in 1991. Canadian operations continued to be adversely impacted by the weak economy and significant competitive pressures. The slight increase in North American operating profits was attributable to increases in armored car and coin wrapping results, almost entirely offset by decreases in ATM and currency processing results. Operating profit of domestic and international air courier operations in the aggregate declined by 44% to $2.7 million in 1992 from $4.8 million in 1991, as increases in international diamond and jewelry business were more than offset by reduced Canadian profits.
Foreign subsidiaries had operating profit of $7.2 million in 1992 compared with $3.7 million in the prior year as increased results in Brazil, Israel and Chile more than offset an earnings decline in the United Kingdom. Although the operating loss for Brazil decreased $3.3 million in 1992 compared with 1991, operations in Brazil, while nearly breaking even, continued to be adversely impacted by cost and pricing pressures caused by a hyperinflationary economy. Operations in Israel benefitted from a growing share of local diamond shipments. Operations in the United Kingdom were affected by competitive price pressures as well as recessionary pressures. Equity earnings of foreign affiliates included in operating profit increased by $.5 million in 1992 to $8.1 million primarily due to higher operating results reported by an affiliate in France. Results from Brink's Mexican affiliate were strong, although 1992 results fell short of prior year earnings. While results for both subsidiaries and equity affiliates increased over the prior year, overhead expenses increased $2.0 million principally for costs related to tighter management oversight and expansion in European markets.
BHS Operating profit of BHS aggregated $26.4 million in 1993 compared with $16.5 million in 1992 and $8.9 million in 1991. The $9.9 million increase in operating profit in 1993 compared with 1992 reflects increased monitoring margin of $11.6 million, partially offset by increased installation expenses of $.9 million and increased overhead costs of $.8 million. The $7.6 million increase in operating profits in 1992 compared with 1991 reflects increased monitoring margin of $7.8 million and reduced installation expenses of $2.5 million, partially offset by increased overhead costs of $2.7 million.
The increased monitoring margin in 1993 as in 1992 was largely attributable to an expanding subscriber base which resulted in improved economies of scale and other cost efficiencies achieved in servicing BHS's subscribers. Monitoring margin in 1993 also benefitted from higher per subscriber revenues. At year-end 1993, BHS had approximately 259,600 subscribers, 44% more than the year-end 1991 subscriber base. New subscribers totalled 59,700 in 1993 and 51,300 in 1992. As a result, BHS's average subscriber base increased by 20% in 1993 and in 1992 when compared with each year prior.
The increased installation expenses in 1993 compared with 1992 largely resulted from the increase in new installations. The reduced installation expenses in 1992 reflect a change in the capitalization rate for home security installations. As of January 1, 1992, BHS elected to capitalize categories of costs not previously capitalized for home security installations to more accurately reflect subscriber installation costs included as capitalized installation costs, which added $4.1 million and $4.3 million to operating profit in 1993 and 1992, respectively. The additional costs not previously capitalized consisted of costs for installation labor and related benefits for supervisory, installation scheduling, equipment testing and other support personnel (in the amount of $2.6 million and $2.3 million in 1993 and 1992, respectively) and costs incurred in maintaining facilities and vehicles dedicated to the installation process (in the amount of $1.5 million and $2.0 million in 1993 and 1992, respectively). The increase in the capitalization rate, while adding to current period profitability comparisons, defers recognition of expenses over the estimated useful life of the installed asset. The additional subscriber installation costs which are currently capitalized were expensed in prior years for subscribers in those years. Because capitalized subscriber installation costs for periods prior to January 1, 1992 were not adjusted for the change in accounting principle, installation costs for subscribers in those years will continue to be depreciated based on the lesser amounts capitalized in those periods. Consequently, depreciation of capitalized subscriber installation costs in the current year and until such capitalized costs prior to January 1, 1992 are fully depreciated will be less than if such prior periods' capitalized costs had been adjusted for the change in accounting. However, the Company believes the effect on net income in 1993 and in 1992 was immaterial. While the amounts of the costs incurred which are capitalized vary based on current market and operating conditions, the types of such costs which are currently included in BHS's capitalization rate will not change. The change in the capitalization rate has no additional effect on current or future cash flows or liquidity.
COAL Coal operations had a $48.2 million operating loss in 1993 compared with an operating profit of $36.9 million in 1992. Operating results in 1993 included a $70.7 million charge for closing costs for mines which were closed at the end of 1993 and scheduled closures of mines in early 1994, including employee benefit costs and certain other noncash charges, together with the estimated liability in connection with previously reported litigation (the so-called "Evergreen Case") brought against the Company and a number of its coal subsidiaries by the trustees of certain pension and benefit trust funds established under collective bargaining agreements with the United Mine Workers of America ("UMWA"). Excluding this charge, coal operating results decreased $14.4 million in 1993 compared with 1992. Operating income in 1993 was negatively impacted by $10.0 million in expenses relating to retiree health benefits required by federal legislation enacted in October 1992 and a $1.8 million charge to settle litigation related to the moisture content of tonnage used to compute royalty payments to the UMWA pension and benefit funds during the period ended February 1, 1988. Coal operating profit also included other operating income of $9.8 million in 1993 compared with $9.0 million in the year-earlier period primarily for third party royalties and sales of properties and equipment.
Average margin (realization less current production costs of coal sold) in 1993 of $3.30 per ton decreased 6% or $.20 per ton for the current year, as a 4% or $1.29 per ton decrease in average realization was only partially offset by a 4% or $1.09 per ton decrease in average current production costs of coal sold. The decrease in average realization in 1993 reflected lower export pricing and a downward price
revision on a key domestic utility contract. The decrease in average current production costs of coal sold in 1993 was mainly due to a higher proportion of production sourced from company surface mine operations.
Sales volume of 22.0 million tons in 1993 was 6% higher than sales volume in the year earlier. Production totalled 17.1 million tons in 1993, which was slightly lower than production in 1992. In 1993, 54% of total production was derived from deep mines and 46% was derived from surface mines compared with 65% and 35% of deep and surface mine production, respectively, in 1992.
The strike by the UMWA against certain coal producers in the eastern United States, which lasted throughout a significant portion of 1993, has been settled. None of the operations of the Company's coal subsidiaries were involved in the strike. As a result of the strike, the supply of metallurgical coal was appreciably reduced. However, Australian producers increased production to absorb the shortfall. The strike had little impact on coal operating profits during 1993 since a large proportion of production is under contract. Coal operations benefitted from improved spot prices for domestic steam coal on relatively small amounts of uncommitted tonnage available for this market.
Steam coal prices, which had strengthened during the strike, however, have weakened since the strike has been settled. Competition in the export metallurgical coal market is expected to be strong for the contract year beginning April 1994. While the Company has not yet reached agreements with its principal metallurgical export coal customers for such contract year, certain Australian, Canadian and U.S. producers of metallurgical coal have recently agreed to price reductions of as much as U.S. $4.00 per metric ton for the upcoming contract year, further exacerbating the deteriorating conditions in the metallurgical coal market which have been evident for over a decade. These recent price settlements may require the Company to further reduce production and sales to the metallurgical coal market. Given these recent developments, and in light of the Company's long-standing strategy to reduce its exposure in the metallurgical coal market, the Company is actively reviewing the carrying value of its production assets to determine whether they are economically viable and whether the Company should accelerate the continuing implementation of this strategy.
During early 1994, coal production was sharply impacted by severe weather conditions which affected much of the United States. These weather conditions also restricted trucking of coal to plants and terminals and impaired shipments from river terminals due to frozen harbors.
On January 14, 1994, Coal operations completed the acquisition of substantially all the coal mining operations and coal sales contracts of Addington Resources, Inc. This acquisition is expected to add approximately 8.5 million tons of low sulphur steam coal sales and production and provide substantial additional reserves of surface minable low sulphur coal. The contracts acquired, some of which contain terms in excess of five years, will provide a broader base of domestic utility customers and reduce exposure in the export metallurgical market, where contract prices are renegotiated annually.
The Company's principal labor agreement with the UMWA expires on June 30, 1994.
In 1992, operating profit for coal was $36.9 million compared with an operating loss of $84.1 million in 1991. Operating results in 1991 included $115.2 million of restructuring charges primarily related to costs associated with mine shutdowns. Production was augmented in 1992 with the addition of a new surface mine in eastern Kentucky, the on-time start-up of the $11 million new Moss 3 preparation plant in September and success of the highwall mining systems utilized at the Heartland surface mine in West Virginia.
Excluding the 1991 restructuring charges, operating results for the Coal segment increased $5.8 million in 1992 compared with 1991. Operating results in 1991 included gains of $5.8 million from the disposal of excess coal reserves. There were no comparable disposals in 1992. Operating profit in 1992 benefitted from a 2.9 million (16%) increase in tonnage sold largely due to shipments to utilities under coal sales contracts acquired in March 1992 and under a contract being supplied by the Company's Heartland mine which began operations in the fourth quarter of 1991. Average margin per ton improved nearly 2% in 1992 compared with 1991, due to a 3% or $.85 per ton decrease in average current production costs of coal sold per ton only partially offset by lower per ton realization. The decrease in average current production costs of coal sold per ton reflects the increase in tonnage sold, increased productivity and a change in production mix. In 1992, 65% of total production was derived from deep mines, and 35% of production was derived from surface mines compared with 76% and 24% of deep and surface mine production, respectively, in 1991. Operating profit in 1992 also benefitted from a $2.4 million reduction in federal and state black lung expenses due to favorable claims experience.
In October 1992, the Coal Industry Retiree Health Benefit Act of 1992 (the "Health Benefit Act") was enacted as part of the Energy Policy Act of 1992. The Health Benefit Act established new rules for the payment of future health care benefits for thousands of retired union mine workers and their dependents. Part of the burden for these payments has been shifted by the Health Benefit Act from certain coal producers, which had a contractual obligation to fund such payments, to producers such as the Company which have collective bargaining agreements with the UMWA that do not require such payments and to numerous other companies which are no longer in the coal business. The Health Benefit Act established a trust fund to which "signatory operators" and "related persons," including the Company and certain of its coal subsidiaries (the "Pittston Companies") would be obligated to pay annual premiums for assigned beneficiaries, together with a pro rata share for certain beneficiaries who never worked for such employers ("unassigned beneficiaries"), in amounts to be determined by the Secretary of Health and Human Services on the basis set forth in the Health Benefit Act.
In October 1993, the Pittston Companies received notices from the Social Security Administration (the "SSA") with regard to their assigned beneficiaries for which they are responsible under the Health Benefit Act; the Pittston Companies also received a calculation of their liability for the first two years. For 1993 and 1994, this liability (on a pretax basis) is approximately $9.1 million and $11.0 million, respectively. The Company believes that the annual liability under the Health Benefit Act for the Pittston Companies' assigned beneficiaries will continue in the $10 to $11 million range for the next ten years and should begin to decline thereafter as the number of such assigned beneficiaries decreases.
Based on the number of beneficiaries actually assigned by the SSA, the Company estimates the aggregate pretax liability relating to the Pittston Companies' assigned beneficiaries at approximately $265-$275 million, which when discounted at 8% provides a present value estimate of approximately $100-$110 million.
The ultimate obligation that will be incurred by the Company could be significantly affected by, among other things, increased medical costs, decreased number of beneficiaries, governmental funding arrangements and such federal health benefit legislation of general application as may be enacted. In addition, the Health Benefit Act requires the Pittston Companies to fund, pro rata according to the total number of assigned beneficiaries, a portion of the health benefits for unassigned beneficiaries. At this time, the funding for such health benefits is being provided from another source and for this and other reasons the Pittston Companies' ultimate obligation for the unassigned beneficiaries cannot be determined. The Company accounts for its obligations under the Health Benefit Act as a participant in a multi-employer plan and recognizes the annual cost on a pay-as-you-go basis.
In February 1990, the Pittston Coal Group companies and the UMWA entered into a successor collective bargaining agreement that resolved a labor dispute and related strike of Pittston Coal Group operations by UMWA-represented employees that began on April 5, 1989. As part of the agreement, the Pittston Coal Group companies agreed
to make a $10 million lump sum payment to the 1950 Benefit Trust Fund and to renew participation in the 1974 Pension and Benefit Trust Funds at specified contribution rates. These aspects of the agreement were subject to formal approval by the trustees of the funds. The trustees did not accept the terms of the agreement and, therefore, payments are being made to escrow accounts for the benefit of union employees.
In 1988, the trustees of certain pension and benefit trust funds established under collective bargaining agreements with the UMWA brought an action (the so-called "Evergreen Case") against the Company and a number of its coal subsidiaries in the United States District Court for the District of Columbia, claiming that the defendants are obligated to contribute to such trust funds in accordance with the provisions of the 1988 National Bituminous Coal Wage Agreement, to which neither the Company nor any of its subsidiaries is a signatory. In January 1992, the Court issued an order granting summary judgment in favor of the trustees on the issue of liability, which was thereafter affirmed by the Court of Appeals. In June 1993 the United States Supreme Court denied a petition for a writ of certiorari. The case has been remanded to District Court, and damage and other issues remain to be decided. In September 1993, the Company filed a motion seeking relief from the District Court's grant of summary judgment based on, among other things, the Company's allegation that plaintiffs improperly withheld evidence that directly refutes plaintiffs' representations to the District Court and the Court of Appeals in this case. In December 1993, that motion was denied.
In furtherance of its ongoing effort to identify other available legal options for seeking relief from what it believes to be an erroneous finding of liability in the Evergreen Case, the Company has filed suit against the Bituminous Coal Operators Association and others to hold them responsible for any damages sustained by the Company as a result of the Evergreen Case. Although the Company is continuing that effort, the Company, following the District Court's ruling in December 1993, recognized the potential liability that may result from an adverse judgment in the Evergreen Case. In any event, any final judgment in the Evergreen Case will be subject to appeal.
As a result of the Health Benefit Act, there is no continuing liability in this case in respect of health benefit funding after February 1, 1993.
MINERAL VENTURES Mineral Ventures was formed in 1989 to develop opportunities in minerals other than coal. Mineral Ventures operations reported an operating loss of $8.3 million for 1993. This loss includes a $7.9 million charge related to the write-down of the company's investment in the Uley graphite mine in Australia. Although reserve drilling of the Uley property indicates substantial graphite deposits, processing difficulties, depressed graphite prices which have remained significantly below the level prevailing at the start of the project and an analysis of various technical and marketing conditions affecting the project resulted in the determination that the assets have been impaired and that loss recognition was appropriate. Excluding the $7.9 million charge, Mineral Ventures operations incurred a $.4 million operating loss. Operating results for 1993 reflected production from the Stawell gold mine. In December 1992, Mineral Ventures acquired its ownership in the Stawell property through its participation in a joint venture with Mining Project Investors Pty Ltd., (in which Mineral Ventures holds a 34% interest). The Stawell gold mine, which is in western Victoria, Australia, currently has proved reserves for approximately four years of production and a current annual output of approximately 70,000 ounces. The joint venture also has exploration rights in the highly prospective district around the mine. Mineral Ventures has a 67% net equity interest in the Stawell mine and its adjacent exploration acreage. In 1993, the Stawell mine produced 73,765 ounces of gold with Mineral Ventures' share of the operating profit amounting to $4.9 million. The contribution to operating profit from the Stawell mine was offset by administrative overhead in addition to exploration expenditures related chiefly to other potential gold mining projects.
Operating losses, which primarily related to expenses for project review and exploration, totalled $3.4 million in 1992 and $3.5 million in 1991.
FOREIGN OPERATIONS A portion of the Company's financial results is derived from activities in several foreign countries, each with a local currency other than the U.S. dollar. Because the financial results of the Company are reported in U.S. dollars, they are affected by the changes in the value of the various foreign currencies in relation to the U.S. dollar. The Company's international activity is not concentrated in any single currency, which limits the risks of foreign rate fluctuations. In addition, foreign currency rate fluctuations may adversely affect transactions which are denominated in currencies other than the functional currency. The Company routinely enters into such transactions in the normal course of its business. Although the diversity of its foreign operations limits the risks associated with such transactions, the Company uses foreign exchange forward contracts to hedge the risks associated with certain transactions denominated in currencies other than the functional currency. Realized and unrealized gains and losses on these contracts are deferred and recognized as part of the specific transaction hedged. At December 31, 1993, the Company held foreign exchange forward contracts of approximately $4.6 million. In addition, cumulative translation adjustments relating to operations in countries with highly inflationary economies are included in net income, along with all transaction gains or losses for the period. Brink's subsidiaries in Brazil and Israel operate in such highly inflationary economies.
Additionally, the Company is subject to other risks customarily associated with doing business in foreign countries, including economic conditions, controls on repatriation of earnings and capital, nationalization, expropriation and other forms of restrictive action by local governments. The future effects, if any, of such risks on the Company cannot be predicted.
OTHER OPERATING INCOME Other operating income increased $.9 million to $20.0 million in 1993 from $19.1 million in 1992 and decreased $11.1 million in 1992 from $30.2 million in 1991. Other operating income principally includes the Company's share of net income of unconsolidated foreign affiliates, which are substantially attributable to equity affiliates of Brink's, and royalty income from coal and natural gas properties. Equity earnings of foreign affiliates totalled $7.5 million, $8.0 million and $7.7 million in 1993, 1992 and 1991, respectively. In 1991, other operating income also included gains aggregating $5.8 million from the disposal of certain excess coal reserves.
CORPORATE AND OTHER EXPENSES General corporate expenses were comparable for 1993, 1992 and 1991 and aggregated $16.7 million, $17.1 million and $16.1 million, respectively, in those years.
Other income (expense), net was a net expense of $4.6 million in 1993, a net expense of $4.0 million in 1992 and net income of $9.8 million in 1991. The net amounts in 1992 and 1991 included gains of $2.3 million and $11.1 million, respectively, from the sales of investments in leveraged leases.
INTEREST EXPENSE Interest expense totalled $10.2 million, $11.1 million and $15.9 million for 1993, 1992 and 1991, respectively. The $1.1 million decrease for 1993 compared with 1992 was largely a result of lower interest rates worldwide. The $4.8 million decrease in interest expense for 1992 compared with 1991 was principally due to lower average interest rates during 1992.
TAXES AND EXTRAORDINARY CREDITS In 1993, the provision for income taxes is less than the statutory federal income tax rate of 35% due to the tax benefits of percentage depletion, favorable adjustments to the Company's deferred tax assets as a result of the increase in the statutory U.S. federal income tax rate and a reduction in the valuation allowance for deferred tax assets primarily in foreign jurisdictions. These benefits were partially offset by state income taxes and goodwill amortization. In 1992, the provision for income taxes exceeded the statutory federal income tax rate of 34% primarily due to provisions for state income taxes, goodwill amortization and the increase in the
valuation allowance for deferred tax assets. In 1991, the credit for income taxes was less than the amount that would have been recognized using the statutory federal income tax rate of 34% since provisions for state income taxes, taxes on foreign earnings and goodwill amortization were in excess of the tax benefit from percentage depletion.
Based on the Company's historical and expected taxable earnings, management believes it is more likely than not that the Company will realize the benefit of the existing deferred tax asset at December 31, 1993.
FINANCIAL CONDITION
CASH FLOW PROVIDED BY OPERATING ACTIVITIES Cash provided by operating activities for 1993 totalled $119.9 million compared with $124.8 million in 1992. Cash required to support the Company's investing and financing activities was less than cash generated from operations and, as a result, there were net repayments of debt in 1993 of $30.2 million and cash and cash equivalents increased $2.1 million during 1993. Net income, noncash charges and changes in operating assets and liabilities in 1993 were significantly affected by after-tax restructuring and other charges of $48.9 million which had no effect in 1993 on cash generated by operations. Of the total amount of the 1993 charges, $10.8 million was for noncash write-downs of assets and the remainder represents liabilities, of which $7.0 million are expected to be paid in 1994. The Company intends to fund any cash requirements during 1994 with anticipated cash flows from operations, with shortfalls, if any, financed through borrowings under revolving credit agreements or short-term borrowing arrangements.
CAPITAL EXPENDITURES Cash capital expenditures totalled $97.8 million in 1993. An additional $64.0 million was financed through capital and operating leases. Approximately 40% of the gross capital expenditures in 1993 were incurred in the Coal segment. Of that amount, greater than 40% of the expenditures was for business expansion, and the remainder was for replacement and maintenance of current ongoing business operations. Expenditures made by Mineral Ventures approximated 2% of the Company's total capital expenditures and were primarily costs incurred for project development. Capital expenditures made by both Burlington and Brink's during 1993 were primarily for replacement and maintenance of current ongoing business operations and comprised approximately 21% and 19%, respectively, of the Company's total. Expenditures incurred by BHS during 1993 were 18% of total expenditures and were primarily for customer installations, representing the expansion in the subscriber base.
OTHER INVESTING ACTIVITIES All other investing activities in 1993 provided cash of $11.8 million. In 1993, the Company sold assets of a coal subsidiary, from which cash, net of any expenses related to the transaction, totalled $9.7 million. Disposal of property, plant and equipment also provided $4.6 million in cash in 1993.
In January 1994, the Company paid $157 million in cash for the acquisition of substantially all the coal mining operations and coal sales contracts of Addington Resources, Inc. (the "Addington Acquisition"). The purchase price of the acquisition was financed through the issuance of $80.5 million of a new series of convertible preferred stock, which is convertible into Minerals Stock, and additional debt under existing revolving credit facilities.
FINANCING Gross capital expenditures in 1994 are not currently expected to increase significantly over 1993 levels. The Company intends to fund such expenditures through cash flow from operating activities or through operating leases if the latter are financially attractive. Any shortfalls will be financed through the Company's revolving credit agreements or short-term borrowing arrangements.
As of December 31, 1993, revolving credit agreements provided for commitments of up to $250.0 million. At December 31, 1993, there was $2.1 million in borrowings outstanding under these agreements. In March 1994, the Company entered into a $350.0 million revolving credit agreement with a syndicate of banks (the "New Facility"),
replacing the Company's previously existing $250.0 million of revolving credit agreements. The New Facility includes a $100.0 million five-year term loan, which matures in March 1999. The New Facility also permits additional borrowings, repayments and reborrowings of up to an aggregate of $250.0 million until March 1999.
DEBT Net cash repayments of outstanding debt totalled $30.2 million in 1993 with total debt outstanding amounting to $75.8 million at year-end. The availability of funds for the repayment of debt in 1993 was largely due to $22.3 million of cash generated from operating activities in excess of the net requirement for investing activities and payment of cash dividends. Proceeds from exercise of stock options provided additional cash of $14.8 million in 1993.
Subsequent to December 31, 1993, the Company financed the Addington Acquisition in part with debt under revolving credit facilities. In March 1994, the additional debt incurred for this acquisition was refinanced with a five-year term loan under the New Facility.
CONTINGENT LIABILITIES In April 1990, the Company entered into a settlement agreement to resolve certain environmental claims against the Company arising from hydrocarbon contamination at a petroleum terminal facility ("Tankport") in Jersey City, New Jersey, which operations were sold in 1983. Under the settlement agreement, the Company is obligated to pay 80% of the remediation costs. Based on data available to the Company and its environmental consultants, the Company estimates its portion of the cleanup costs on an undiscounted basis using existing technologies to be between $4.5 million and $13.5 million over a period of three to five years. Management is unable to determine that any amount within that range is a better estimate due to a variety of uncertainties, which include the extent of the contamination at the site, the permitted technologies for remediation and the regulatory standards by which the cleanup will be measured by the New Jersey Department of Environmental Protection and Energy.
The Company commenced insurance coverage litigation in 1990, in the United States District Court for the District of New Jersey, seeking a declaratory judgment that all amounts payable by the Company pursuant to the Tankport obligation were reimbursable under comprehensive general liability and pollution liability policies maintained by the Company. Although the underwriters have disputed this claim, management and its legal counsel believe that recovery is probable of realization in the full amount of the claim. This conclusion is based upon, among other things, the nature of the pollution policies which were broadly designed to cover such contingent liabilities, the favorable state of the law in the State of New Jersey (whose laws have been found to control the interpretation of the policies), and numerous other factual considerations which support the Company's analysis of the insurance contracts and rebut many of the underwriters' defenses.
Accordingly, since management and its legal counsel believe that recovery is probable of realization in the full amount of the claim, there is no net liability in regard to the Tankport obligation.
CAPITALIZATION On July 26, 1993, the Company's shareholders approved the Services Stock Proposal, as described in the Company's proxy statement dated June 24, 1993, which resulted in the reclassification of the Company's common stock. The outstanding shares of common stock of the Company were redesignated as Pittston Services Group Common Stock ("Services Stock") on a share-for-share basis and a second class of common stock, designated as Pittston Minerals Group Common Stock ("Minerals Stock"), was distributed on the basis of one- fifth of one share of Minerals Stock for each share of the Company's previous common stock held by shareholders of record on July 26, 1993. Minerals Stock and Services Stock are designed to provide shareholders with separate securities reflecting the performance of the Pittston Minerals Group (the "Minerals Group") and the Pittston Services Group (the "Services Group"), respectively, without diminishing the benefits of remaining a single corporation or precluding future transactions affecting either Group.
The redesignation of the Company's common stock as Services Stock and the distribution of Minerals Stock as a result of the approval of the Services Stock Proposal did not result in any transfer of assets and liabilities of the Company or any of its subsidiaries. Holders of Services Stock and Minerals Stock are shareholders of the Company, which continues to be responsible for all its liabilities. Therefore, financial developments affecting the Minerals Group or the Services Group that affect the Company's financial condition could affect the results of operations and financial condition of both Groups. The change in the capital structure of the Company had no effect on the Company's total capital, except as to expenses incurred in the execution of the Services Stock Proposal. Since the approval of the Services Stock Proposal, capitalization of the Company has been affected by the share activity related to each of the classes of common stock.
As of December 31, 1993, debt as a percent of total capitalization (total debt and shareholders' equity) was 18%, decreasing from 23% at December 31, 1992 largely due to decreased revolving credit debt at the end of 1993.
In July 1993, the Company's Board of Directors (the "Board") authorized a new share repurchase program under which up to 1,250,000 shares of Services Stock and 250,000 shares of Minerals Stock may be repurchased. This program replaced the previous program under which 1,500,000 shares of common stock of the Company remained authorized for repurchase. During 1993 under the previous program 75,000 shares of the Company's common stock were repurchased at a total cost of $1.1 million. Under the new share repurchase program through December 31, 1993, 19,000 shares of Minerals Stock was repurchased at a total cost of $.4 million. There were no repurchases of Services Stock during 1993.
In January 1994, the Company issued $80.5 million of a new series of convertible preferred stock, which is convertible into Minerals Stock, to finance a portion of the Addington Acquisition.
DIVIDENDS The Board intends to declare and pay dividends on Services Stock and Minerals Stock based on the earnings, financial condition, cash flow and business requirements of the Services Group and the Minerals Group, respectively. Since the Company remains subject to Virginia law limitations on dividends and to dividend restrictions in its public debt and bank credit agreements, losses by one Group could affect the Company's ability to pay dividends in respect of stock relating to the other Group. Dividends on Minerals Stock are also limited by the Available Minerals Dividend Amount as defined in the Company's Articles of Incorporation. At December 31, 1993, the Available Minerals Dividend Amount was at least $10.1 million. After giving effect to the issuance of the convertible preferred stock, the pro forma Available Minerals Dividend Amount would have been at least $85.6 million.
On an equivalent basis, in 1993 the Company paid dividends of 62.04 cents per share of Minerals Stock and 19.09 cents per share of Services Stock compared with 49.24 cents per share of Minerals Stock and 15.15 cents per share of Services Stock in 1992.
In January 1994, 161,000 shares of convertible preferred stock (convertible into Minerals Stock) were issued to finance a portion of the Addington Acquisition. Commencing March 1, 1994, annual cumulative dividends of $31.25 per share of convertible preferred stock are payable quarterly, in cash, in arrears, out of all funds of the Company legally available therefor, when, as and if declared by the Company's Board of Directors. Such stock bears a liquidation preference of $500 per share, plus an amount equal to accrued and unpaid dividends thereon.
PENDING ACCOUNTING CHANGES The Company is required to implement a new accounting standard for postemployment benefits - SFAS No. 112 - in 1994. SFAS No. 112 requires employers who provide benefits to former employees after employment but before retirement to accrue such costs as the benefits accumulate or vest. The Company has determined that the cumulative effect of adopting SFAS No. 112 is immaterial.
The Company is required to implement a new accounting standard for investments in debt and equity securities - SFAS No. 115 - in 1994. SFAS No. 115 requires classification of debt and equity securities and recognition of changes in the fair value of the securities based on the purpose for which the securities are held. The Company has determined that the cumulative effect of adopting SFAS No. 115 is immaterial. PITTSTON SERVICES GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The financial statements of the Pittston Services Group (the "Services Group") include the balance sheets, results of operations and cash flows of Burlington Air Express Inc. ("Burlington"), Brink's, Incorporated ("Brink's") and Brink's Home Security, Inc. ("BHS"), and a portion of The Pittston Company's (the "Company") corporate assets and liabilities and related transactions which are not separately identified with operations of a specific segment. The Services Group's financial statements are prepared using the amounts included in the Company's consolidated financial statements. Corporate allocations reflected in these financial statements are determined based upon methods which management believes to be an equitable allocation of such expenses and credits. The accounting policies applicable to the preparation of the Services Group's financial statements may be modified or rescinded at the sole discretion of the Company's Board of Directors (the "Board") without the approval of the shareholders, although there is no intention to do so.
The Company will provide to holders of Pittston Services Group Common Stock ("Services Stock") separate financial statements, financial reviews, descriptions of business and other relevant information for the Services Group in addition to consolidated financial information of the Company. Notwithstanding the attribution of assets and liabilities (including contingent liabilities) between the Pittston Minerals Group (the "Minerals Group") and the Services Group for the purpose of preparing their financial statements, this attribution and the change in the capital structure of the Company as a result of the approval of the Services Stock Proposal, as described in the Company's proxy statement dated June 24, 1993, did not result in any transfer of assets and liabilities of the Company or any of its subsidiaries. Holders of Services Stock are shareholders of the Company, which continues to be responsible for all its liabilities. Therefore, financial developments affecting the Minerals Group or the Services Group that affect the Company's financial condition could affect the results of operations and financial condition of both Groups. Accordingly, the Company's consolidated financial statements must be read in connection with the Services Group's financial statements.
The following discussion is a summary of the key factors management considers necessary in reviewing the Services Group's results of operations, liquidity and capital resources. This discussion should be read in conjunction with the financial statements and related notes of the Company.
RESULTS OF OPERATIONS Net income for the Services Group for 1993 was $47.1 million compared with $27.3 million for 1992. Operating profit for 1993 was $89.9 million compared with $57.4 million in the prior year. Each of the segments in the Services Group contributed to the increase in operating profit for the current year compared with the prior year. Net income and operating profit in 1992 were positively impacted by a pension credit of $2.5 million and $4.0 million, respectively, relating to the amortization of the unrecognized initial net pension asset at the date of adoption of Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions", which was recognized over the estimated remaining average service life of employees since the date of adoption, which expired at the end of 1992. Revenues for 1993 increased $153.9 million compared with 1992, of which $97.7 million was from Burlington, $37.9 million was from Brink's and $18.3 million was from BHS. Operating expenses and selling, general and administrative expenses for 1993 increased $116.7 million, of which $75.7 million was from Burlington, $31.7 million was from Brink's, $8.3 million was from BHS and $1.0 million was due to an increase in the allocation of corporate expenses.
In 1992, net income increased $6.1 million to $27.3 million from $21.2 million in 1991. Operating profit for 1992 was $57.4 million compared with operating profit of $54.7 million in 1991. The $2.7 million increase in operating profit is attributable to an increase in results for BHS partially offset by decreased results for Burlington. As of January 1, 1992, BHS elected to capitalize categories of costs not previously capitalized for home security installation to more accurately reflect subscriber installation costs. The effect of this change in accounting principle was to increase net income in 1992 by $2.6 million. Combined revenues for 1992 increased by $112.9 million, of which $69.4 million was attributable to Burlington, $28.7 million was attributable to Brink's and $14.8 million was attributable to BHS. Operating expenses and selling, general and administrative expenses for 1992 increased $109.6 million, of which $74.6 million was attributable to Burlington, $27.3 million was attributable to Brink's, $7.2 million was attributable to BHS and $.5 million was attributable to an increase in the allocation of corporate expenses.
BURLINGTON Operating profit of Burlington increased $22.9 million to $38.0 million in 1993 from $15.1 million in 1992. Worldwide revenues increased $97.8 million or 11% to $998.1 million in 1993 from $900.3 million in 1992. The increase in revenues primarily reflects volume increases only partially offset by lower average yields (revenues per pound). Total weight shipped worldwide for 1993 increased 14% to 1,020.4 million pounds from 893.0 million pounds in 1992. Operating expenses increased $76.2 million in 1993, while selling, general and administrative expenses decreased $.5 million in 1993 compared with the prior year. Selling, general and administrative expenses in 1992 were adversely affected by charges for costs related to organizational downsizing in both domestic and foreign operations. Higher operating expenses resulting from the increased volume of business in 1993 were, however, favorably impacted by increased efficiency in private fleet operations achieved as a result of a fleet upgrade to DC8-71 aircraft replacing B707 aircraft, accomplished by lease transactions at year-end 1992 and in early 1993. Two additional DC8-71's were added to the fleet during the fourth quarter of 1993, replacing less fuel efficient DC8-63 freighters. These aircraft meet Stage III noise regulations and provide the company with a significant increase in its lift capacity. During the 1993 fourth quarter Burlington also completed a 30% expansion of its airfreight hub in Toledo, Ohio. This expansion assists in achieving continuing efficiency gains, including higher average weight shipped per container.
The increase in operating profit for 1993 compared with 1992 is attributable to increased Americas' operating profit of $22.0 million and increased foreign operating profit of $.9 million. The increase in Americas' operating profit was largely due to increased domestic and export volume and lower transportation costs per pound, partially offset by decreased average yields. Intra-Americas' volume increases resulted from strong electronics industry shipments as well as increased shipments from the health care industry, retail businesses and local accounts. While average yields decreased in 1993 compared with 1992 reflecting a highly competitive pricing environment, market improvement was evident during the last quarter of the year as load factors reached record levels throughout the industry.
Burlington's operating profit decreased $4.7 million to $15.1 million in 1992 from $19.8 million in 1991 even though worldwide revenues increased $69.4 million or 8%. The increase in revenues reflected significant company-wide volume increases occurring principally during the latter part of 1992, offset by weaker average yields. The 1992 volume gains reflected recovering economic conditions. Yield declines resulted from a change in customer mix, due to a loss of high-yielding business with volume gains in lower-yielding accounts, and a change in product mix to an increased proportion of second-day business. The decline in operating profit, resulting from increased operating expenses which exceeded increased revenues is principally attributable to decreased Americas' operating profit of $8.3 million, which was only partially offset by increased foreign operating profit of $3.6 million.
Americas' operating profit was adversely affected by decreased yields in 1992, only partially offset by volume gains. Operating profit of foreign subsidiaries increased $3.6 million in the aggregate to $12.5 million from $8.9 million in 1991 as improved results in the Far East more than offset declines in Europe. Operating profit in the Far East benefitted from volume increases despite pressures on yields. Operating profit in Europe was adversely impacted by the weakening in foreign currencies in relation to the U.S. dollar. However, margins in local currencies were maintained due to strong volumes, despite lower yields. In 1991, although operating expenses were adversely affected by $2.8 million of costs related to the move of Burlington's freight sorting hub from Fort Wayne, Indiana to Toledo Express Airport in Ohio, station costs and corporate support group costs were positively impacted by productivity gains.
BRINK'S Operating profit of Brink's totalled $35.0 million in 1993 compared with $30.4 million in 1992. Worldwide operating revenues increased 9% or $37.9 million to $481.9 million with increased operating expenses and selling, general and administrative expenses of $31.7 million. Revenues increased for North American operations largely as a result of new business, but were partially offset by weak securities volumes for U.S. air courier operations. Operating expenses increased largely as a result of new business expansion, while selling, general and administrative expenses increased only slightly compared with the prior year. Other operating income decreased $1.5 million in 1993 almost entirely due to a $1.2 million decrease in equity earnings of foreign affiliates.
Improved operating results from North American ground operations, air courier operations and international subsidiaries in 1993 compared with 1992 were partially offset by decreased equity earnings of foreign affiliates. North American ground operations had a 25% or $3.6 million operating profit improvement in 1993 compared with 1992 with increases in ATM, armored car and coin wrapping results, partially offset by a decrease in currency processing results. Air courier results increased $.5 million in 1993 largely due to high volume of precious metals exports, foreign currency shipments and new money shipments, which more than offset lower diamond and jewelry margins and the continued decline in the domestic securities business. Operating results for international subsidiaries increased $1.2 million compared with 1992, while equity earnings of foreign affiliates, included in operating profit decreased $1.2 million to $6.9 million in 1993 from $8.1 million in 1992. The increased results for international subsidiaries were largely attributable to earnings reported for operations in Brazil, partially offset by decreased results from a U.K. subsidiary. Operations in Brazil reported a $1.4 million operating profit in 1993 compared with a $.3 million operating loss in 1992. Although results were positive during 1993, operational and inflationary problems caused by the Brazilian economy make it uncertain as to whether this favorable trend in earnings will continue. Results in the U.K. were affected by competitive price pressures and recessionary pressures and were impacted by the cost of a labor settlement which will reduce future labor rates. In 1993, equity earnings of foreign affiliates were negatively impacted by substantially lower earnings of a 20% owned affiliate in Mexico. Operations in Mexico have been affected by a recessionary economy, new competitive pressures, losses from new business ventures and severance costs incurred in streamlining the work force.
In 1992, Brink's operating profit increased $.4 million to $30.4 million from $30.0 million in 1991. Worldwide operating revenues increased 7% or $28.7 million to $444.0 million with increased operating expenses and selling, general and administrative expenses of $27.3 million and decreased other operating income of $1.0 million. Revenues increased for domestic operations as a result of new business, expansion of service with existing customers and increased specials work as a result of Hurricane Andrew. U.S. revenue increases were partially offset by decreases from Canada as a result of competitive pricing pressures as well as recessionary pressures. Operating costs increased as a result of providing new and expanded service for domestic customers, rising foreign labor costs and costs incurred for expansion in foreign markets. These operating cost increases were partially offset by benefits gained from domestic operating efficiencies. Increased operating results from foreign and North American ground operations of $2.2 million and $.3 million, respectively, were offset by a $2.1 million reduction in air courier profits. Operating profit of North American ground operations in 1992 increased 2% to $14.3 million from $14.0 million in 1991. Canadian operations continued to be adversely impacted by the weak economy and significant competitive pressures. The slight increase in North American operating profits was attributable to increases in armored car and coin wrapping results, almost entirely offset by decreases in ATM and currency processing results. Operating profit of domestic and international air courier operations in the aggregate declined by 44% to $2.7 million in 1992 from $4.8 million in 1991, as increases in international diamond and jewelry business were more than offset by reduced Canadian profits. Foreign subsidiaries had operating profit of $7.2 million in 1992 compared with $3.7 million in the prior year as increased results in Brazil, Israel and Chile more than offset an earnings decline in the United Kingdom. Although the operating loss for Brazil decreased $3.3 million in 1992 compared with 1991, operations in Brazil, while nearly breaking even, continued to be adversely impacted by cost and pricing pressures caused by a hyperinflationary economy. Operations in Israel benefitted from a growing share of local diamond shipments. Operations in the United Kingdom were affected by competitive price pressures as well as recessionary pressures. Equity earnings of foreign affiliates included in operating profit increased by $.5 million in 1992 to $8.1 million primarily due to higher operating results reported by an affiliate in France. Results from Brink's Mexican affiliate were strong, although 1992 results fell short of prior year earnings. While results for both subsidiaries and equity affiliates increased over the prior year, overhead expenses increased $2.0 million principally for costs related to tighter management oversight and expansion in European markets.
BHS Operating profit of BHS aggregated $26.4 million in 1993 compared with $16.5 million in 1992 and $8.9 million in 1991. The $9.9 million increase in operating profit in 1993 compared with 1992 reflects increased monitoring margin of $11.6 million, partially offset by increased installation expenses of $.9 million and increased overhead costs of $.8 million. The $7.6 million increase in operating profits in 1992 compared with 1991 reflects increased monitoring margin of $7.8 million and reduced installation expenses of $2.5 million, partially offset by increased overhead costs of $2.7 million.
The increased monitoring margin in 1993 as in 1992 was largely attributable to an expanding subscriber base which resulted in improved economies of scale and other cost efficiencies achieved in servicing BHS's subscribers. Monitoring margin in 1993 also benefitted from higher per subscriber revenues. At year-end 1993, BHS had approximately 259,600 subscribers, 44% more than the year-end 1991 subscriber base. New subscribers totalled 59,700 in 1993 and 51,300 in 1992. As a result, BHS's average subscriber base increased by 20% in 1993 and in 1992 when compared with each year prior.
The increased installation expenses in 1993 compared with 1992 largely resulted from the increase in new installations. The reduced installation expenses in 1992 reflect a change in the capitalization rate for home security installations. As of January 1, 1992, BHS elected to capitalize categories of costs not previously capitalized for home security installations to more accurately reflect subscriber installation costs included as capitalized installation costs, which added $4.1 million and $4.3 million to operating profit in 1993 and 1992, respectively. The additional costs not previously capitalized consisted of costs for installation labor and related benefits for supervisory, installation scheduling, equipment testing and other support personnel (in the amount of $2.6 million and $2.3 million in 1993 and 1992, respectively) and costs incurred in maintaining facilities and vehicles dedicated to the installation process (in the amount of $1.5 million and $2.0 million in 1993 and 1992, respectively). The increase in the capitalization rate, while adding to current period profitability comparisons, defers recognition of expenses over the estimated useful life of the installed asset. The additional subscriber installation costs which are currently capitalized were expensed in prior years for subscribers in those years. Because capitalized subscriber installation costs for periods prior to January 1, 1992 were not adjusted for the change in accounting principle, installation costs for subscribers in those years will continue to be depreciated based on the lesser amounts capitalized in those periods. Consequently, depreciation of capitalized subscriber installation costs in the current year and until such capitalized costs prior to January 1, 1992 are fully depreciated will be less than if such prior periods' capitalized costs had been adjusted for the change in accounting. However, the Company believes the effect on net income in 1993 and in 1992 was immaterial. While the amounts of the costs incurred which are capitalized vary based on current market and operating conditions, the types of such costs which are currently included in BHS's capitalization rate will not change. The change in the capitalization rate has no additional effect on current or future cash flows or liquidity. FOREIGN OPERATIONS A significant portion of the Services Group's financial results is derived from activities in several foreign countries, each with a local currency other than the U.S. dollar. Because the financial results of the Services Group are reported in U.S. dollars, they are affected by the changes in the value of the various foreign currencies in relation to the U.S. dollar. The Services Group's international activity is not concentrated in any single currency, which limits the risks of foreign rate fluctuation. In addition, foreign currency rate fluctuations may adversely affect transactions which are denominated in currencies other than the functional currency. The Services Group routinely enters into such transactions in the normal course of its business. Although the diversity of its foreign operations limits the risks associated with such transactions, the Company, on behalf of the Services Group, uses foreign exchange forward contracts to hedge the risk associated with certain transactions denominated in currencies other than the functional currency. Realized and unrealized gains and losses on these contracts are deferred and recognized as part of the specific transaction hedged. At December 31, 1993, the Company held, on behalf of the Services Group, foreign exchange forward contracts of approximately $4.6 million. In addition, cumulative translation adjustments relating to operations in countries with highly inflationary economies are included in net income, along with all transaction gains or losses for the period. Brink's subsidiaries in Brazil and Israel operate in such highly inflationary economies.
Additionally, the Services Group is subject to other risks customarily associated with doing business in foreign countries, including economic conditions, controls on repatriation of earnings and capital, nationalization, expropriation and other forms of restrictive action by local governments. The future effects, if any, of such risks on the Services Group cannot be predicted.
CORPORATE EXPENSES A portion of the Company's corporate general and administrative expenses and other shared services has been allocated to the Services Group based upon utilization and other methods and criteria which management believes to be equitable and a reasonable estimate of such expenses as if the Services Group operated on a stand alone basis. These allocations were $9.5 million, $8.6 million and $8.0 million in 1993, 1992 and 1991, respectively.
OTHER OPERATING INCOME Other operating income decreased $.6 million to $9.7 million in 1993 from $10.3 million in 1992 and decreased $.5 million in 1992 from $10.8 million in 1991. Other operating income consists primarily of equity earnings of foreign affiliates. These earnings, which are primarily attributable to equity affiliates of Brink's, amounted to $7.0 million, $8.2 million and $7.7 million 1993, 1992 and 1991, respectively.
OTHER INCOME (EXPENSE), NET Other income (expense), net improved by $1.9 million to a net expense of $4.1 million in 1993 from a net expense of $6.0 million in 1992. In 1992, other income (expense), net decreased by $4.6 million to a net expense of $6.0 million from a net expense of $1.4 million a year earlier. In 1992, other income (expense), net included losses on asset sales. Other changes for the comparable periods are largely due to fluctuations in foreign translation losses.
INTEREST EXPENSE Interest expense for 1993 increased $1.2 million to $8.8 million from $7.6 million in 1992 and in 1992 interest expense decreased $6.4 million from $14.0 million a year earlier. The decrease in 1992 compared to 1991 was principally due to lower average interest rates during the year.
TAXES AND EXTRAORDINARY CREDITS In 1993 and 1992, the provision for income taxes exceeded the statutory federal income tax rate of 35% in 1993 and 34% in 1992 primarily because of provisions for state income taxes and goodwill amortization. In 1991, the provision for income taxes exceeded the statutory federal income tax rate of 34% primarily because of provisions for state income taxes, taxes on foreign earnings and goodwill amortization. FINANCIAL CONDITION A portion of the Company's corporate assets and liabilities has been attributed to the Services Group based upon utilization of the shared services from which assets and liabilities are generated, which management believes to be equitable and a reasonable estimate of the assets and liabilities which would be generated if the Services Group operated on a stand alone basis.
Corporate assets which were allocated to the Services Group consisted primarily of pension assets and deferred income taxes and amounted to $33.5 million and $36.0 million at December 31, 1993 and 1992, respectively.
CASH FLOW PROVIDED BY OPERATING ACTIVITIES Cash provided by operations totalled $91.4 million in 1993, an $11.9 million increase compared with $79.4 million generated by operations in 1992. The net increase in 1993 compared with 1992 consisted of a $19.8 million increase in net income and a $10.5 million increase attributable to a change in noncash charges and credits, partially offset by $18.4 million in additional requirements to fund operating assets and liabilities.
Cash generated from operations of the Services Group exceeded cash requirements for investing and financing activities and, as a result, cash and cash equivalents increased $1.9 million during 1993 to a year-end total of $30.3 million.
CAPITAL EXPENDITURES Cash capital expenditures totalled $76.0 million in 1993. An additional $18.5 million was financed through capital and operating leases. A substantial portion of the Services Group's total cash capital expenditures was attributable to BHS customer installations representing the expansion in the subscriber base. Of the total cash capital expenditures, $26.4 million or 35% related to these costs. Capital expenditures made by both Burlington and Brink's during 1993 were primarily for replacement and maintenance of current ongoing business operations.
Cash capital expenditures for 1993 were funded by cash flow from operating activities, with any shortfalls financed through the Company by borrowings under its revolving credit agreements or short-term borrowing arrangements, which were thereby attributed to the Services Group.
FINANCING Gross capital expenditures in 1994 are not currently expected to increase significantly over 1993 levels. The Services Group intends to fund such expenditures through cash flow from operating activities or through operating leases if the latter are financially attractive. Any shortfalls will be financed through the Company's revolving credit agreements or short-term borrowing arrangements or borrowings from the Minerals Group.
As of December 31, 1993, revolving credit agreements provided for commitments of up to $250.0 million. At December 31, 1993, there was $2.1 million in borrowings outstanding under these agreements which was attributed to the Services Group. In March 1994, the Company entered into a $350.0 million revolving credit agreement with a syndicate of banks (the "New Facility"), replacing the Company's previously existing $250.0 million of revolving credit agreements. The New Facility includes a $100.0 million five-year term loan, which matures in March 1999. The New Facility also permits additional borrowings, repayments and reborrowings of up to an aggregate of $250.0 million until March 1999.
DEBT Total debt outstanding for the Services Group amounted to $88.8 million at year-end 1993, including $13.3 million payable to the Minerals Group. During 1993, cash generated from operations exceeded requirements for investing activities and as a result, net debt repayments totalled $17.0 million. CONTINGENT LIABILITIES Under the Coal Industry Retiree Health Benefit Act of 1992 (the "Health Benefit Act"), the Company and its majority-owned subsidiaries at July 20, 1992, including the Services Group are jointly and severally liable with the Minerals Group for the costs of health care coverage provided for by that Act. For a description of the Health Benefit Act and a calculation of certain of such costs, see Note 13 to the Company's consolidated financial statements. At this time, the Company expects the Minerals Group to generate sufficient cash flow to discharge its obligations under the Act.
In April 1990, the Company entered into a settlement agreement to resolve certain environmental claims against the Company arising from hydrocarbon contamination at a petroleum terminal facility ("Tankport") in Jersey City, New Jersey, which operations were sold in 1983. Under the settlement agreement, the Company is obligated to pay 80% of the remediation costs. Based on data available to the Company and its environmental consultants, the Company estimates its portion of the cleanup costs on an undiscounted basis using existing technologies to be between $4.5 million and $13.5 million over a period of three to five years. Management is unable to determine that any amount within that range is a better estimate due to a variety of uncertainties, which include the extent of the contamination at the site, the permitted technologies for remediation and the regulatory standards by which the cleanup will be measured by the New Jersey Department of Environmental Protection and Energy.
The Company commenced insurance coverage litigation in 1990, in the United States District Court for the District of New Jersey, seeking a declaratory judgment that all amounts payable by the Company pursuant to the Tankport obligation were reimbursable under comprehensive general liability and pollution liability policies maintained by the Company. Although the underwriters have disputed this claim, management and its legal counsel believe that recovery is probable of realization in the full amount of the claim. This conclusion is based upon, among other things, the nature of the pollution policies which were broadly designed to cover such contingent liabilities, the favorable state of the law in the State of New Jersey (whose laws have been found to control the interpretation of the policies), and numerous other factual considerations which support the Company's analysis of the insurance contracts and rebut many of the underwriters' defenses.
Accordingly, since management and its legal counsel believe that recovery is probable of realization in the full amount of the claim, there is no net liability in regard to the Tankport obligation.
CAPITALIZATION On July 26, 1993, the Company's shareholders approved the Services Stock Proposal, as described in the Company's proxy statement dated June 24, 1993, which resulted in the reclassification of the Company's common stock. The outstanding shares of common stock of the Company were redesignated as Services Stock on a share-for-share basis and a second class of common stock, designated as Pittston Mineral Group Common Stock ("Minerals Stock), was distributed on the basis of one-fifth of one share of Minerals Stock for each share of the Company's previous common stock held by shareholders of record on July 26, 1993. Minerals Stock and Services Stock are designed to provide shareholders with separate securities reflecting the performance of the Minerals Group and the Services Group, respectively, without diminishing the benefits of remaining a single corporation or precluding future transactions affecting either Group.
The redesignation of the Company's common stock as Services Stock and the distribution of Minerals Stock as a result of the approval of the Services Stock Proposal did not result in any transfer of assets and liabilities of the Company or any of its subsidiaries. Holders of Services Stock and Minerals Stock are shareholders of the Company, which continues to be responsible for all its liabilities. Therefore, financial developments affecting the Minerals Group or the Services Group that affect the Company's financial condition could affect the results of operations and financial condition of both Groups. The change in the capital structure of the Company had no effect on the Company's total capital, except as to expenses incurred in the execution of the Services Stock Proposal. Since the approval of the Services Stock Proposal, capitalization of the Services Group has been affected by all share activity related to Services Stock.
In July 1993, the Board authorized a new share repurchase program under which up to 1,250,000 shares of Services Stock and 250,000 shares of Minerals Stock may be repurchased. This program replaced the previous program under which 1,500,000 shares of common stock of the Company remained authorized for repurchase. During 1993 under the previous program 75,000 shares of the Company's common stock were repurchased at a total cost of $1.1 million. There were no repurchases of Services Stock during 1993 under the new share repurchase program.
DIVIDENDS The Board intends to declare and pay dividends on Services Stock based on the earnings, financial condition, cash flow and business requirements of the Services Group. Since the Company remains subject to Virginia law limitations on dividends and to dividend restrictions in its public debt and bank credit agreements, losses by the Minerals Group could affect the Company's ability to pay dividends in respect of stock relating to the Services Group.
On an equivalent basis, in 1993 the Company paid dividends of 19.09 cents per share of Services Stock compared with 15.15 cents per share of Services Stock in 1992.
In January 1994, the Company issued 161,000 shares or $80.5 million of a new series of convertible preferred stock, which is convertible into Minerals Stock, to finance a portion of a coal acquisition. While the issuance of the preferred stock had no effect on the capitalization of the Services Group, commencing March 1, 1994, annual cumulative dividends of $31.25 per share of convertible preferred stock are payable quarterly, in cash, out of all funds of the Company legally available therefor, when, as and if declared by the Board. Such stock also bears a liquidation preference of $500 per share plus an amount equal to accrued and unpaid dividends thereon.
PENDING ACCOUNTING CHANGES The Services Group is required to implement a new accounting standard for postemployment benefits - Statement of Financial Accounting Standards ("SFAS") No. 112 - in 1994. SFAS No. 112 requires employers who provide benefits to former employees after employment but before retirement to accrue such costs as the benefits accumulate or vest. The Services Group has determined that the cumulative effect of adopting SFAS No. 112 is immaterial.
The Company is required to implement a new accounting standard for investments in debt and equity securities - SFAS No. 115 - in 1994. SFAS No. 115 requires classification of debt and equity securities and recognition of changes in the fair value of the securities based on the purpose for which the securities are held. The Services Group has determined that the cumulative effect of adopting SFAS No. 115 is immaterial. PITTSTON MINERALS GROUP MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The financial statements of the Pittston Minerals Group (the "Minerals Group") include the balance sheets, results of operations and cash flows of the Coal and Mineral Ventures operations of The Pittston Company (the "Company"), and a portion of the Company's corporate assets and liabilities and related transactions which are not separately identified with operations of a specific segment. The Minerals Group's financial statements are prepared using the amounts included in the Company's consolidated financial statements. Corporate allocations reflected in these financial statements are determined based upon methods which management believes to be an equitable allocation of such expenses and credits. The accounting policies applicable to the preparation of the Minerals Group's financial statements may be modified or rescinded at the sole discretion of the Company's Board of Directors (the "Board") without the approval of the shareholders, although there is no intention to do so.
The Company will provide to holders of the Pittston Minerals Group Common Stock ("Minerals Stock") separate financial statements, financial reviews, descriptions of business and other relevant information for the Minerals Group in addition to consolidated financial information of the Company. Notwithstanding the attribution of assets and liabilities (including contingent liabilities) between the Minerals Group and the Pittston Services Group (the "Services Group") for the purpose of preparing their financial statements, this attribution and the change in the capital structure of the Company as a result of the approval of the Services Stock Proposal, as described in the Company's proxy statement dated June 24, 1993, did not result in any transfer of assets and liabilities of the Company or any of its subsidiaries. Holders of Minerals Stock are shareholders of the Company, which continues to be responsible for all its liabilities. Therefore, financial developments affecting the Minerals Group or the Services Group that affect the Company's financial condition could affect the results of operations and financial condition of both Groups. Accordingly, the Company's consolidated financial statements must be read in connection with the Minerals Group's financial statements.
The following discussion is a summary of the key factors management considers necessary in reviewing the Minerals Group's results of operations, liquidity and capital resources. This discussion should be read in conjunction with the financial statements and related notes of the Company.
RESULTS OF OPERATIONS In 1993, the Minerals Group had a net loss of $33.0 million compared with net income of $21.8 million for 1992. In 1993, the Minerals Group had an operating loss of $63.8 million compared with an operating profit of $32.1 million for 1992. Net income and operating profit for 1993 included restructuring and other charges totalling $48.9 million and $78.6 million, respectively. The charges impacted both Coal and Mineral Ventures operations, and consequently, these operations each reported operating losses for 1993. Net income and operating profit for 1992 were positively impacted by a pension credit of $4.4 million and $7.0 million, respectively, relating to the amortization of the unrecognized initial net pension asset at the date of adoption of Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions", which was recognized over the estimated remaining average service life of the Company's employees since the date of adoption which expired at the end of 1992.
Net income for 1992 was $21.8 million compared with a net loss of $173.0 million for 1991. Operating profit for 1992 was $32.1 million compared with an operating loss of $88.6 million in 1991. The operating loss in 1991 included restructuring charges for Coal operations of $115.2 million. Excluding the 1991 restructuring charges, operating profit increased $5.5 million in 1992 compared with 1991. The net loss for 1991 was due to the coal restructuring charges and to the net effect of two accounting changes adopted in 1991. The Minerals Group adopted the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes" and SFAS No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions". The cumulative effect of SFAS No. 109 increased net income by $6.4 million in 1991, while the cumulative effect of SFAS No. 106 decreased net income by $129.7 million in 1991.
COAL Coal operations had a $48.2 million operating loss in 1993 compared with an operating profit of $36.9 million in 1992. Operating results in 1993 included a $70.7 million charge for closing costs for mines which were closed at the end of 1993 and scheduled closures of mines in early 1994, including employee benefit costs and certain other noncash charges, together with the estimated liability in connection with previously reported litigation (the so-called "Evergreen Case") brought against the Company and a number of its coal subsidiaries by the trustees of certain pension and benefit trust funds established under collective bargaining agreements with the United Mine Workers of America ("UMWA"). Excluding this charge, coal operating results decreased $14.4 million in 1993 compared with 1992. Operating income in 1993 was negatively impacted by $10.0 million in expenses relating to retiree health benefits required by federal legislation enacted in October 1992 and a $1.8 million charge to settle litigation related to the moisture content of tonnage used to compute royalty payments to the UMWA pension and benefit funds during the period ended February 1, 1988. Coal operating profit also included other operating income of $9.8 million in 1993 compared with $9.0 million in the year-earlier period primarily for third party royalties and sales of properties and equipment.
Average margin (realization less current production costs of coal sold) in 1993 of $3.30 per ton decreased 6% or $.20 per ton for the current year, as a 4% or $1.29 per ton decrease in average realization was only partially offset by a 4% or $1.09 per ton decrease in average current production costs of coal sold. The decrease in average realization in 1993 reflected lower export pricing and a downward price revision on a key domestic utility contract. The decrease in average current production costs of coal sold in 1993 was mainly due to a higher proportion of production sourced from company surface mine operations. Sales volume of 22.0 million tons in 1993 was 6% higher than sales volume in the year earlier. Production totalled 17.1 million tons in 1993, which was slightly lower than production in 1992. In 1993, 54% of total production was derived from deep mines and 46% was derived from surface mines compared with 65% and 35% of deep and surface mine production, respectively, in 1992.
The strike by the UMWA against certain coal producers in the eastern United States, which lasted throughout a significant portion of 1993, has been settled. None of the operations of the Company's coal subsidiaries were involved in the strike. As a result of the strike, the supply of metallurgical coal was appreciably reduced. However, Australian producers increased production to absorb the shortfall. The strike had little impact on coal operating profits during 1993 since a large proportion of production is under contract. Coal operations benefitted from improved spot prices for domestic steam coal on relatively small amounts of uncommitted tonnage available for this market.
Steam coal prices, which had strengthened during the strike, however, have weakened since the strike has been settled. Competition in the export metallurgical coal market is expected to be strong for the contract year beginning April 1994. While the Minerals Group has not yet reached agreements with its principal metallurgical export coal customers for such contract year, certain Australian, Canadian and U.S. producers of metallurgical coal have recently agreed to price reductions of as much as U.S. $4.00 per metric ton for the upcoming contract year, further exacerbating the deteriorating conditions in the metallurgical coal market which have been evident for over a decade. These recent price settlements may require the Minerals Group to further reduce production and sales to the metallurgical coal market. Given these recent developments and in light of the Company's long-standing strategy to reduce its exposure in the metallurgical coal market, the Minerals Group is actively reviewing the carrying value of its production assets to determine whether they are economically viable and whether the Minerals Group should accelerate the continuing implementation of this strategy. During early 1994, coal production was sharply impacted by severe weather conditions which affected much of the United States. These weather conditions also restricted trucking of coal to plants and terminals and impaired shipments from river terminals due to frozen harbors.
On January 14, 1994, Coal operations completed the acquisition of substantially all the coal mining operations and coal sales contracts of Addington Resources, Inc. This acquisition is expected to add approximately 8.5 million tons of low sulphur steam coal sales and production and provide substantial additional reserves of surface minable low sulphur coal. The contracts acquired, some of which contain terms in excess of five years, will provide a broader base of domestic utility customers and reduce exposure in the export metallurgical market, where contract prices are renegotiated annually.
The Company's principal labor agreement with the UMWA expires on June 30, 1994.
In 1992, operating profit for coal was $36.9 million compared with an operating loss of $84.1 million in 1991. Operating results in 1991 included $115.2 million of restructuring charges primarily related to costs associated with mine shutdowns. Production was augmented in 1992 with the addition of a new surface mine in eastern Kentucky, the on-time start-up of the $11 million new Moss 3 preparation plant in September and success of the highwall mining systems utilized at the Heartland surface mine in West Virginia.
Excluding the 1991 restructuring charges, operating results for the Coal segment increased $5.8 million in 1992 compared with 1991. Operating results in 1991 included gains of $5.8 million from the disposal of excess coal reserves. There were no comparable disposals in 1992. Operating profit in 1992 benefitted from a 2.9 million (16%) increase in tonnage sold largely due to shipments to utilities under coal sales contracts acquired in March 1992 and under a contract being supplied by the Company's Heartland mine which began operations in the fourth quarter of 1991. Average margin per ton improved nearly 2% in 1992 compared with 1991, due to a 3% or $.85 per ton decrease in average current production costs of coal sold per ton only partially offset by lower per ton realization. The decrease in average current production costs of coal sold per ton reflects the increase in tonnage sold, increased productivity and a change in production mix. In 1992, 65% of total production was derived from deep mines, and 35% of production was derived from surface mines compared with 76% and 24% of deep and surface mine production respectively, in 1991. Operating profit in 1992 also benefitted from a $2.4 million reduction in federal and state black lung expenses due to favorable claims experience.
In October 1992, the Coal Industry Retiree Health Benefit Act of 1992 (the "Health Benefit Act") was enacted as part of the Energy Policy Act of 1992. The Health Benefit Act established new rules for the payment of future health care benefits for thousands of retired union mine workers and their dependents. Part of the burden for these payments has been shifted by the Health Benefit Act from certain coal producers, which had a contractual obligation to fund such payments, to producers such as the Company which have collective bargaining agreements with the UMWA that do not require such payments and to numerous other companies which are no longer in the coal business. The Health Benefit Act established a trust fund to which "signatory operators" and "related persons," including the Company and certain of its coal subsidiaries (the "Pittston Companies") would be obligated to pay annual premiums for assigned beneficiaries, together with a pro rata share for certain beneficiaries who never worked for such employers ("unassigned beneficiaries"), in amounts to be determined by the Secretary of Health and Human Services on the basis set forth in the Health Benefit Act.
In October 1993, the Pittston Companies received notices from the Social Security Administration (the "SSA") with regard to their assigned beneficiaries for which they are responsible under the Health Benefit Act; the Pittston Companies also received a calculation of their liability for the first two years. For 1993 and 1994, this liability (on a pretax basis) is approximately $9.1 million and $11.0 million, respectively. The Company believes that the annual liability under the Health Benefit Act for the Pittston Companies' assigned beneficiaries will continue in the $10 to $11 million range for the next ten years and should begin to decline thereafter as the number of such assigned beneficiaries decreases. Based on the number of beneficiaries actually assigned by the SSA, the Company estimates the aggregate pretax liability relating to the Pittston Companies' assigned beneficiaries at approximately $265-$275 million, which when discounted at 8% provides a present value estimate of approximately $100-$110 million.
The ultimate obligation that will be incurred by the Company could be significantly affected by, among other things, increased medical costs, decreased number of beneficiaries, governmental funding arrangements and such federal health benefit legislation of general application as may be enacted. In addition, the Health Benefit Act requires the Pittston Companies to fund, pro rata according to the total number of assigned beneficiaries, a portion of the health benefits for unassigned beneficiaries. At this time, the funding for such health benefits is being provided from another source and for this and other reasons the Pittston Companies' ultimate obligation for the unassigned beneficiaries cannot be determined. The Company accounts for its obligations under the Health Benefit Act as a participant in a multi-employer plan and recognizes the annual cost on a pay-as-you-go basis.
In February 1990, the Pittston Coal Group companies and the UMWA entered into a successor collective bargaining agreement that resolved a labor dispute and related strike of Pittston Coal Group operations by UMWA-represented employees that began on April 5, 1989. As part of the agreement, the Pittston Coal Group companies agreed to make a $10 million lump sum payment to the 1950 Benefit Trust Fund and to renew participation in the 1974 Pension and Benefit Trust Funds at specified contribution rates. These aspects of the agreement were subject to formal approval by the trustees of the funds. The trustees did not accept the terms of the agreement and, therefore, payments are being made to escrow accounts for the benefit of union employees.
In 1988, the trustees of certain pension and benefit funds established under collective bargaining agreements with the UMWA brought an action (the so-called "Evergreen Case") against the Company and a number of its coal subsidiaries in the United States District Court for the District of Columbia, claiming that the defendants are obligated to contribute to such trust funds in accordance with the provisions of the 1988 National Bituminous Coal Wage Agreement, to which neither the Company nor any of its subsidiaries is a signatory. In January 1992, the Court issued an order granting summary judgment in favor of the trustees on the issue of liability, which was thereafter affirmed by the Court of Appeals. In June 1993 the United States Supreme Court denied a petition for a writ of certiorari. The case has been remanded to District Court, and damage and other issues remain to be decided. In September 1993, the Company filed a motion seeking relief from the District Court's grant of summary judgment based on, among other things, the Company's allegation that plaintiffs improperly withheld evidence that directly refutes plaintiffs' representations to the District Court and the Court of Appeals in this case. In December 1993, that motion was denied.
In furtherance of its ongoing effort to identify other available legal options for seeking relief from what it believes to be an erroneous finding of liability in the Evergreen Case, the Company has filed suit against the Bituminous Coal Operators Association and others to hold them responsible for any damages sustained by the Company as a result of the Evergreen Case. Although the Company is continuing that effort, the Company, following the District Court's ruling in December 1993, recognized the potential liability that may result from an adverse judgment in the Evergreen Case. In any event, any final judgment in the Evergreen Case will be subject to appeal.
As a result of the Health Benefit Act, there is no continuing liability in this case in respect of health benefit funding after February 1, 1993.
MINERAL VENTURES Mineral Ventures was formed in 1989 to develop opportunities in minerals other than coal. Mineral Ventures operations reported an operating loss of $8.3 million for 1993. This loss includes a $7.9 million charge related to the write-down of the Minerals Group's investment in the Uley graphite mine in Australia. Although reserve drilling of the Uley property indicates substantial graphite deposits, processing difficulties, depressed graphite prices which have remained significantly below the level prevailing at the start of the project and an analysis of various technical and marketing conditions affecting the project resulted in the determination that the assets have been impaired and that loss recognition was appropriate. Excluding the $7.9 million charge, Mineral Ventures operations incurred a $.4 million operating loss. Operating results for 1993 reflected production from the Stawell gold mine. In December 1992, Mineral Ventures acquired its ownership in the Stawell property through its participation in a joint venture with Mining Project Investors Pty Ltd., (in which Mineral Ventures holds a 34% interest). The Stawell gold mine, which is in western Victoria, Australia, currently has proved reserves for approximately four years of production and a current annual output of approximately 70,000 ounces. The joint venture also has exploration rights in the highly prospective district around the mine. Mineral Ventures has a 67% net equity interest in the Stawell mine and its adjacent exploration acreage. In 1993, the Stawell mine produced 73,765 ounces of gold with Mineral Ventures' share of the operating profit amounting to $4.9 million. The contribution to operating profit from the Stawell mine was offset by administrative overhead in addition to exploration expenditures related chiefly to other potential gold mining projects.
Operating losses, which primarily related to expenses for project review and exploration, totalled $3.4 million in 1992 and $3.5 million in 1991.
CORPORATE EXPENSES A portion of the Company's corporate general and administrative expenses and other shared services has been allocated to the Minerals Group based upon utilization and other methods and criteria which management believes to be equitable and a reasonable estimate of such expenses as if the Minerals Group operated on a stand alone basis. These allocations were $7.2 million, $8.6 million and $8.1 million in 1993, 1992 and 1991, respectively.
OTHER OPERATING INCOME Other operating income for the Minerals Group primarily consists of royalty income from coal and natural gas properties and gains and losses attributable to sales of property and equipment. Other operating income increased $1.5 million to $10.3 million in 1993 from $8.8 million in 1992 and decreased $10.6 million in 1992 from $19.4 million in 1991. In 1991, other operating income included gains aggregating $5.8 million from the disposal of certain excess coal reserves. There were no comparable disposals in 1993 or 1992.
OTHER INCOME (LOSS), NET Other income (loss), net was a net loss of $.5 million in 1993 and net income in 1992 and 1991 of $1.9 million and $11.1 million, respectively. The net amounts in 1992 and 1991 included gains of $2.3 million and $11.1 million, respectively, from the sales of investments in leveraged leases.
INTEREST EXPENSE Interest expense in 1993 decreased $2.2 million from $3.5 million in 1992 and increased $1.5 million in 1992 from $2.0 million in 1991. The decrease in 1993 was attributable to lower outstanding debt during the year, partially offset by interest assessed in 1993 on settlement of coal litigation related to the moisture content of tonnage used to compute royalty payments to UMWA pension and benefit funds. Interest expense in 1993, 1992 and 1991 included a portion of the Company's interest expense related to borrowings from the Company's revolving credit lines which was attributed to the Minerals Group. The amount of interest expense attributed to the Minerals Group for 1993, 1992 and 1991 was $.4 million, $2.8 million and $1.4 million, respectively.
TAXES AND EXTRAORDINARY CREDITS In 1993, the credit for income taxes is higher than the amount that would have been recognized using the statutory federal income tax rate of 35% due to the tax benefits of percentage depletion, favorable adjustments to deferred tax assets as a result of the increase in the statutory U.S. federal income tax rate and a reduction in the valuation allowance for deferred tax assets primarily in foreign jurisdictions. In 1992, the provision for income taxes was less than the statutory federal income tax rate of 34% and in 1991 the credit for income taxes was higher than the amount that would have been recognized using the federal statutory income tax rate of 34% because of the tax benefit from percentage depletion.
The Minerals Group's net deferred federal tax assets are based upon their expected utilization in the Company's consolidated federal income tax return and the benefit that would accrue to the Minerals Group under the Company's tax allocation policy.
FINANCIAL CONDITION A portion of the Company's corporate assets and liabilities has been attributed to the Minerals Group based upon utilization of the shared services from which assets and liabilities are generated, which management believes to be equitable and a reasonable estimate of the assets and liabilities which would be generated if the Minerals Group operated on a stand alone basis.
Corporate assets which were allocated to the Minerals Group consisted primarily of pension assets and deferred income taxes and amounted to $90.1 million and $54.3 million at December 31, 1993 and 1992, respectively.
CASH FLOW PROVIDED BY OPERATING ACTIVITIES Cash provided by operations totalled $28.4 million in 1993, a $17.0 million decrease compared with $45.4 million generated by operations in 1992. The net decrease in 1993 compared with 1992 consisted of a $54.8 million decrease attributable to the change in net income and a $19.9 million decrease attributable to a change in net noncash charges and credits, partially offset by a $57.7 million decrease attributable to changes in operating assets and liabilities. Net income, noncash charges and changes in operating assets and liabilities in 1993 were significantly affected by after-tax restructuring and other charges for Minerals Group of $48.9 million which had no effect in 1993 on cash generated by operations. Of the total amount of the 1993 charges, $10.8 million was for noncash write-downs of assets and the remainder represents liabilities, of which $7.0 million are expected to be paid in 1994. The Minerals Group intends to fund any cash requirements during 1994 with anticipated cash flows from operations, with shortfalls, if any, financed through borrowings under the Company's revolving credit agreements or short-term borrowing arrangements or borrowings from the Services Group.
Cash required to support the Minerals Group's investing activities was less than cash generated from operations and, as a result, after financing its stock activities, the Minerals Group made an additional cash loan to the Services Group of $13.3 million during 1993.
CAPITAL EXPENDITURES Cash capital expenditures totalled $21.7 million for the 1993. An additional $45.5 million was financed in 1993 through operating leases which were predominately for surface mining equipment. Approximately 96% of the gross capital expenditures in 1993 were incurred in the Coal segment. Of that amount, greater than 40% of the expenditures was for business expansion, and the remainder was for replacement and maintenance of current ongoing business operations. Gross expenditures made by Mineral Ventures operations approximated 4% of the Minerals Group's total capital expenditures and were primarily costs incurred for project development.
Cash capital expenditures for 1993 were funded by cash flow from operating activities, with any shortfalls financed through the Company by borrowings under its revolving credit agreements or short-term borrowing arrangements, which were thereby attributed to the Minerals Group.
OTHER INVESTING ACTIVITIES All other investing activities in 1993 provided net cash of $12.0 million, which was largely attributable to proceeds from the sale of the assets of a coal subsidiary. Cash, net of any expenses related to the transaction, totaled $9.7 million.
In January 1994, the Minerals Group paid $157 million in cash for the acquisition of substantially all the coal mining operations and coal sales contracts of Addington Resources, Inc. (the "Addington Acquisition"). The purchase price of the acquisition was financed through the issuance of $80.5 million of a new series of convertible preferred stock, which is convertible into Minerals Stock, and additional debt under existing revolving credit facilities.
FINANCING Gross capital expenditures in 1994 are not currently expected to increase significantly over 1993 levels. The Minerals Group intends to fund such expenditures through cash flow from operating activities or through operating leases if the latter are financially attractive. Any shortfalls will be financed through the Company's revolving credit agreements or short-term borrowing arrangements. As of December 31, 1993, revolving credit agreements provided for commitments of up to $250.0 million. At December 31, 1993, no portion of the borrowings outstanding under those agreements, which amounted to $2.1 million, was attributed to the Minerals Group, as cash generated from operations was sufficient for Minerals' investing and financing activities. In March 1994, the Company entered into a $350.0 million revolving credit agreement with a syndicate of banks (the "New Facility"), replacing the Company's previously existing $250.0 million of revolving credit agreements. The New Facility includes a $100.0 million five-year term loan, which matures in March 1999. The New Facility also permits additional borrowings, repayments and reborrowings of up to an aggregate of $250.0 million until March 1999.
DEBT Total debt outstanding for the Minerals Group amounted to $.3 million. At December 31, 1993, none of the Company's long-term debt was attributed to the Minerals Group.
Subsequent to December 31, 1993, the Addington Acquisition was financed in part with debt under the Company's revolving credit facilities, which was attributed to the Minerals Group. In March 1994, the additional debt incurred for this acquisition was refinanced with a five-year term loan under the New Facility.
CONTINGENT LIABILITIES In April 1990, the Company entered into a settlement agreement to resolve certain environmental claims against the Company arising from hydrocarbon contamination at a petroleum terminal facility ("Tankport") in Jersey City, New Jersey, which operations were sold in 1983. Under the settlement agreement, the Company is obligated to pay 80% of the remediation costs. Based on data available to the Company and its environmental consultants, the Company estimates its portion of the cleanup costs on an undiscounted basis using existing technologies to be between $4.5 million and $13.5 million over a period of three to five years. Management is unable to determine that any amount within that range is a better estimate due to a variety of uncertainties, which include the extent of the contamination at the site, the permitted technologies for remediation and the regulatory standards by which the cleanup will be measured by the New Jersey Department of Environmental Protection and Energy.
The Company commenced insurance coverage litigation in 1990, in the United States District Court for the District of New Jersey, seeking a declaratory judgment that all amounts payable by the Company pursuant to the Tankport obligation were reimbursable under comprehensive general liability and pollution liability policies maintained by the Company. Although the underwriters have disputed this claim, management and its legal counsel believe that recovery is probable of realization in the full amount of the claim. This conclusion is based upon, among other things, the nature of the pollution policies which were broadly designed to cover such contingent liabilities, the favorable state of the law in the State of New Jersey (whose laws have been found to control the interpretation of the policies), and numerous other factual considerations which support the Company's analysis of the insurance contracts and rebut many of the underwriters' defenses.
Accordingly, since management and its legal counsel believe that recovery is probable of realization in the full amount of the claim, there is no net liability in regard to the Tankport obligation.
CAPITALIZATION On July 26, 1993, the Company's shareholders approved the Services Stock Proposal, as described in the Company's proxy statement dated June 24, 1993, which resulted in the reclassification of the Company's common stock. The outstanding shares of common stock of the Company were redesignated as Pittston Services Group Common Stock ("Services Stock") on a share-for-share basis and a second class of common stock, designated as Minerals Stock, was distributed on the basis of one-fifth of one share of Minerals Stock for each share of the Company's previous common stock held by shareholders of record on July 26, 1993. Minerals Stock and Services Stock are designed to provide shareholders with separate securities reflecting the performance of the Minerals Group and the Services Group, respectively, without diminishing the benefits of remaining a single corporation or precluding future transactions affecting either Group.
The redesignation of the Company's common stock as Services Stock and the distribution of Minerals Stock as a result of the approval of the Services Stock Proposal did not result in any transfer of assets and liabilities of the Company or any of its subsidiaries. Holders of Services Stock and Minerals Stock are shareholders of the Company, which continues to be responsible for all its liabilities. Therefore, financial developments affecting the Minerals Group or the Services Group that affect the Company's financial condition could affect the results of operations and financial condition of both Groups. The change in the capital structure of the Company had no effect on the Company's total capital, except as to expenses incurred in the execution of the Services Stock Proposal. Since the creation of Minerals Stock upon approval of the Services Stock Proposal, capitalization of the Minerals Group has been affected by all share activity related to Minerals Stock.
In July 1993, the Board authorized a new share repurchase program under which up to 1,250,000 shares of Services Stock and 250,000 shares of Minerals Stock may be repurchased. This program replaced the previous program under which 1,500,000 shares of common stock of the Company remained authorized for repurchase. During 1993 under the previous program 75,000 shares of the Company's common stock were repurchased at a total cost of $1.1 million. Under the new share repurchase program through December 31, 1993, 19,000 shares of Minerals Stock were repurchased at a total cost of $.4 million.
In January 1994, the Company issued $80.5 million of a new series of convertible preferred stock, which is convertible into Minerals Stock, to finance a portion of the Addington Acquisition.
DIVIDENDS The Board intends to declare and pay dividends on Minerals Stock based on the earnings, financial condition, cash flow and business requirements of the Minerals Group. Since the Company remains subject to Virginia law limitations on dividends and to dividend restrictions in its public debt and bank credit agreements, losses incurred by the Services Group could affect the Company's ability to pay dividends in respect of stock relating to the Minerals Group. Dividends on Minerals Stock are also limited by the Available Minerals Dividend Amount as defined in the Company's Articles of Incorporation. At December 31, 1993, the Available Minerals Dividend Amount was at least $10.1 million. After giving effect to the issuance of the convertible preferred stock, the pro forma Available Minerals Dividend Amount would have been at least $85.6 million.
On an equivalent basis, in 1993 the Company paid dividends on 62.04 cents per share of Minerals Stock compared with 49.24 cents per share of Minerals Stock in 1992.
In January 1994, 161,000 shares of convertible preferred stock (convertible into Minerals Stock) were issued to finance a portion of the Addington Acquisition. Commencing March 1, 1994, annual cumulative dividends of $31.25 per share of convertible preferred stock are payable quarterly, in cash, in arrears from the date of original issue out of all funds of the Company legally available therefor, when, as and if declared by the Board. Such stock bears a liquidation preference of $500 per share, plus an amount equal to accrued and unpaid dividends thereon.
PENDING ACCOUNTING CHANGES The Minerals Group is required to implement a new accounting standard for postemployment benefits - SFAS No. 112 - in 1994. SFAS No. 112 requires employers who provide benefits to former employees after employment but before retirement to accrue such costs as the benefits accumulate or vest. The Minerals Group has determined the effect of adopting SFAS No. 112 is immaterial.
The Minerals Group is required to implement a new accounting standard for investments in debt and equity securities - SFAS No. 115 - in 1994. SFAS No. 115 requires classification of debt and equity securities and recognition of changes in the fair value of the securities based on the purpose for which the securities are held. The Minerals Group does not have investments in debt or equity securities and therefore the provisions of SFAS No. 115 do not apply.
Item 8: | 78890 | 1993 |
Item 6. Selected Financial Data The information required by this Item is contained in Part II, Item 7 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Business Conditions Northrop's industry segments - aircraft, electronics, missiles and unmanned vehicle systems (MUVS) and services - are each a factor in the broadly defined aerospace industry. Much of the work in the missiles and unmanned vehicle systems segment is still classified, and contracts and program details cannot be disclosed. While Northrop is subject to the usual vagaries of the marketplace, it is also affected by the unique characteristics of the aerospace industry and by certain elements peculiar to its own business mix. Northrop is one of about a dozen major companies in the industry that compete for the relatively small number of large, long-term programs that characterize both the defense and commercial segments of the aerospace business. It is common in the aerospace industry for work on major programs to be shared between a number of companies. A company competing to be a prime contractor can turn out to be a subcontractor. It is not uncommon to compete with customers, and to simultaneously be both a supplier to and customer of a given competitor. Boeing, Lockheed and McDonnell Douglas are the largest companies in the aerospace industry at this time. Northrop also competes against many other companies for a relatively large number of smaller programs, notably in the electronics areas. Competition is intense, yet the nature of major aerospace programs, conducted under binding contracts, allows companies that perform well to benefit from a level of program continuity unknown in many industries. Thus, intense competition and long operating cycles are both characteristic of the industry's - and Northrop's - business. The B-2 bomber, for which the company is the prime contractor, is Northrop's largest program. Northrop's B-2 Division is responsible for assembly (in Palmdale, California) of the B-2's airframe, systems integration and parts of the B-2's navigation and electronic warfare/situational awareness system. Major subcontractors include Boeing, which makes the aft and outboard wing sections, landing gear and fuel system and Vought Aircraft, which makes fuselage sections. The Air Force plans to operate two B-2 bomber squadrons of eight aircraft each with the remaining four operational aircraft available to fill in for those in depot being serviced or upgraded. The company's Aircraft Division is the principal subcontractor on the McDonnell Douglas F/A-18 program. The F/A-18 is a fighter/ground-attack aircraft that can carry either one or two crew members. It is principally deployed by the U.S. Navy on aircraft carriers, but several nations have purchased the aircraft and use it as a land-based combat aircraft. The company builds approximately 40% of the aircraft including the center and aft fuselage sections and vertical tails. Of the several versions of the F/A-18 in service, the A is a single seat combat aircraft that was first delivered to the Navy in 1980 and the B is a two seat version principally used for training. A/B production ended in 1987 when a transition was made to the C and D versions of the aircraft that are now in production. The single seat C version differs from the A through better avionics, electronic warfare capability, the ability to carry more advanced missiles and a longer range. The F/A-18E/F program is an improved version of the F/A-18C/D under development for the U.S. Navy as its next generation multi- mission aircraft. Northrop's principal commercial program is the production of shipsets for the Boeing 747, which it has done since the program's inception in 1966. The company builds the 153 foot center fuselage section and related cargo and passenger doors, floor beams and other structural components. Northrop's Aircraft Division is responsible for developing the AGM-137 Tri-Service Stand-Off Attack Missile (TSSAM) which is a stealthy conventional cruise missile. The program is being managed by the Air Force, and was originally intended for all three U.S. military services, before the Army's recent withdrawal. The company currently intends to produce this missile at its Perry, Georgia, facility. Many aspects of the program remain classified. The company's Aircraft Division also produces aerial targets, principally the BQM-74/Chukar. The BQM-74 series has been in production since the 1960s. It is used by the Navy for air defense training, gunnery practice and weapon system evaluation. The company builds the airframe and the electronics that are used to guide the drone with the drone's engine being produced by Williams International. ECM denotes electronic countermeasures equipment manufactured by the company's Electronics Systems Division (ESD) - Rolling Meadows Site. The largest program in this business area is the AN/ALQ-135, which is an internally mounted radar jammer deployed on aircraft as part of that aircraft's Tactical Electronic Warfare System. The AN/ALQ-162 "Shadowbox" is a jammer built specifically to counter continuous wave (CW) radars. The AN/ALQ-162 has been installed on F/A-18C/D and AV-8B aircraft. It is also being deployed on U.S.Army helicopters and special mission aircraft and it has been sold to the Danish Air Force for installation on Draken and fighters. Northrop's ESD-Hawthorne Site, as the prime contractor to the U.S. Army, is developing a "brilliant" anti-armor submunition designated as BAT with production scheduled to commence in 1997. BAT is a three foot long, 44 pound, wide-area-attack submunition that would be used to disable and destroy armored vehicles and trucks. BATs are meant to be carried and dispensed by a larger missile. BATS will be ejected over an armored vehicle column or attacking formation. Each BAT has an infrared sensor that can home in on the heat generated by a vehicle's engine, and an acoustic sensor that can home in on the noise created by the tank or truck's engine. Tables of contract acquisitions, sales, and funded order backlog by major program follow and complement industry segment data. B-2, F/A-18 and 747 are currently the major programs of the aircraft industry segment. ECM, BAT and MX Peacekeeper are included in the electronics industry segment. The company's MUVS industry segment includes TSSAM. The "all other" category includes aerial targets and other work done by the MUVS industry segment, as well as the balance of the company's numerous other contracts, classified and unclassified.
RESULTS OF OPERATIONS BY INDUSTRY SEGMENT AND MAJOR CUSTOMER
Individual companies prosper in the competitive aerospace/defense environment according to their ability to develop and market innovative products. They must also have the ability to provide the people, facilities, equipment and financial capacity needed to deliver those products with maximum efficiency. It is necessary to maintain, as the company has, sources for raw materials, fabricated parts, electronic components and major subassemblies. In this manufacturing and systems integration environment, effective oversight of subcontractors and suppliers is as vital to success as managing internal operations. Northrop's operating policies are designed to enhance these capabilities. The company also believes that it maintains good relations with its employees, a small number of whom are covered by collective bargaining agreements. U.S. Government programs in which Northrop either participates, or strives to participate, must compete with other programs for consideration during our nation's budget formulation and appropriation processes. As a consequence of the end of the Cold War and pressure to reduce the federal budget deficit, the U.S. defense budget is expected to continue to decline for a number of years. Budget decisions made in this environment will have long-term consequences for the size and structure of Northrop and the entire defense industry. An important factor in determining Northrop's ability to successfully compete for future contracts will be its cost structure vis-a-vis other bidders. Given these conditions, it is difficult to predict the amount and rate of decline in defense outlays. Although the ultimate size of future defense budgets remains uncertain, the defense needs of the nation are expected to provide a substantial research and development (R&D) and procurement business base for the company to pursue in the future. Northrop has historically concentrated much of its efforts in such high technology areas as stealth and precision weapons. Even though a high priority has been assigned by the Department of Defense to our major programs, there remains the possibility that one or more of them may be reduced, stretched or terminated. In the commercial aircraft market, many airlines have deferred deliveries and purchases of new aircraft because of financial difficulties. This has caused The Boeing Company to announce substantial reductions in its scheduled production of various jetliners, including the 747. As a result, Northrop's subcontract workload for the 747 has been stretched out beginning in late 1993, with deliveries declining 40 percent through mid-1994 and another 33 percent through mid-1995. Although business conditions in the commercial aircraft industry currently remain tenuous, the company is optimistic about the longer-term prospects for its commercial aircraft structures business. In September 1992, Northrop purchased a minority interest in the parent company of Vought Aircraft Company (VAC), a manufacturer of major subsections for both commercial and military aircraft. Northrop has an option to purchase the remaining interest during a three-year period beginning in late 1995. The investment was made in line with our previously stated strategy to increase Northrop's participation in these markets over the longer term. The decision to exercise the option will be based in part on the business climate of the industry in the three-year period. VAC's cash flow has been large enough to enable it to repay all the debt undertaken to finance the acquisition, permit the early cancellation of Northrop's loan guaranties, and pay its first cash dividend to Northrop, nearly $2 million in 1993. Northrop's emphasis on debt reduction, primarily through better cash management, has resulted in lowering debt by over 86 percent during the last four years, from $1.12 billion to $160 million. This gives Northrop the ability to pursue new business opportunities when justified by acceptable financial returns and technological risks. Northrop examines opportunities to acquire or invest in new businesses and technologies to strengthen its traditional business areas. The company also is exploring new directions for marketing and capitalizing on its technologies and skills by entering into joint ventures, partnerships or associations with companies that are world class in nontraditional fields. Northrop, as well as many other companies in the defense industry, continues to suffer the effects of the Department of Defense's practice in the 1980s of structuring new, high-risk development contracts as fixed-price or capped cost-reimbursement type contracts. Although Northrop stopped accepting these types of contracts in 1988, it has experienced financial losses on several programs acquired under them in the past, including TSSAM. This is Northrop's last remaining development program being carried out under a fixed-price contract. While Northrop conducts most of its business with the U.S. Government, principally the Department of Defense, commercial sales still represent a significant portion of total revenue.Prime contracts with various agencies of the U.S. Government and subcontracts with other prime contractors are subject to a profusion of procurement regulations, with noncompliance found by any one agency possibly resulting in fines, penalties, debarment or suspension from receiving additional contracts with all agencies. Given the company's dependence on government business, suspension or debarment could have a material adverse affect on the company's future. Moreover, these contracts may be terminated at the Government's convenience. In the event of termination for convenience, however, contractors are normally protected by provisions covering reimbursement for costs incurred as well as the payment of any applicable fees or profits. Federal, state and local laws relating to the protection of the environment affect the company's manufacturing operations. The company has provided for the estimated cost to complete remediation where it is probable that the company will incur such costs in the future, including those for which it has been named a Potentially Responsible Party (PRP) by the Environmental Protection Agency or similarly designated by other environmental agencies. The company has been designated a PRP under federal Superfund laws at three hazardous waste sites (Chemtronics, Stringfellow and Operating Industries, Inc.) and under state law at four sites (Southland Oil; ESD - Precision Products Plants 2 and 7; and Lubrication Company of America). It is difficult to estimate the timing and ultimate amount of environmental cleanup costs to be incurred in the future due to the uncertainties regarding the extent of the required cleanup and the status of the law, regulations and their interpretations. Nonetheless, to assess the potential impact on the company's financial statements, management estimates the total reasonably possible remediation costs that could be incurred by the company. Such estimates take into consideration the professional judgment of the company's environmental engineers and, when necessary, consultation with outside environmental specialists. In most instances, only a range of reasonably possible costs can be estimated. The top end of the range is reflected as the total estimate of reasonably possible costs; however, in the determination of accruals the most probable amount is used when determinable and the low end of the range is used when no single amount is more probable. The company records accruals for environmental cleanup costs in the accounting period in which the company's responsibility is established and the costs can be reasonably estimated. Management estimates that at December 31, 1993, the reasonably possible range of future costs for environmental remediation, including Superfund sites, is $14 million to $26 million, of which $14 million has been accrued. The amount accrued has not been offset by potential recoveries from insurance carriers or other potentially responsible parties (PRPs). Should other PRPs not pay their allocable share of remediation costs the company may have to incur costs in addition to those already estimated and accrued. In 1993 the company was awarded a judgement of $6.7 million against its insurance carrier with respect to costs associated with the ESD-Precision Products Plant 2 remediation. This award is currently on appeal and is not reflected in the company's 1993 financial statements. The company is making the necessary investments to comply with environmental laws; however, the amounts, while not insignificant, are not considered material to the company's financial position or results of its operations.
Measures of Volume Contract acquisitions tend to fluctuate widely and are determined by the size and timing of new and add-on orders. The effects of multiyear orders and/or funding can be seen in the highs and lows shown in the following table. B-2 acquisitions in 1993 include incremental funding for ongoing development work, long-lead funding for the last five remaining production aircraft, spares and other customer support for this 20 operational aircraft program. In January of 1994, $2.4 billion of funding was awarded to complete these five aircraft by modifying, effective October 29, 1993, the previous Low Rate Initial Production (LRIP) contract. The company still stands to gain future new post-production business, such as airframe depot maintenance, repair of components, operational software changes and product improvement modifications. The debate over the future of the B-2, which is built on the nation's only extant bomber producing facility, has yet to take place. Without future production orders the nations's multi- billion dollar investment in this capability will be disassembled and largely irretrievable. .......................................................................... Contract Acquisitions $ in millions 1993 1992 1991 1990 1989
B-2 $2,632 $2,235 $4,794 $3,749 $3,065 F/A-18C/D 89 576 564 529 632 F/A-18E/F 743 131 10 747 242 76 870 950 719 ECM 445 361 431 395 303 TSSAM 248 349 369 277 428 BAT 90 147 82 51 30 MX Peacekeeper 26 4 28 84 79 ATF 191 242 All other 292 285 404 374 485 $4,807 $4,164 $7,552 $6,600 $5,983 .......................................................................... In 1993, $743 million of funding was received toward the development of the next generation F/A-18, the E/F version. This development program has an estimated value of $1.4 billion to Northrop. No orders for new F/A- 18C/D shipsets were received in 1993 from the McDonnell Douglas Corporation. In 1992, orders for 88 F/A-18C/D shipsets were received. In 1991, 70 F/A-18C/D shipsets were ordered, compared with 84 in each of the years 1990 and 1989. The Boeing Company ordered one hundred 747 shipsets in each of the years 1989 through 1991. In 1993, additional contract value was received for, among other things, extending the delivery schedule of those shipsets into 1996. Year-to-year sales vary less than contract acquisitions and reflect performance under new and ongoing contracts. Sales for 1994 currently are expected to be about $4.4 billion. .......................................................................... Net Sales $ in millions 1993 1992 1991 1990 1989 B-2 $2,881 $3,212 $3,100 $2,744 $2,554 F/A-18C/D 362 492 562 597 629 F/A-18E/F 279 118 10 747 531 549 540 483 461 ECM 372 378 415 425 341 TSSAM 179 265 390 343 219 BAT 100 135 71 55 22 MX Peacekeeper 31 46 90 153 239 ATF 191 242 All other 328 355 516 499 541 $5,063 $5,550 $5,694 $5,490 $5,248 .......................................................................... The increasing trend of B-2 sales, begun in 1990 was reversed in 1993, one year earlier than forecasted a year ago. A decrease in revenues from engineering and manufacturing development (EMD) work exceeded the decrease in revenues for production work. The level of EMD effort, included in amounts reported as customer-sponsored R&D, constituted 28 percent of the total B-2 revenue, down from 34 percent in 1992. Current planning data indicate that the level of overall B-2 revenue will decline roughly 20 percent per year for the remainder of the decade. Sales under the F/A-18C/D program declined in 1993 with the delivery of 52 shipsets. In 1992, the company delivered 75 shipsets, compared with 80 in 1991, 94 in 1990, and 101 in 1989. In 1994 and 1995, the company plans to deliver 42 and 60 F/A-18C/D shipsets respectively. F/A-18E/F revenue is expected to exceed $400 million in 1994. Deliveries of 747 center fuselages were 54 in 1993, 60 in 1992, 62 in 1991, 56 in 1990, and 54 in 1989. Thirty-one fuselages are expected to be delivered in 1994 and 26 in 1995. Sales reversals were recorded on the TSSAM contract amounting to $128 million in 1993, $80 million in 1992 and $120 million in 1989. These reversals followed reductions in the estimate of the percentage of work completed to date on the contract. In addition, 1991 MUVS segment sales included the final revenue earned from the conclusion that year of the Tacit Rainbow missile program. Electronics segment revenues declined 13 percent in 1993 with half the decline coming from two programs -- lower BAT development revenue and lower MX Peacekeeper sales. The final seven Peacekeeper IMUs were delivered in 1991 versus 16 in 1990, and 28 in 1989. Ongoing system support work will generate a modest amount of future revenue. The second largest cause of reduced electronics segment revenues in 1993 stemmed from lower sales in the sensor product area while in both 1993 and 1992 fewer deliveries of missile components by the ESD-Precision Products operation were made versus the respective previous year. Overall Electronics sales are expected to decline only slightly for 1994. The year-end funded order backlog is the sum of the previous year-end backlog plus the year's contract acquisitions minus the year's sales. Backlog is converted into the following years' sales as deliveries are made under contract terms. It is expected that approximately 60 percent of the 1993 year-end backlog will be converted into sales in 1994. .......................................................................... Funded Order Backlog $ in millions 1993 1992 1991 1990 1989 B-2 $3,921 $4,170 $5,147 $3,453 $2,448 F/A-18C/D 443 716 632 630 698 F/A-18E/F 477 13 747 723 1,012 1,485 1,155 688 ECM 540 467 484 468 498 TSSAM 367 298 214 235 301 BAT 20 30 18 7 11 MX Peacekeeper 17 22 64 126 195 All other 411 447 517 629 754 $6,919 $7,175 $8,561 $6,703 $5,593 .......................................................................... Total U.S. Government orders, including those made on behalf of foreign governments (FMS), comprised 89 percent of the backlog at the end of 1993 compared with 85 percent at the end of 1992, 82 percent at the end of both 1991 and 1990, and 87 percent at the end of 1989. Total foreign customer orders, including FMS, accounted for 3 percent of the backlog at the end of 1993 compared with 2 percent in 1992, 3 percent in 1991, 4 percent in 1990, and 3 percent in 1989. Domestic commercial business remaining in backlog at the end of 1993 was 11 percent, 14 percent at the end of 1992, 17 percent for both 1991 and 1990, and 12 percent at the end of 1989.
Measures of Performance
Loss provisions made during 1993 on the TSSAM development contract aggregated $201 million, and followed similar provisions of $152 million made in the third quarter of 1992 and $150 million in the second quarter of 1989. The expected loss from the performance of this classified long-term fixed-price R&D contract caused major losses in the MUVS segment during four of the last six years. Most of these provisions resulted from additional costs necessary to comply with contractual requirements. Other recent factors included the U. S. Army's January 1994 stop work order preparatory to the deletion of its variant of TSSAM along with the Government's indication that it has further delayed a production decision on other variants until June 1994. Production delays cause increased amounts of sustaining labor to be absorbed by the development phase of the program. Anticipated total production quantities are approaching one-half of those originally contemplated. This could result in an increased production cost per unit. The company faces the challenge of successfully completing, by the end of 1997, the development phase of the program in which it has invested over $600 million. Given the pressure to shrink the defense budget, the Government may have to consider whether it should complete the current TSSAM program as planned, modify it, or terminate it for its convenience and reallocate available funds to other activities. The company plans to recover the $144 million investment in plant and equipment that it made for the production phase of the program through its successful execution. Should the Government decide not to produce the missile, the company will seek to recoup its investment from the government. Because of the nature of the TSSAM long-term fixed-price development contract, additional losses are possible. The ultimate loss on this contract will depend not only upon the accuracy of the company's cost projections, but also the eventual outcome of an equitable settlement of outstanding contractual issues with the U.S. Government, including a $154 million claim filed in November 1993. The company's traditional line of aerial targets was profitable in each of the last five years. The overall increase in MUVS operating profit in 1991 versus 1990 resulted from the completion of the Tacit Rainbow missile program at less cost than had previously been estimated. The company has improved the margin rate of each of its two largest and most mature industry segments -- Aircraft and Electronics. These improvements have been partially offset by the poor performance of the MUVS segment. Company-wide efforts to improve and streamline the management of the business continue. Tighter business controls, cost reduction, cash management and effective asset utilization are all aimed at contributing to two important long standing financial goals; achieving a 20 percent return on equity and repaying debt, if we so choose, by the mid-1990s. This financial report demonstrates the degree to which the accomplishment of these goals is being achieved. Operating profit in the aircraft industry segment increased to its highest level ever in 1993 as margin rates improved on all major aircraft programs - B-2, F/A-18 and 747. The F/A-18 and 747 improvements came despite reduced shipset deliveries in 1993. The primary cause of aircraft segment operating profit being higher in 1991 than 1992 was the one percentage point increase in the B-2 LRIP contract margin rate made during the fourth quarter of 1991 on sales recorded prior to that date ($40 million of margin). This 1991 margin rate adjustment followed definitization of the LRIP contract late in the year and took into account the company's production and assembly experience as of that date. Setting aside the $40 million adjustment, the B-2 program provided an increasing amount of operating margin in each of the last three years as the mix of sales continue its shift from relatively low-margin R&D work to production work. Following the recent award of the last increment of production funding for the B-2 the company will record future operating margin increases on all production aircraft as these units are delivered and accepted by the customer. At the time each unit is delivered an assessment will be made of the status of the production contract so as to estimate the amount of any probable additional margin available beyond that previously recognized. That unit's proportionate share of any such unrecognized remaining balance will then be recorded. In this fashion it is believed that margin improvements will be recognized on a more demonstrable basis, much like in the case of incentive or award fees. The current 15 production units are scheduled for their initial delivery over a five year period, which began in December 1993. All but two units (four equivalent units for this purpose) will be returned for scheduled retrofitting with final deliveries beginning in 1997 and ending in 2000. It is anticipated that the total of 30 equivalent units will be delivered at a rate of from three to five per year over the next seven years. Affecting the comparison of 1992 aircraft operating profit with that of 1991 were the slightly lower rates of margin earned on fewer F/A-18C/D and 747 shipset deliveries. In addition, a low rate of margin was recorded in 1992 on the F/A-18E/F as this program is in its early phase of development. Partially offsetting the B-2 margin improvement for 1991 was the lower rate of margin earned on the reduced number of F/A-18 shipsets delivered during 1991. A slightly lower rate of margin was earned on higher 747 shipset deliveries generating an overall increase in the amount of 747 margin. Affecting comparisons of 1991 aircraft segment operating profit with those of the previous two years are the amounts invested and written off on the ATF program - $66 million during 1990, compared with $73 million in 1989. With the completion of the DEM/VAL phase of ATF in 1990 the company discontinued making any material amount of expenditures for company-sponsored R&D. The 13 percent sales decline in the electronics segment for 1993 was accompanied by an 11 percent decline in operating profit. An increase in ECM operating margin and the benefit of a $5 million reduced loss at ESD's Precision Products operation offset lower margins in the sensor product area and on the BAT program. The amount and rate of operating profit earned by the electronics segment increased during 1992 despite the loss incurred by ESD Precision Products. ESD Precision Product's operating loss declined $7 million from that of 1991. In 1992 Precision Products suffered from the effects of a 24 percent sales decline coupled with a $6 million write-off of unrecoverable inventoried costs. Also influencing the trend in the electronics segment operating profit has been the replacement of high-margin Peacekeeper production revenue by low-margin BAT development revenue. While the rate of operating profit for 1991 improved slightly for the electronics segment, the amount of profit declined $2 million. The rate increase was largely achieved by the ECM area where improved margins accompanied higher sales of the successful AN/ALQ-135 system developed for the fighter aircraft. Offsetting this increase was the cost of settling various legal and product disputes, principally for ESD Precision Products. Of the aggregate of $31 million in provisions made during 1991 for these issues, $12 million is reported in Other Deductions in the Consolidated Statements of Operations. Operating margin in 1993 included $71 million of pension income compared with $83 million in 1992, and $23 million in 1991. Nearly offsetting the 1993 reduction in pension income was 1993's decline in the cost of providing retiree health care and life insurance benefits - $32 million in 1993 versus $41 million in 1992, and $47 million in 1991. For calculating the liability balances for these plans at December 31, 1993 the company reduced the discount rate used from 8 to 7 percent and changed its employee turnover assumptions. The net affect of this served to increase year-end liability balances for all plans by $402 million. Also, for 1994, these changes will cause a $27 million reduction in pension income and an $8 million increase in retiree health care and life insurance benefit costs from what they otherwise would be. The Financial Accounting Standards Board's (FASB) accounting standard No. 106 - Employers' Accounting for Postretirement Benefits Other than Pensions - was adopted by the company in 1991. The liability representing previously unrecognized costs of $145 million for all years prior to 1991 was recorded as of January 1, 1991, with an after-tax effect on earnings of $88 million or $1.86 per share. The company's adoption in 1992 of the new FASB accounting standard No. 112 - Employers' Accounting for Postemployment Benefits - had no material effect on the company's financial position or operating results. Interest expense declined in each of the last four years - $9 million in 1993, $33 million in 1992, $15 million in 1991, and $29 million in 1990, with nearly all of these reductions stemming from four years of debt reduction which totaled $960 million, or 86 percent. In 1991 the company adopted the FASB standard No. 109 - Accounting for Income Taxes - and recorded, as of January 1, 1991, a benefit of $21 million, or 43 cents per share. As described in the accounting policy footnote to the financial statements, any future change in the tax rate would result in the immediate recognition in current earnings of the cumulative effect from deferred tax assets and liabilities. The company's effective federal income tax rate was 43.5 percent in 1993, 32.8 percent in 1992, and 3.2 percent in 1991. The rate for 1993 would have been 31.8 percent but for the effects of the retroactive application of The Revenue Reconciliation Act of 1993. The one percentage point increase in the federal statutory income tax rate, now 35 percent, required the redetermination of December 31, 1992 deferred tax asset and liability balances. This redetermination added $18 million to 1993's tax provision thereby reducing earnings per share by 38 cents. During 1989 final regulations were issued concerning the research tax credit. The company took a conservative approach in calculating its tax provisions since 1981 pursuant to uncertain proposed regulations. An exhaustive study was undertaken throughout the company to redetermine qualifying expenditures in compliance with final regulations so as to recalculate prior years' tax credits and amend its tax returns as appropriate. The benefit resulting from the conclusion of that study was the $90 million in additional research credits recognized in the determination of the 1991 effective tax rate of 3.2 percent.
Measures of Liquidity and Capital Resources The evolution of the company's financial condition and liquidity, which began in 1990, continued to improve in 1993. Over these last four years operating cash flows have averaged $385 million annually. While cash flow from operations increased $96 million in 1993 over that of 1992, it declined $325 million in 1992 from that of 1991. Much of the increase in 1991's cash flow from operations resulted from the company finalizing the B-2 LRIP contract, after it was about 50 percent complete, as well as follow-on contracts for 747 and F/A-18 work. To a great extent the pace of delivery of B-2 production aircraft and the satisfactory completion of program milestones will dictate the future level of any required capital resources. Provisions for contract losses are one of the important elements shown in illustrating the difference between Net Income(Loss) and cash flows from operating activities shown in the Reconciliation section of the Consolidated Statements of Cash Flows. Cash outflow resulting from accrued forward loss provisions on fixed-price R&D contracts follows in succeeding periods, when the costs that they represent are incurred. Most of the $664 million in loss provisions made in the MUVS segment over the last six years was necessitated by the TSSAM program. As of December 31, 1993 all but $140 million of those loss provisions represent costs already incurred. The trend and relationship of sales volume with accounts receivable and inventoried cost balances, before and after the benefit of progress payments, is a useful measure in assessing liquidity. In 1987 the company's net investment in these balances represented 25 percent of sales. It had subsequently grown to 32 percent at year-end 1989, when Northrop's debt peaked, before dropping to 27 percent at the end of 1993. The largest recent reduction in gross accounts receivable and inventoried cost balances occurred in 1991 as the result of the final billing and collection of ATF contract balances, along with the completion of a number of B-2 contract milestones during the year. A reduction in the rate used by the Government to make progress payments to its customers applies to new contracts entered into after legislation was enacted in 1993. Therefore, it is not expected to have a demonstrable effect on the company's level of working capital in the near term.
The following table is a condensed summary of the detailed cash flow information contained in the Consolidated Statements of Cash Flows. ..........................................................................
Year ended December 31 1993 1992 1991 1990 1989 Cash came from Customers 99% 98% 100% 85% 86% Lenders 1% 2% 11% 13% Buyers of assets 4% 1% 100% 100% 100% 100% 100% Cash went to Employees and suppliers of services and materials 89% 93% 88% 81% 83% Lenders 8% 3% 9% 16% 13% Suppliers of facilities 2% 2% 2% 2% 3% Sellers of assets 1% Shareholders 1% 1% 1% 1% 1% 100% 100% 100% 100% 100% ..........................................................................
The above percentages of gross cash receipts and disbursements portray the extent to which lenders supplemented customer financing until 1990 when it became possible to repay that support through improved collections from customers. Some other important indicators of short-term liquidity are the trend in working capital, the current ratio and the ratio of long-term debt to shareholders' equity. This information is reported in the table captioned Selected Financial Data. Total debt peaked at $1.3 billion in mid-1989. In February of 1990 the company sold its headquarters complex in Los Angeles and applied the net proceeds of $218 million toward reducing its short-term debt. In October 1990 the company reduced its former $750 million credit agreement to $400 million and converted that amount of short-term debt into long-term debt that was repayable in 20 quarterly installments of $20 million. The company at its option elected to prepay larger amounts. Cash flow from operations during 1992 was sufficient to enable the company to pay the four required installments totaling $80 million in converted credit agreement debt as well as to prepay another $60 million of this debt. In February of 1993 the last two installments totaling $40 million were prepaid and in November $210 million of private placement debt was paid. During three months of 1993 it was necessary to supplement cash provided by operations with short-term borrowings. These borrowings peaked at $232 million and none was outstanding at 1993's year end. They were necessitated by intermittent spikes in working capital needs on the B-2 and TSSAM programs. Future near-term borrowing needs will be met through the use of short-term credit lines and the company's $400 million revolving credit agreement, which was renewed with comparable terms for four more years in January 1994. To provide for long-term liquidity the company believes it could obtain additional capital from such sources as: the public or private capital markets, the further sale of assets, sale and leaseback of operating assets and leasing rather than purchasing new assets. The company's final amount of indebtedness, $160 million of private placement debt, is due to be paid in November 1995. The cash improvement program underway throughout the company since early 1989 has produced favorable results, with the expectation that further efforts will result in minimizing, if not eliminating, the need to make short-term borrowings during 1994. Cash generated from operations is expected to be more than sufficient in 1994 to finance capital expansion projects and continue paying dividends to the shareholders. Noncontract R&D expenditures are expected to approximate $100 million in 1994 compared with $97 million in 1993. Capital expenditure commitments at December 31, 1993, were approximately $115 million including $9 million for environmental control and compliance purposes. The 1994 forecast of capital expenditures is $100 million. The company will continue to provide the productive capacity to perform its existing contracts, dispose of assets no longer needed to fulfill operational requirements, prepare for future contracts and conduct R&D in the pursuit of developing opportunities. While these expenditures tend to limit short-term liquidity and profitability, they are made with the intention of improving the long-term growth and profitability of the company. Based on recent cash flow improvements, anticipated future positive cash flows, and unused and available capital resources, management believes that it is in a strong position to pursue its strategic options - acquiring one or more other businesses, raising cash dividends, repurchasing outstanding common shares, or making other investments, to maximize the long-term return to our shareholders.
Item 8. | 72945 | 1993 |
Item 6. Selected Financial Data
Information regarding selected financial data of the Company is found in the "Five-Year Consolidated Financial Summary" on page 49 of this 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 found on pages 41 to 48 of this report.
Item 8. | 31277 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial information for the Company presented below under the captions "Statement of Operations Data" and "Balance Sheet Data" for, and as of the end of, each of the years in the five-year period ended December 31, 1993, is derived from the Company's Consolidated Financial Statements. This selected consolidated financial information should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations", appearing elsewhere in this Report.
- - --------------- (1) The historical consolidated financial results for the Company are not comparable from year to year because of the acquisition of various broadcasting properties by the Company during the periods covered. See "Business--Background" and "Management's Discussion and Analysis of Financial Condition and Results of Operations", appearing elsewhere in this Report.
(2) See Notes 1(f) and 2 of the Notes to the Company's Consolidated Financial Statements, appearing elsewhere in this Report.
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 revenues for the year ended December 31, 1993 were $204,522,000 as compared to $150,230,000 for the year ended December 31, 1992, an increase of approximately 36%. The increase was due principally to higher advertising revenues at most of the Company's stations and the 1993 Acquisitions and the acquisition of WFAN-AM effective April 16, 1992. On a pro forma basis, assuming the above acquisitions had occurred as of the beginning of 1992, net revenues for the year ended December 31, 1993 would have increased by approximately 14%.
Station operating expenses (excluding depreciation and amortization) for the year ended December 31, 1993 were $109,601,000, as compared to $81,707,000, for the year ended December 31,1992 an increase of approximately 34%. The increase was due principally to the above acquisitions, expenses associated with higher revenues and higher programming expenses. On a pro forma basis, assuming the above acquisitions had occurred as of the beginning of 1992, station operating expenses in 1993 would have increased by approximately 12%.
Depreciation and amortization expense for the year ended December 31, 1993 was $38,853,000, as compared to $28,926,000 for the year ended December 31, 1992, an increase of approximately $9,927,000 or 34%. The increase was due to the depreciation and amortization expense associated with the above acquisitions, partially offset by lower depreciation and amortization expense at the Company's other radio stations.
Operating income for the year ended December 31, 1993 was $51,232,000, as compared to $35,415,000 for the year ended December 31, 1992, an increase of approximately 45%. The increase was due principally to improved results at the Company's radio stations.
Net financing expense (defined as interest expense less interest income) for the year ended December 31, 1993 was $36,291,000 as compared to $38,238,000 for the year ended December 31, 1992, a decrease of approximately 5% The decrease was due principally to lower interest rates during 1993.
Net earnings before extraordinary items for the year ended December 31, 1993 was $14,335,000 ($0.35 per share) as compared to a net loss of $9,432,000 ($0.30 per share) for the year ended December 31, 1992, an increase of approximately $23,767,000. As a result of the Common Stock IPO in February 1992, the Company recorded in 1992 a non-recurring charge of approximately $6,503,000, resulting from the issuance in 1990 of Common Stock to management.
In 1992, the Company recorded extraordinary charges of approximately $12,318,000, including the write-off of deferred financing costs of approximately $7,416,000, as a result of (a) the redemption of all of the remaining, approximately $98,000,000 principal amount of the Company's 14.25% Subordinated Discount Debentures (the "14.25% Subordinated Debentures"), and (b) the refinancing of the Company's then existing bank credit agreement.
YEAR ENDED DECEMBER 31, 1992 COMPARED TO YEAR ENDED DECEMBER 31, 1991
Net revenues for the year ended December 31, 1992 were $150,230,000, as compared to $117,959,000 for the year ended December 31, 1991, an increase of approximately $32,271,000, or 27%. The increase was due principally to the acquisition of New York radio station WFAN-AM, effective April 16, 1992, revenues associated with the various sports broadcasting rights, and higher local advertising revenues generally at the Company's stations in Los Angeles, New York, Detroit, Tampa/St. Petersburg, Philadelphia, Chicago, and Washington, D.C., partially offset by lower revenues at the Company's stations in Dallas/Fort Worth. On a pro forma basis, assuming the acquisition of WFAN-AM had occurred as of the beginning of 1991, net revenues in 1992, as compared to 1991, would have increased by approximately 8%.
Station operating expenses (excluding depreciation and amortization) for the year ended December 31, 1992 were $81,707,000, as compared to $61,207,000 for the year ended December 31, 1991, an increase of approximately $20,500,000, or 33%. The increase was due principally to the acquisition of WFAN-AM and costs associated with various sports broadcasting rights. On a pro forma basis, assuming the acquisition of WFAN-AM had occurred as of the beginning of 1991, station operating expenses in 1992, as compared to 1991, would have increased by approximately 8%.
Depreciation and amortization expense for the year ended December 31, 1992 was $28,926,000, as compared to $25,582,000 for the year ended December 31, 1991, an increase of approximately $3,344,000, or 13%. The increase was due to the acquisition of WFAN-AM.
Operating income for the year ended December 31, 1992 was $35,415,000, as compared to $27,472,000 for the year ended December 31, 1991, an increase of approximately $7,943,000, or 29%. The increase was due principally to higher net revenues.
Net financing expense (defined as interest expense less interest income) for the year ended December 31, 1992 was $38,238,000, as compared to $51,492,000 for the year ended December 31, 1991, a decrease of approximately 26%. The decrease was due principally to lower total borrowings, as well as lower interest rates during 1992. The Company's net financing expenses consist principally of interest on borrowings under its bank credit agreement and of interest on the 10 3/8% Senior Subordinated Notes Due 2002, which were sold to the public in March 1992. The Company redeemed all of its outstanding 14.25% Subordinated Debentures in 1992.
Net loss before extraordinary items for the year ended December 31, 1992 was $9,432,000, as compared to a net loss of $24,026,000 for the year ended December 31, 1991, a decrease of approximately 61%. As a result of the Common Stock IPO in February 1992, the Company recorded a non-recurring, non-cash charge of approximately $6,503,000 during the first quarter of 1992, resulting from the issuance in 1990 of approximately 836,107 shares of the Company's common stock to management. Excluding the effect of this non-cash charge, net loss before extraordinary items for the year ended December 31, 1992 would have been $2,929,000, as compared to $24,026,000 for the year ended December 31, 1991, a decrease of approximately 88%.
For the year ended December 31, 1992, the Company recorded extraordinary charges of approximately $12,318,000, including the write-off of non-cash deferred financing costs of approximately $7,416,000, as a result of (a) the redemption of all of the remaining, approximately $98,000,000 principal amount of the Company's 14.25% Subordinated Debentures, at a cost of approximately $102,900,000, and (b) the refinancing of the Company's bank credit agreement, in September 1992, in connection with the execution of a new bank credit agreement. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources", appearing elsewhere in this Report. The Company recorded an extraordinary gain of approximately $18,020,000 during 1991, as a result of the purchase of approximately $87 million principal amount of its 14.25% Subordinated Debentures at a discount.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary needs for capital are to make acquisitions of radio stations and to cover debt service payments on its indebtedness. The Company's radio stations do not typically require substantial investments in capital expenditures. For the year ended December 31, 1993, net cash flow from operating activities was approximately $45,211,000, as compared to $18,310,000 for the year ended December 31, 1992, an increase of approximately $26,901,000 or 147%. The increase was principally due to improved earnings in 1993 partially offset by higher working capital requirements.
In February 1993, the Company borrowed $103 million under the Credit Agreement to finance the acquisition and working capital of radio stations WZGC-FM, WZLX-FM and WUSN-FM. In September 1993, the Company borrowed approximately $18 million under the Credit Agreement to finance the acquisition and working capital of WIP-AM.
On May 13, 1993, the Company completed the Second Common Stock Offering for net proceeds to the Company of approximately $100 million (including approximately $10.1 million paid to the Company upon exercise of certain warrants sold in the offering). The net proceeds from the offering were used to pay down borrowings under the acquisition facility under the Credit Agreement.
The net cash flow from operating activities of approximately $45.2 million together with total cash from financing activities of approximately $78.1 million were used to finance acquisitions and capital expenditures of $123.3 million.
The Credit Agreement contains various covenants and restrictions that impose certain limitations on the Company and its subsidiaries, including, among others, limitations on the incurrence of additional indebtedness by the Company or its subsidiaries, the payment of cash dividends or other distributions, the redemption or repurchase of the capital stock of the Company, the issuance of additional capital stock of the Company, the making of investments and acquisitions, and other similar limitations.
Under the terms of a Security Agreement among the Company, its subsidiaries, and one of the banks acting as collateral agent, substantially all of the assets of the Company and its subsidiaries, as well as the stock of the Company's subsidiaries, are pledged to secure borrowings under the Credit Agreement.
The Credit Agreement provides for the repayment of borrowings on a quarterly basis through September 2000. See Note 5 of the Notes to the Company's Consolidated Financial Statements. The Credit Agreement also permits voluntary prepayments in whole or in part at any time, and it requires mandatory prepayments under specified circumstances.
In February 1994, the Company borrowed approximately $116 million under the Credit Agreement to finance the acquisition of Los Angeles radio station KRTH-FM.
The Company is currently negotiating with its Agent Bank under the Credit Agreement to increase its acquisition facility by $150 million. The purchase price of the pending acquisitions of WPGC-AM/FM and WXYT-AM is expected to be financed by additional bank borrowings.
ITEM 8. | 792863 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
OVERVIEW
LG&E Energy Corp.'s net income and earnings per share of common stock increased in 1993 as compared to 1992 because of strong performances by both the utility and the non-utility businesses. The contribution from Louisville Gas and Electric Company (LG&E) resulted primarily from a more normalized weather pattern in the utility's service area and the sale of a 12.88% interest in Trimble County Unit 1. Contributions to net income from the Company's non-utility businesses resulted primarily from earnings from projects under construction and in operation, project finance closings, and earnings from plants operated and maintained on behalf of third parties. In addition, earnings from the Company's 36.5% investment in Natural Gas Clearinghouse (NGC) increased in 1993 as compared to 1992. In December 1993, the Company agreed to sell its partnership interest in NGC to NOVA Corporation of Alberta, Canada. The sale was completed in January 1994, and the Company expects to post a pre-tax gain of approximately $87 million in the first quarter of 1994.
Effective January 1, 1994, the Company announced a major realignment of its business units to reflect its outlook for rapidly emerging competition in all segments of the energy services industry. In addition to this organizational change, the Company is presently re-evaluating its regulatory strategy to pursue full cost recovery of certain deferred expenses which the Company has recorded as regulatory assets. See Future Outlook for a further discussion of this matter.
The following discussion and analysis by management focuses on those factors that had a material effect on the Company's financial results of operations and financial condition during 1993 and 1992 and should be read in connection with the consolidated financial statements and notes thereto. The Company's financial results and conditions are dependent to a large degree on the financial results and conditions of Louisville Gas and Electric Company.
RESULTS OF OPERATIONS
Earnings per Share
The Company's earnings per common share increased 36 cents for 1993 over 1992, including the 10 cents per common share gain recognized from the sale of a 12.88% portion of the Trimble County plant to the Indiana Municipal Power Agency (IMPA). LG&E's contribution to earnings came from increased electric sales as a result of the warmer summer weather experienced in 1993, higher sales to other utilities and reduced costs for debt and preferred stock attributable to favorable refinancing activities. Contributions to earnings from the non-utility businesses came from construction profits recognized by LG&E Power Inc. (LPI), earnings from operating power projects, a financial closing related to a power project and strong performance by NGC.
After excluding the 13 cents per common share gain recognized in 1991 by LG&E on the sale of a 12.12% portion of the Trimble County plant to Illinois Municipal Electric Agency (IMEA), earnings for 1992 decreased 10 cents from 1991. This decrease was due primarily to lower electric
sales to residential customers as a result of the cooler summer experienced in 1992 (40 cents), increased operating and depreciation expenses (15 cents), decreased interest earned on temporary cash investments of LG&E (3 cents), and various other factors (4 cents). These items were partially offset by the contribution to earnings from non-utility operations in 1992 (40 cents) and favorable financing activities of LG&E (12 cents).
Rates and Regulation
LG&E is subject to the jurisdiction of the Public Service Commission of Kentucky (Commission) in virtually all matters related to electric and gas utility regulation. LG&E last filed for a rate increase with the Commission in June 1990 based on the test-year ended April 30, 1990. The request was for a general rate increase of $34.9 million ($31.0 million electric and $3.9 million gas). A final order was issued in September 1991 that effectively granted LG&E an annual increase in rates of $6.8 million ($6.1 million electric and $.7 million gas). The Commission's order authorized a rate of return on common equity of 12.5%.
On April 21, 1993, LG&E, the Kentucky Attorney General, the Jefferson County Attorney, and representatives of several customer-interest groups filed with the Commission a request for approval of a comprehensive agreement on demand side management (DSM) programs. Under the agreement, LG&E will commit up to $3.3 million over three years (from 1994 through 1996) for initial programs that include a residential energy conservation and education program and a commercial conservation audit program. Future programs will be developed through a formal collaborative process. The agreement contains a rate mechanism that will (1) provide LG&E concurrent recovery of DSM program costs, (2) provide LG&E an incentive for implementing DSM programs, and (3) allow LG&E to recover revenues due to lost sales associated with the DSM programs. On November 12, 1993, the Commission approved the agreement.
Revenues from lost sales to residential customers are collected through a "decoupling mechanism". LG&E's residential decoupling mechanism breaks the link between the level of LG&E's residential kilowatt-hour and Mcf sales and its non- fuel revenues. Under traditional regulation, a utility's revenue varies with changes in its level of kilowatt-hour or Mcf sales. The residential decoupling mechanism will allow LG&E to recover a predetermined level of revenue per customer based on the rate set in LG&E's last rate case, which will not vary with the level of kilowatt-hour or Mcf sales. Residential revenues will be adjusted to reflect (1) changes in the number of residential customers and (2) a pre-established annual growth factor in residential revenue per customer. Decoupling, in effect, removes the impact on LG&E's non-fuel revenues from changes in kilowatt-hour or Mcf sales due to weather, fluctuations in the economy, and conservation efforts. Under this mechanism, if actual sales produce lower revenues than are produced by the predetermined per-customer amount, the difference is deferred for recovery from customers through an adjustment in rates over a period that will not exceed two years. Conversely, if actual sales produce more revenues than would be realized using the predetermined per-customer amount, the difference will be returned to customers through subsequent rate adjustments over a period not to exceed two years. Residential revenues reported in the financial statements for 1994 through 1996 will be determined in accordance with the predetermined amount per customer plus growth, and recovery of fuel and gas costs. The difference between the revenues shown in the financial statements and the amounts billed to customers will be recorded on the balance sheet and deferred for future recovery from or return to customers.
As more fully discussed in Note 11 of Notes to Financial Statements under Item 8, the Commission has set a procedural schedule to determine the appropriate ratemaking treatment to exclude 25% of the Trimble County plant from customer rates.
On May 24, 1993, the Federal Energy Regulatory Commission (FERC) gave final approval for a market-based rate tariff and two transmission service tariffs that were filed by LG&E. This tariff enables LG&E to sell up to 75 Mw of firm generation capacity at market-based rates. It also enables LG&E to sell an unlimited amount of non-firm power at market-based rates, as long as the power is from LG&E's own generation resources.
Under the two transmission service tariffs that were approved by FERC, utilities, independent power producers, and qualifying co-generation or small power production facilities may obtain firm or coordination transmission service from LG&E. These tariffs provide open access to LG&E's transmission system and enable parties requesting either type of transmission service to transmit wholesale power across LG&E's system. However, service under these tariffs is not available to ultimate consumers of electric utility service.
Revenues
A comparison of LG&E's revenues for the years 1993 and 1992 with the immediately preceding years reflects both increases and decreases which have been segregated by the following principal causes (in thousands of $):
Electric revenues increased in 1993 primarily because of the warmer summer weather. Sales of electricity to other utilities increased over 1992 levels due to LG&E's aggressive efforts in marketing off-system sales of energy. The increase in gas sales for 1993 is largely attributable to cooler winter weather in the region and customer growth.
Non-utility revenues of $123.5 million are $6.5 million or 5% lower than last year due to lower project development fees and revenues. Construction revenues of $120 million were roughly equal to 1992, as progress continued on LPI's currently active projects at Roanoke Valley I and II in North Carolina, and Rensselaer in New York. LPI derives the majority of its revenues from the construction of power plants while its operating profit consists of plant development and construction profits in addition to earnings from operating power projects.
LPI's ability to sustain this level of revenues is dependent, in part, upon its ability to continue to obtain major engineering and construction contracts.
Expenses
Fuel for electric generation and gas supply expenses account for a large segment of the Company's total operating costs. LG&E's electric and gas rates contain a fuel adjustment clause and a gas supply clause, respectively, whereby increases or decreases in the cost of fuel and gas supply may be reflected in LG&E's rates, subject to the approval of the Commission.
Fuel expenses increased in 1993 primarily because of an increase in generation and the higher cost of coal purchased. The average delivered cost per ton of coal purchased for LG&E was $26.58 in 1993, $25.17 in 1992, and $24.51 in 1991.
LG&E's increase in power purchased expense reflects an increase in the quantity of power purchased mainly because of wheeling arrangements with other utilities.
Gas supply expenses increased in 1993 and 1992 largely because of an increase in both the cost and the volume of gas purchased. The average unit cost per Mcf of purchased gas for LG&E was $2.91 in 1993, $2.77 in 1992, and $2.39 in 1991.
Utility operating and maintenance expenses increased approximately $5 million in 1993. This increase is primarily attributable to increased expenses for operation and maintenance of electric generating plants and higher administrative and general costs. The $2 million increase in 1992 over 1991 resulted primarily from costs associated with legal settlements relating to personal injury claims and storm damage expenses. General increases in labor and material costs are also reflected in operation and maintenance expenses.
Non-utility expenses reflect the operating and business development expenses associated with the Company's non-utility operations. The majority of the expenses reflected herein pertain to LPI, including construction, project development, and general and administrative costs. LPI was acquired in December 1991.
Other income and (deductions) decreased in 1993. Other income includes a $3.9 million before-tax gain on the sale of a 12.88% ownership interest in LG&E's Trimble County Unit 1 to IMPA. Other deductions reflect charges applicable to business restructurings and other non-recurring charge-offs. A decrease in 1992 from 1991 resulted primarily from a $7.9 million gain recorded in 1991 on the sale of a 12.12% ownership interest in Trimble County to IMEA and decreased interest income of $3 million from temporary cash investments.
Interest charges decreased in 1993 and 1992 primarily because of an aggressive program to refinance at lower interest rates. LG&E refinanced approximately $205 million of its outstanding debt in 1993. The lower interest requirement at LG&E was partially offset by interest charges related to debt issued for the Company's expansion into non-utility businesses.
Variations in income tax expenses are largely attributable to changes in pre-tax income and an increase in the corporate Federal income tax rate from 34% to 35% effective January 1, 1993.
Preferred dividends reflect the lower dividend rates that resulted from LG&E's refunding of the $25 million, $8.90 Series with a $5.875 Series in May 1993. In February 1992, LG&E refunded the $8.72 and $9.54 Series with $50 million of Auction Rate Series. LG&E's weighted average preferred dividend rate at December 31, 1993, was 4.72%; at December 31, 1992, 5.36%.
Income from discontinued operations reflect the net earnings realized from the Company's investment in NGC. In January 1994, the Company sold its interest in NGC. (See Note 3 of Notes to Financial Statements under Item 8. | 861388 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
- ------------------ (a) The distribution for the first quarter of 1990 of $.3225 was declared on December 8, 1989. Such amount was accrued as a distribution in the 1989 financial statements but is reflected as a 1990 distribution in the table above.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
This discussion should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements.
FINANCIAL CONDITION
MERGER TRANSACTION
On February 28, 1994, EQK Green Acres, L.P. (the 'Partnership') merged with and into Green Acres Mall Corp., a wholly-owned subsidiary of EQK Green Acres Trust (the 'Trust'). The Trust and the Partnership are collectively referred to herein as the 'Company.' See Item 1 and Note 1 to the consolidated financial statements for a discussion of the Company's common shares (the 'Common Shares') issued in connection with this merger (the 'Merger').
The issuance of 10,277,469 Common Shares to the Unitholders and the General Partners on account of their respective percentage interests in the Partnership represents a reorganization of entities under common control and, accordingly, was accounted for in a manner similar to a pooling of interests. The financial statements of the Partnership and the Trust have been combined at historical cost retroactive to January 1, 1991. The issuance of these Common Shares has been reflected as of this date at the amount of the Unitholders' and General Partners' original contributions to the Partnership.
The issuance of Common Shares to the Special General Partner on account of its residual interest in the Partnership and to Equitable Realty Portfolio Management, Inc. (the 'Advisor') will be reflected in the Company's consolidated financial statements as of February 28, 1994 and March 30, 1994, respectively. The issuance of Common Shares to the Special General Partner will increase the Company's carrying value of land and buildings and improvements by $3,024,000 and $13,347,000, respectively, representing the value of the Special General Partner's residual interest in accordance with the allocation methodology utilized by the Partnership in connection with the Merger. Annual depreciation expense will increase by approximately $342,000 as a result of the increase in the basis of the Mall. The issuance of Common Shares to the Advisor will be reflected as a charge to earnings during the first quarter of 1994 in the approximate amount of $3,843,000.
In connection with the Merger, the Company recognized as an expense nonrecurring legal, accounting, and printing costs aggregating approximately $1,250,000.
CASH FLOWS FROM OPERATING, INVESTING, AND FINANCING ACTIVITIES
Cash flows from operating activities for 1993 and 1992 were $6,649,000 and $13,719,000, respectively. The 1993 results, and the related decline from 1992, are principally attributable to payments in 1993 of $1,951,000 and $2,684,000 for 1992 real estate taxes and deferred advisory and property management fees, respectively, and the payments of $1,123,000 for interest on the collateralized floating rate notes (the 'Floating Rate Notes'), $686,000 for deferred leasing costs, and $382,000 for Merger costs.
During 1992, the Company's net cash provided by operating activities decreased by $1,131,000 compared to 1991. The primary cause of this decrease was the payment of $2,203,000 in 1992 for certain advisory and property management fees attributable to 1991. In 1991, the payment of these fees had been deferred, resulting in a nonrecurring cash flow benefit in that year. Offsetting this benefit in 1991 was the nonrecurrence of certain real estate taxes collected in 1990 attributable to the one-time acceleration of the billing of such taxes to tenants, and higher interest costs.
Cash flows from investing activities increased by $6,713,000 in 1993 over the prior year, primarily due to the receipt of proceeds from the April 1993 transfer of an adjacent industrial tract (the 'Bulova Parcel') to Home Depot. Pursuant to a lease/purchase agreement, Home Depot paid
$9,500,000 to the Company, a portion of which was used to complete the purchase of the Bulova Parcel. In connection with this lease/purchase agreement, the Company recognized a gain on sale of real estate of $440,000 during 1993. Subsequent to December 31, 1993, the Company's restricted cash balance of $500,000 was released from escrow.
During 1992, net cash used in investing activities by the Company increased $193,000 compared to 1991. The Company's capital expenditures for 1992 included payments of $1,884,000 related to the acquisition of the Bulova Parcel, predevelopment costs of $1,110,000 related to the deferred mall expansion project and tenant allowance and other capital items. In 1991, the Company completed a $2,700,000 interior renovation, and spent an additional $2,100,000 in developing the Plaza.
Cash flows used in financing activities for 1993 and 1992 were $8,753,000 and $8,220,000, respectively. The increase in cash used in financing activities is primarily attributable to the refinancing activities in August 1993 in which the net proceeds from the issuance of the Floating Rate Notes were used to purchase a zero coupon mortgage note (the 'Zero Note') and to repay $16,500,000 in second mortgage financing.
During 1992, the Company's net cash used in financing activities increased $300,000 compared to 1991. The increase was due to a decline in net additional borrowings substantially offset by lower distributions paid to Common Shareholders.
The Company believes that Funds from Operations represents an indicator of its ability to make cash distributions. Funds from Operations is defined as net income before depreciation, amortization of financing and other deferred expenses, and gains or losses on sales of assets. Management believes that Funds from Operations is the most significant factor in determining the amount of cash distributions, although Funds from Operations does not represent net income or cash flows from operating activities as defined by generally accepted accounting principles and is not necessarily indicative of cash available to fund all cash flow needs. Furthermore, Funds from Operations should not be considered as an alternative to net income as an indicator of the Company's operating performance or to cash flows from operating activities as a measure of liquidity.
As indicated in the Consolidated Statements of Cash Flows, the Company experienced an unfavorable trend in cash provided by operating activities over the periods presented. However, the trend in Funds from Operations, which is not affected by temporary changes in working capital, has not been as unfavorable. The following table sets forth Funds from Operations and cash provided by operating activities of the Company for the periods indicated:
The decrease of $1,152,000 in Funds from Operations for 1993 compared to 1992 is attributable to the 1993 incurrence of currently payable interest expense on the Floating Rate Notes and payments of Merger expenses of $1,824,000 and $1,250,000, respectively, offset by the nonrecurrence of a $1,439,000 write-off of capitalized predevelopment costs in 1992. The decline of $1,479,000 in Funds from Operations for 1992 compared to 1991 is also attributable to this 1992 write-off.
DEBT REFINANCING
On August 19, 1993, the Company, through a wholly-owned subsidiary, issued the Floating Rate Notes in an aggregate principal amount of $118,000,000. The Floating Rate Notes are secured by a first mortgage on substantially all of the real property comprising Green Acres Mall and a first leasehold mortgage on the Plaza. The early extinguishment of the Zero Note, as described above, resulted in an extraordinary charge of $6,373,000. The remainder of the proceeds from the Floating Rate Notes was used to purchase an interest rate cap and to pay mortgage recording taxes and other
costs incurred in connection with the refinancing. The entire principal amount of the Floating Rate Notes is due on their maturity date, August 19, 1998. The Floating Rate Notes have a floating interest rate equal to 78 basis points in excess of the three-month LIBOR. The interest rate on this debt, which is subject to quarterly reset, was 4.28% at December 31, 1993. Payments of interest expense will be funded from cash flows from operations supplemented, as necessary, by borrowings under the revolving credit facility described below. Amortization of the deferred financing costs, approximating $1,161,000 per annum, will result in an additional charge (non-cash) to interest expense. As a result of an interest rate cap agreement also entered into on August 19, 1993, the effective interest rate of the Floating Rate Notes will not exceed 9% per annum. The mortgage and indenture relating to the Floating Rate Notes limit additional indebtedness that may be incurred by Green Acres Mall Corp., but not by the Trust. Those agreements also contain certain other covenants which, among other matters, effectively subordinate distributions from Green Acres Mall Corp. to the debt service requirements of the Floating Rate Notes. On August 19, 1993, the Partnership also obtained an 18 month unsecured revolving credit facility in the amount of $3,400,000 which bears interest at 1% over the lender's prime rate (effective interest rate of 7.00% at December 31, 1993). At December 31, 1993, $1,800,000 was outstanding. The Floating Rate Notes' mortgage agreement places certain limitations on the Company's ability to borrow under the line of credit agreement. At December 31, 1993, limitations related to future capital expenditures reduced the Company's available borrowing capacity to approximately $1,150,000. In February 1994, the Company borrowed an additional $900,000 under this credit facility.
The Company anticipates that it will refinance the revolving credit facility prior to the expiration of such facility. The Company also anticipates that it will refinance the Floating Rate Notes at maturity in August 1998. Given the substantial equity the Partnership has in the Property (the principal amount of the Floating Rate Notes represents less than 50% of the Property's estimated fair value at December 31, 1993), Management anticipates that it will have considerable flexibility in obtaining such refinancing. However, at this time, Management has not identified any specific sources of such refinancing.
In connection with the issuance of the Floating Rate Notes, interest expense is expected to decline significantly after 1993. Although the refinancing program will result in substantial interest savings, interest will be payable currently rather than accrued and, as a result, cash flow available for distributions will be reflective of such expenditures.
DIVIDENDS
The Company's current quarterly dividend rate of $.275 per Common Share represents an annual dividend rate of $1.10 per Common Share. The issuance of Common Shares to the Special General Partner and the Advisor will reduce the cash available per Common Share for distribution to the former Unitholders of the Partnership. However, the Special General Partner and the Advisor have agreed that all distributions received by them prior to May 1995 on account of the Common Shares issued in respect of the Special General Partner's residual interest in the Partnership and the termination of the agreement with the Advisor will be reinvested through a distribution reinvestment plan in newly issued Common Shares. As a result, the issuance of such Common Shares to the Special General Partner and Advisor will not affect cash flow available for distribution to the former Unitholders of the Partnership until after May 1995.
Management anticipates that annual distributions on account of 1994 operations will be $1.10 per Common Share. The Company expects that an increase in Funds from Operations (before interest) will offset the effect of paying interest on the Floating Rate Notes on a current basis in 1994 and through maturity. The anticipated growth in Funds from Operations in 1994 reflects cost reductions resulting from the termination of the Advisory Agreement, net of costs associated with the Company's planned acquisitions program, and an increase in rental revenues. The Company also received, during the first quarter of 1994, $1,500,000 from the sale of two acres of property to Home Depot, which supplements Funds from Operations available for distribution. During 1994, the Company anticipates that its capital expenditures will be approximately $2,900,000 which it intends to fund from borrowings. The Company is currently pursuing an extension of its existing line of credit, although there can be no assurance that it will receive such an extension. Should it be unable to fund capital expenditures from borrowings, or should there be a shortfall in budgeted revenue growth or an unanticipated increase in interest expense, the Company's ability to maintain distributions at $1.10 per Common Share could be adversely affected.
Commencing in May 1995, the Special General Partner and the Advisor will be entitled to receive cash distributions on their Common Shares. Consequently, in addition to the aforementioned growth in Funds from Operations required in 1994, Funds from Operations in 1995 must increase an additional $1,950,000 to maintain the current distribution rate of $1.10 per Common Share for 1995 and future years. Based on the information presently available, Management believes that stipulated rent increases from existing tenants, additional income from new tenants, renewal of expiring leases at higher market rents and increases in percentage rents will increase Funds from Operations by an amount sufficient to sustain the current dividend level in 1995, although there is no assurance as to this. Further, it is anticipated that capital expenditure requirements will decline significantly in 1995 due to the completion of the remerchandising program and the resulting reduction in future tenant allowances.
The Company intends to acquire additional real estate investments. Financing for any such investments would be sought through any combination of public or private debt and/or equity financing (including possibly financing provided in whole or in part by sellers) determined by the Company to be advisable at the time. It is premature to seek such financing and there can be no assurance that any such financing could be obtained on favorable terms or at all.
RESULTS OF OPERATIONS
COMPARISON OF 1993, 1992, AND 1991
The Company reported a net loss of $5,223,000 ($.51 per Common Share) in 1993, compared with a net loss of $163,000 ($.02 per Common Share) in 1992 and net income of $2,511,000 ($.24 per Common Share) in 1991.
The 1993 results were impacted by the recognition of an extraordinary loss of $6,373,000 ($.62 per Common Share) from the early retirement of the Zero Note. The extraordinary loss was comprised principally of prepayment penalties and the write-off of deferred financing costs. Earnings in 1993 also declined as a result of the recognition of $1,250,000 of Merger costs. The earnings decline in 1993 was partially offset by the $440,000 gain on sale of real estate and a decrease in interest expense from 1992.
The 1992 results were impacted by the writeoff of predevelopment costs. In June 1992, the Company announced its decision to defer a planned expansion of the Mall due to its inability to secure financing for this project. It is uncertain when, or if, the expansion program will be resumed. Accordingly, capitalized costs related to the predevelopment phase of the expansion, totaling $1,439,000, were written off. The earnings decline in 1992 over 1991 was also affected by higher interest expense in 1992, partially offset by an increase in revenues from rental operations. The trend in earnings is more fully described in the discussion of revenues and expenses that follows.
Revenues from rental operations in 1993 decreased modestly from the prior year. The decline in 1993 revenues of $106,000 was attributable to a $334,000 decline in Plaza revenues, primarily related to the buildout of the new Kmart discount store, partially offset by higher Mall revenues attributable to specialty leasing of space to temporary tenants.
In January 1993, the Company replaced Pergament Home Improvement Center, Inc. ('Pergament'), one of the Plaza's anchor tenants, and all but one of the Plaza's small store spaces, with a new Kmart discount store. In connection with the lease termination, the Partnership paid $450,000 to Pergament on July 1, 1993. The Company also paid a $150,000 fee to the Advisor in connection with the securing of Kmart as a new anchor tenant. This change in Plaza tenants is expected
to generate an additional $350,000 of income from rental operations on an annualized basis compared to the income generated from the Plaza in 1992.
Revenues from rental operations in 1992 increased from 1991 by $3,061,000 or 18%. Approximately one-half of the revenue increase was attributable to the operation of the Plaza, which was open for its first full year of business in 1992. In addition, the 1992 minimum rent from mall tenants increased due to improved occupancy, percentage rents increased due to higher tenant sales levels and other income increased due to an expanded temporary leasing program.
Net operating expenses increased in 1993 to $2,059,000 from $1,779,000 in 1992 and $195,000 in 1991. This $280,000 increase in 1993 is primarily attributable to increases in net real estate taxes and food court costs of $147,000 and $119,000, respectively. The increase in net operating expenses in 1992 over 1991 is due to an increase in the expenses of the Plaza, which was in its first full year of operations, and increases in net operating expenses associated with common area maintenance and real estate taxes of $485,000 and $522,000, respectively.
Included in net operating expenses are property management fees of $786,000, $785,000, and $697,000 for 1993, 1992, and 1991, respectively, attributable to the related agreement with Compass Retail, Inc. ("Compass"). In connection with the Merger, the agreement with Compass was amended and restated to extend its termination date by two years to August 31, 1998, and to limit Compass' scope of responsibilities primarily to accounting and financial services currently provided in connection with the operations of the Property. Compass' compensation will be reduced from 4% to 2% of net rental and service income collected from tenants.
Operating expense increases attributable to inflation generally do not have a significant effect on the Company's income from rental operations as substantially all operating expenses are reimbursed by tenants in accordance with the terms of their leases.
Advisory fees have declined to $1,625,000 in 1993 from $1,709,000 in 1992 and $1,931,000 in 1991. The advisory fee was comprised of an annual base fee of $250,000 and an annual subordinated incentive advisory fee of $1,250,000 which increased in proportion to the amount by which aggregate distributions of operating cash flow to Unitholders exceed a ten percent return on the Unitholder's Adjusted Capital Contributions (as defined in the Partnership Agreement). Decreases in operating cash flows over the three year period account for the reductions in the advisory fees. The advisory agreement will terminate on March 30, 1994, upon the expiration of a 30-day transition period agreement.
The provision for doubtful accounts was $424,000 in 1993, $809,000 in 1992 and $505,000 in 1991. The 1992 provision was attributable to anticipated losses associated with certain delinquent tenants whose leases were subsequently terminated. Such tenants were symptomatic of credit risk found in the retail industry, particularly among smaller local and regional tenants. Due to the absence of significant credit losses and due to certain recoveries of receivables previously written off, the Company experienced an improvement in its provision for doubtful accounts in 1993.
Interest expense was $9,834,000, $10,787,000, and $8,401,000 for 1993, 1992, and 1991, respectively. The decrease in interest expense in 1993 over 1992 is due to the August 19, 1993 debt refinancing. The Zero Note, with an effective interest rate of 10.4% per annum, and the $16,500,000 in second mortgage financing, bearing interest at rates between 6% and 7% per annum, were replaced with Floating Rates Notes that had an initial interest rate of 4.03% that was reset to 4.28% on November 12, 1993. Interest expense increased in 1992 over 1991 due to the amortization of the discount on the Zero Note. In addition, 1992 interest expense increased due to a full year of interest recognized on the capitalized portion of the Plaza lease, higher interest cost on the line of credit and interest payable on the deferred advisory and property management fees.
Other expenses consist primarily of the administrative costs of running the Company. There were no significant fluctuations in these costs during the three-year period ended December 31, 1993.
Distributions to security holders were $11,305,000 ($1.10 per Common Share) in 1993, $11,999,000 ($1.168 per Common Share) in 1992, and $13,823,000 ($1.345 per Common Share) in 1991. The Company has paid out substantially all of its net cash flow since inception. Taking into account the anticipated impact on net cash flow of the previously discussed refinancing, distributions were reduced to an annual rate of $1.10 in June 1992.
ITEM 8. | 912025 | 1993 |
Item 6. Selected Financial Data
FIVE YEAR COMPARISON OF SELECTED FINANCIAL DATA Dollars in thousands (except per-share data)
(1) The Company adopted the installment method for homesite sales effective January 1, 1989. Prior to 1989, Avatar used the full accrual method of profit recognition for homesite sales. During 1993, the sale of the Midwest Water Utilities was completed. (See Results of Operations.)
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands)
RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant factors that have affected Avatar during the periods included in the accompanying consolidated statements of operations.
A summary of the period to period changes in the items included in the consolidated statements of income is shown below.
Operations for the years ended December 31, 1993, 1992 and 1991 resulted in a pre-tax gain (loss) before the changes in accounting methods and extraordinary item of $18,236, ($4,342) and ($12,307), respectively. The improvement in pre-tax income during 1993 compared to 1992 is primarily attributable to the sale of the Midwest Water Utilities for $62,000 which resulted in a pre-tax gain of $21,822 and an adjustment to the estimated development liability for sold land as a result of the purchase of Rio Rico Utilities of $4,532. The improvement in pre-tax results of operations in 1992 compared to 1991 was primarily attributable to higher profit contributions from the Company's utility operations and lower real estate selling expenses.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RESULTS OF OPERATIONS -- continued
Avatar uses the installment method of profit recognition for homesite sales. Under the installment method the gross profit on recorded homesite sales is deferred and recognized in income of future periods, as principal payments on contracts are received. Fluctuations in deferred gross profit result from deferred gross profit on current homesite sales less recognized deferred gross profit on prior years' homesite sales.
In accordance with the Company's business plan, the Company continued its gradual transition from selling predominantly Avatar- owned homesites to providing a diversified mix of products and services including introducing additional housing products, developing amenities and support facilities, expanding vacation ownership operations, expanding property management services and converting land holdings into income producing operations. Avatar's business plan also established objectives of modifying the Company's historic homesite sales program with the goal of maintaining or slightly increasing homesite sales volume. A slight improvement in consumer confidence and the economy combined to enable the Company to achieve budgeted levels for homesite sales volume in 1993. The 1993 average selling prices of housing and homesites were comparable to 1992 levels.
Gross real estate revenues increased 15% during 1993 when compared to 1992 and decreased 7.9% during 1992 when compared to 1991. The increase in real estate revenues for 1993 when compared to 1992 is primarily a result of increased housing and homesite sales volume. Real estate expenses increased $2,594 or 5.8% in 1993 when compared to 1992 and decreased $7,831 or 14.9% in 1992 when compared to 1991. The increase in real estate expenses for 1993 when compared to 1992 is primarily a result of an increase in cost of products sold due to the increase in real estate sales. Margins have improved based on a reduction in related costs as a percentage of real estate sales and a more profitable sales mix of increased homesite and housing sales for 1993 when compared to 1992. The decline in real estate revenues and expenses for 1992 when compared to 1991 resulted primarily from decreased homesite and housing sales during 1992.
Utility revenues decreased $7,252 or 13.6% during 1993 when compared to 1992 and increased $4,078 or 8.3% during 1992 when compared to 1991. Utility expenses decreased $1,991 or 5.4% during 1993 when compared to 1992 and increased $1,173 or 3.3% during 1992 when compared to 1991. Utility revenues decreased in 1993 as a result of the sale of the Midwest Water Utilities which closed on August 31, 1993. Utility expenses did not decline correspondingly primarily due to increased expenses relating to postretirement benefit costs. The increases for 1992 when compared to 1991 are due to increases in Avatar's customer base and rate increases. In comparing the remaining utility subsidiaries, revenues increased $1,565 or 6.4% in 1993 when compared to 1992 and expenses increased $4,699 or 38.9% in 1993 when compared to 1992. The increase in expenses is primarily a result of postretirement benefit costs, the amortization of rate case costs, and the accrual of professional fees.
Interest income decreased $2,411 or 14.7% during 1993 when compared to 1992 and $2,686 or 14.1% during 1992 when compared to 1991. The declines in interest income are attributable to lower average aggregate balances of the Company's contract and mortgage notes receivable portfolio. The
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RESULTS OF OPERATIONS -- continued
average balance of Avatar's receivable portfolio was $127,909, $153,053 and $181,550 for 1993, 1992 and 1991, respectively. This decrease in interest income was partially offset by earnings from Avatar's investment securities of $903, $479 and $927 for 1993, 1992 and 1991, respectively.
Pre-tax gain on sale of subsidiaries of $21,822 in 1993 is a result of the sale of the Midwest Water Utilities which generated net proceeds of approximately $59,371.
Other revenues for 1993 includes a reduction of the estimated development liability for sold land of $4,532 as a result of the purchase of Rio Rico Utilities.
General and administrative expenses increased $811 or 10.4% in 1993 compared to 1992 and $196 or 2.6% during 1992 when compared to 1991. The increases in 1993 and 1992 are primarily a result of incentive compensation recorded for senior officers and an increase in professional fees. Additionally, an increase in real estate revenue contributed to the increase for 1993.
Interest expense decreased $2,822 or 15.3% in 1993 when compared to 1992 and $738 or 3.8% during 1992 when compared to 1991. These decreases are attributable to an overall decrease in notes, mortgage notes and other debt outstanding during 1993 and lower interest rates during 1992 than in 1991.
LIQUIDITY AND CAPITAL RESOURCES
Avatar's primary business activities, which include homesite sales, land development and utility services, are capital intensive in nature. Avatar expects to fund its operations and capital requirements through a combination of cash and investment securities on hand, operating cash flows and external borrowings.
In 1993, net cash provided by operating activities amounted to $9,925 and resulted primarily from operations including principal payments on contracts receivable of $21,249. Net cash provided by investing activities of $14,823 in 1993 resulted from the proceeds from the sale of subsidiaries of $59,371 and proceeds from the sale of securities of $17,444 reduced by investments in property, plant and equipment of $11,567 and investments in securities of $50,425. Net cash used in financing activities of $20,214 resulted primarily from the principal payment on revolving lines of credit and long-term borrowings of $48,538 and the purchase of treasury stock of $27,000 less net proceeds from revolving lines of credit and long-term borrowings of $26,121 and proceeds from the issuance of common stock in conjunction with the redemption/conversion of the 5-1/4% Debentures (as defined below) of $30,340.
Avatar renegotiated certain of its existing bank credit lines and established a new credit line, thereby increasing its secured lines of credit from $36,200 at December 31, 1992, to $45,534 at December 31, 1993. Avatar's unsecured credit lines were decreased from $44,500 at December 31, 1992, to $15,000 at December 31, 1993. The unused portions of these credit lines were $17,000 and $10,325 for the secured and unsecured lines, respectively, at December 31, 1993. Included in these lines of credit is a new line of credit entered into during 1993, secured by investments, which had
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
LIQUIDITY AND CAPITAL RESOURCES -- continued
an outstanding balance at December 31, 1993 of $13,000 and will mature during the fourth quarter of 1994. Also included is an amended and restated line of credit with a balance outstanding at December 31, 1993 of $15,534 collateralized by certain contracts receivables and due May 31, 1995.
Avatar has planned utility construction for 1994 totaling approximately $22,000. Additionally, the Company has planned land development expenditures of $9,700 during 1994, which will result in additional homesite inventory and preservation of development permits. It is anticipated that land development and utility construction expenditures for 1994 will be funded by operating cash flow and borrowings from external sources.
On June 4, 1993 the Company called for the redemption of all its outstanding 5-1/4% convertible-purchase subordinated debentures due May 1, 2007 (the ``5-1/4% Debentures ) at a redemption price of 100% of the principal amount plus accrued and unpaid interest from January 15, 1993 through the redemption date of July 4, 1993. The principal purpose of the redemption was to reduce the Company's annual interest expense, improve its liquidity and increase its stockholders' equity. Holders were entitled to convert their 5-1/4% Debentures into shares of the Company's common stock at a conversion price of $23.00 per share provided they paid in cash an amount equal to the principal amount of the 5-1/4% Debentures being converted, for which they received additional shares of common stock equal to the number issued on conversion. A total of $30,917 principal amount of the 5-1/4% Debentures were converted and 2,688,276 shares of common stock were issued. The remaining $57 principal amount of 5-1/4% Debentures were redeemed as of July 4, 1993. The net result of this transaction, after expenses, was an increase in cash of $30,340, a decrease in debt of $30,973 and an increase in stockholders' equity of $60,835.
The closing of the sale of the Midwest Water Utilities took place on August 31, 1993, with an aggregate selling price of $62,000, resulting in a pre-tax gain of $21,822.
The Company has invested approximately $51,000 in investment securities which are classified as trading. The Company intends to continue to actively trade such securities in an effort to generate profits and will reinvest such profits until such time as the Company 's cash requirements necessitate the use or partial use of the portfolio proceeds. Avatar's investment portfolio at December 31, 1993 includes $20,045 invested in corporate bonds rated B- or above by Moody's and/or Standard and Poor's and $12,775 invested in non-rated bonds of companies which are in bankruptcy and have defaulted as to payments of principal and interest on such bonds. These bonds are thinly traded and may require sixty to ninety days to liquidate. The portfolio also includes an unsecured claim on a company in bankruptcy of $5,689 which is not readily marketable, $7,020 of equity securities, $1,661 of money market accounts and $3,994 of U.S. Goverment and Agency securities. As of December 31, 1993, $39,932 of the investments serves as collateral for a secured line of credit with an outstanding balance of $13,000.
On September 30, 1993 the Company purchased 1,000,000 shares of the Company's common stock from the estate of Peter J. Sharp for $27.00 per share resulting in a decrease in cash of $27,000 and a corresponding decrease in stockholders' equity. These shares are being held in the Company's treasury for future corporate purposes.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
LIQUIDITY AND CAPITAL RESOURCES -- continued
Avatar's Board of Directors has authorized expenditures for the purchase of Avatar's 8% and 9% senior debentures. During 1993, Avatar expended $31 for the purchase of its 8% senior debentures and $1,106 for the purchase of its 9% debentures. As of December 31, 1993, the remaining authorization for such expenditures was $4,301.
As a result of the proceeds received from the sale of the Midwest Water Utilities and the redemption/conversion of the 5-1/4% Debentures, net of the funds expended for the stock repurchase, the Company believes it has sufficient capital resources to satisfy anticipated liquidity requirements.
Management does not anticipate a significant change in interest rates for 1994, and accordingly, does not expect Avatar's primary business activities to be adversely affected by interest rates. Avatar's homesite sales are not dependent upon the customer obtaining third party financing. A high interest rate environment would be likely to adversely affect Avatar's real estate results of operations and liquidity because certain of Avatar's debt obligations are tied to prevailing interest rates. Increases in interest rates affecting the Company's utility operations generally are passed on to the consumer through the regulatory process.
EFFECTS OF INFLATION AND ECONOMIC CONDITIONS
Inflation has had a minimal impact on Avatar's operations over the past several years, and management believes its effect has been neither significant nor greater than its effect to the industry as a whole. It is anticipated that the impact of inflation on Avatar's operations for 1994 will not be significant.
IMPACT OF TAX INSTALLMENT METHOD
In 1992, 1991, 1989 and 1988, the Company elected the installment method for recording a substantial amount of its homesite sales in its federal income tax return, which deferred taxable income into future fiscal periods. As a result of this election, the Company may be required to pay compound interest on certain federal income taxes in future fiscal periods attributable to the taxable income deferred under the installment method. The Company believes that the potential interest amount, if any, will not be material to its financial position and results of operations of the affected future periods.
RETIREMENT PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
In December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". The Company adopted this statement in 1993, as required. This statement requires the accrual of postretirement benefits (such as health care benefits) during the years an employee provides services. These benefits for retirees are currently provided only to the employees of the Company's utility subsidiaries. The costs of these benefits were previously expensed on a pay-as-you-go basis. The accrual for postretirement benefit costs at December 31, 1993 amounted to $712.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued
RETIREMENT PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS--continued
As discussed in Notes J and K to the consolidated financial statements, the weighted average discount rate used in determining both the projected benefit obligation for the Company's defined benefit pension plan and the accumulated postretirement benefit obligation for its postretirement benefit plan is 8%. If the Company were to lower the discount rate by 1/2% in 1994, it would result in an increase in the obligation. To illustrate, a decrease in the discount rate from 8% to 7-1/2% in determining the projected benefit obligation for the Company's defined benefit pension plan, would increase the obligation by approximately $275 and pension expense by approximately $44. The same change in discount rate in estimating the accumulated postretirement benefit obligation for the Company's defined benefit postretirement plan, would increase the obligation by approximately $200. Because the Company has elected to record the transition obligation for postretirement benefits over 20 years, as allowed by Statement No. 106, the effect of reducing the discount rate from 8% to 7-1/2% in 1994 would be less than $30.
Item 8. | 39677 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain data for the years ended December 31 (in thousands, except per share data):
(a) Due to the acquisition of SEI in the second quarter of 1991, amounts are not comparable to prior years.
(b) Per share amounts are calculated after preferred dividends of $810,000, except for 1993 which is $724,000.
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 Consolidated Financial Statements of the Company and the related Notes.
BUSINESS COMBINATIONS AND ACQUISITIONS
The Company makes its decisions to acquire or invest in businesses based on financial and strategic considerations. The Company may from time to time invest in or acquire businesses or assets in addition to those described below.
In May 1991, the Company acquired ownership of approximately 82% of the common stock of SEI for approximately $166,800,000 in cash and $22,745,000 principal amount of ten-year notes. This acquisition was accounted for using the purchase method of accounting and, accordingly, the operations of SEI have been included in the Company's financial statements from the date of acquisition. In July 1992, the Company acquired the remaining minority interest (see Note 2).
In December 1991, the Company acquired Hamilton Projects and ownership of certain television programming, and received $24,000,000 in cash, in exchange for its distribution rights to Hanna-Barbera's animated programming (see Note 2).
In September 1992, the Company purchased from Carolco domestic television distribution rights for more than 150 feature films, together with certain
related receivables. The purchase price for these assets included $50,000,000 in cash and the assumption of approximately $14,000,000 in related liabilities. The cash portion of the purchase price was funded through SEI's bank facility (see Notes 3 and 4).
In September 1993, the Company and Republic entered into an agreement in principle pursuant to which the Company agreed to acquire by merger all of the outstanding shares of common stock of Republic for $13 per share in cash, including the approximate 35% interest in Republic held by BEC. Additionally, certain options to acquire Republic common stock will be converted into options to acquire the Company's Common Stock. In December 1993, the Company and Republic entered into a definitive agreement covering the Republic Merger, which is expected to be consummated in the second quarter of 1994. The aggregate cash payments to the shareholders of Republic will be approximately $100,000,000, which will be funded through borrowings under the Company's credit arrangements with BEC (see Note 4 and "Financial Condition" below).
RESULTS OF CONTINUING OPERATIONS
The results of operations for any period are significantly affected by the quantity and performance of the Company's film product which is licensed to, and available for exhibition by, licensees in various media and territories. Consequently, results of operations may vary significantly between periods, and the results of operations in any one period may not be indicative of results of operations in future periods.
The success of the Company's business depends, in part, upon the network exhibition of its television series over several years to allow for more profitable licensing and syndication arrangements. During the initial years of a television series, network and international license fees normally approximate the production costs of the series, and accordingly the Company recognizes only minimal profit or loss during this period. If a sufficient number of episodes of a series are produced, the Company is reasonably assured that it will also be able to sell the series in the domestic off-network market, and the Company would then expect to be able to realize a more substantial profit with respect to the series.
The Company's business in general may also be affected by the public taste, which is unpredictable and subject to change, and by conditions within the filmed entertainment industry, including, but not limited to, the quality and availability of creative talent and the negotiation and renewal of union contracts relating to writers, directors, actors, musicians and studio craftsmen as well as any changes in the law and governmental regulation. In 1993, a Federal district court vacated certain provisions of consent decrees which prohibited television networks from acquiring financial interests and syndication rights in television programming produced by non-network suppliers such as the Company. Accordingly, subject to certain restrictions imposed by the Federal Communications Commission, the networks will be able to negotiate with program suppliers to acquire financial interests and syndication rights in television programs that air on the networks and therefore could become competitors of the Company.
The following paragraphs discuss significant items in the Consolidated Statements of Operations for the three years ended December 31, 1993.
REVENUE
The following table sets forth the components of revenue from the Company's major markets
for the years ended December 31 (in thousands):
* Includes only the eight months following the acquisition of SEI.
Network revenue remained at approximately the same level in 1993 as in 1992, as opposed to the significant increase in such revenue in 1992. In 1993, the Company delivered fewer hours of programming than in 1992, but the effect of this decrease was offset by an increase in the average license fee per hour or episode of programming. The increase in 1992 was attributable to (i) the fact that the results of operations include SEI's operations for only eight months in 1991 as compared to 12 months in 1992; and (ii) the delivery of additional programming in 1992.
Network revenue in all three periods included license fees attributable to "Beverly Hills, 90210." The license fees from "Melrose Place" began in the fall of 1992. Both of these series have been ordered by the Fox network for the 1994/1995 season, and "Beverly Hills, 90210" is also expected to be released in the domestic off-network marketplace in the fall of 1994. The Company has received orders for two new series, "Burke's Law" (13 episodes) and "Winnetka Road" (six episodes), for the current season, as well as an order for two four hour mini-series, one based on James Michener's novel "Texas" and the other based on Stephen King's novel "The Langoliers." The CBS network has also ordered an additional 13 episodes of "Burke's Law" for the 1994/1995 season.
Home video revenue increased $14,161,000 or 103%, in 1993 as compared to 1992. This increase was primarily due to the distribution of "Happily Ever After," an animated feature film, and the international licensing of "The Stand." The increase in such revenue in 1992 was $8,097,000, or 142%, as compared to 1991, primarily due to (i) the significant efforts by the Company to increase its presence in the home video distribution market, and (ii) the fact that SEI's operations were only included for eight months in 1991.
International film distribution revenue decreased $5,024,000, or 24%, in 1993 as compared to 1992. During 1993, the Company delivered two feature films, "Short Cuts" and "Shadowlands," as compared to four during 1992, including "The Player." There were no comparable distribution activities in 1991.
Licensing and merchandising revenue remained relatively constant in 1993, but increased $13,535,000 or 530%, in 1992 as compared to 1991. The increase from 1991 to 1992
was primarily due to the successful licensing of "Beverly Hills, 90210," and the acquisition of Hamilton Projects in December 1991.
Other distribution revenue includes revenue from the licensing of the Company's extensive library of feature films and television programming in worldwide free and pay television markets other than domestic network television. The revenue from these markets remained relatively stable between 1993 and 1992. The increase between 1992 and 1991 was primarily due to the inclusion of SEI's operations for only eight months in 1991. Generally, the future growth in these markets is expected to occur in the international area rather than the domestic market; see Item 1. "Business - Distribution."
FILM AND TELEVISION COSTS
Film and television costs consist primarily of the amortization of capitalized product costs and the accrual of third party participations and residuals. Such costs in 1993 increased $4,457,000, or 2%, as compared to 1992, primarily as a result of the overall increase in revenue in 1993, although the percentage relationship between such costs and the related revenue decreased to 73% in 1993 from 76% in 1992. Such costs increased $106,924,000, or 119%, in 1992 as compared to 1991; this increase also resulted primarily from the increases in the Company's revenue. Additionally, the percentage relationship between these costs and the related revenue increased from 73% in 1991 to 76% in 1992. This percentage relationship is a function of (i) the mix of film product generating revenue in each period and (ii) changes in the projected profitability of individual film product based on the Company's estimates of such product's ultimate revenue and costs.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative costs in 1993 decreased $1,516,000, or 4%, as compared to 1992. This decrease primarily resulted from a decrease in management fees charged to the Company by the Company's former principal shareholder in
1993 following BEC's acquisition of a majority interest in the Company. Selling, general and administrative costs in 1992 increased $11,392,000, or 48%, as compared to 1991, primarily due to the inclusion of SEI's costs for only the last eight months of 1991 as compared to a full twelve months for 1992. In addition, a subsidiary recorded a nonrecurring gain from the relocation of its offices in 1991.
INTEREST INCOME
Interest income increased $1,347,000 in 1993 as compared to 1992, following an increase of $890,000 in 1992 as compared to 1991. These increases were principally due to the amortization of discount on receivables acquired from Carolco for the full year 1993 and from the date of acquisition in 1992.
INTEREST EXPENSE
Interest expense in 1993 decreased $2,019,000, or 20%, despite the Company's increased level of borrowings during the first three quarters of 1993. This decrease was primarily due to (i) the lower effective interest rates during the year and (ii) the repayment or redemption of a substantial amount of the Company's debt during the fourth quarter of 1993 (see Note 4 and "Financial Condition" below). Interest expense increased $2,890,000, or 41%, in 1992 due to the Company's increased level of borrowings during the year. The Company's borrowings will increase in 1994 as a result of the amounts borrowed to fund the aquisition of Republic (see Note 15).
MINORITY INTEREST
During 1992 the Company had minority interest expense of $1,327,000 related to the earnings of SEI for the period up to the date of the Company's acquisition of the minority interest. In 1991 the similar charge was $932,000. There was no
such charge in 1993.
PROVISION FOR INCOME TAXES
During 1993, the Company's provision for income taxes increased $3,871,000, or 42%, over the provision in 1992. This increase was primarily due to the increase in pre-tax income in 1993, as described in the foregoing paragraphs. The effective tax rate decreased significantly in 1993, largely as a result of the effect of a reduction in the valuation allowance against the realizability of certain tax loss and credit ("tax attribute") carryforwards. Tax benefits from the utilization of certain tax attribute carryforwards in 1992 and 1991 were recorded as extraordinary items under then applicable accounting rules. (See Note 10).
The Company adopted Statement of Financial Accounting Standards No. 109 ("SFAS 109") effective January 1, 1993. The cumulative effect of adopting SFAS 109 was not material.
During 1992, the provision for income taxes increased by $6,350,000, or 224%, as compared to 1991. This increase is primarily due to the increase in pre-tax income, partially offset by a decrease in the overall effective tax rate for the year, as a result of the reduced effect of non-deductible intangible expenses.
DISCONTINUED OPERATIONS
The Company, formerly known as The Charter Company, was engaged in petroleum marketing operations, but in 1991 and 1992 sold substantially all of the remaining such operations. (See Note 11.)
In April 1991, the Company completed the sale of its interest in an oil producing concession to two of its partners in the concession. The Company recognized a net gain of $8,848,000 after a provision for income taxes of $4,556,000.
During July and August 1992, the Company sold two subsidiaries and a terminal facility. In December 1992 and January 1993, the Company sold its remaining utility supply contracts. No material gain or loss resulted from the overall disposition of these operations. The Company continues to sell the few remaining assets of the discontinued operations whenever possible and to settle remaining obligations associated with the discontinued operations.
The financial position of discontinued operations is presented in the Balance Sheets under the caption "Net liabilities related to discontinued operations." Included in such amounts are certain allowances for estimated losses on disposal of the remaining oil operations and disputed claims relating to the reorganization in 1986 under Chapter 11 of the Bankruptcy Code. These allowances totaled approximately $29,621,000 and $30,587,000 at December 31, 1993 and 1992, respectively. See Note 11 regarding the insurance-type indemnity agreement the Company entered into in early 1993 which covers up to $35,000,000 in such claims over a threshold of $25,000,000.
The Company is involved in a number of legal actions including threatened claims, pending lawsuits and contract disputes, environmental clean-up assessments, damages from alleged dioxin contamination and other matters. Some of the parties involved in such actions seek significant amounts of damages. While the outcome of these suits and claims cannot be predicted with certainty, the Company believes based upon its knowledge of the facts and circumstances and applicable law that the ultimate resolution of such suits and claims will not have a material adverse effect on the Company's results of operations or financial condition. This belief is also based upon allowances that have been established for estimated losses on disposal of former operations and remaining Chapter 11 disputed claims and an insurance-type indemnity agreement which covers up to $35,000,000 of certain such liabilities in excess of a threshold amount of $25,000,000, subject to certain adjustments. Substantial portions of such allowances are intended to cover environmental costs associated with the Company's former operations.
Although there are significant uncertainties inherent in estimating environmental liabilities, based upon the Company's experience it is considered unlikely that the amount of possible environmental liabilities and Chapter 11 disputed claims would exceed the amount of the allowances by more than $50 million.
In 1993, the Company had a net loss from discontinued operations of $3,971,000 after an income tax benefit of $2,529,000. This loss resulted primarily from the premium paid for the insurance-type indemnity described above.
EXTRAORDINARY ITEMS
In connection with the early extinguishment of certain indebtedness, the Company in 1993 recorded an extraordinary loss of $2,022,000 (net of a tax benefit of $1,287,000) from the write-off of unamortized discount and debt issuance costs relating to such debt. During 1992 and 1991, the Company had extraordinary income of $3,948,000 and $4,572,000, respectively, from tax benefits relating to utilization of certain tax attribute carryforwards; a similar benefit in 1993 was included in the Company's provision for income taxes in accordance with the provisions of SFAS 109.
FINANCIAL CONDITION
The Company's operations require the production of film product and the acquisition of rights to distribute film product produced by others. The Company's expenditures in this regard totalled $150,648,000 and $154,607,000 in 1993 and 1992, respectively. The cost of producing network television programming is largely funded through the receipt of the related network license fees. The cost of other production and acquisition activities is funded through the Company's operating cash flow and borrowings under its various credit arrangements.
In connection with the Republic Merger, the Company in October 1993 issued 13,362,215 shares of the Company's Common Stock to BEC in exchange for 3,652,542 shares of BEC common stock. The BEC shares were subsequently resold, with the Company realizing approximately $100,445,000 in proceeds. The Company subsequently used these proceeds to prepay or redeem (i) all of the outstanding principal amount of its 10% Senior Subordinated Notes and 12% Subordinated Debentures, (ii) approximately $39,500,000 of SEI's bank debt and (iii) all of its outstanding Preferred Stock. (See Notes 4 and 6). As a result, the Company will borrow under its credit facilities to fund the completion of the Republic Merger in the second quarter of 1994.
In January 1994, the Company terminated its existing bank credit agreement and entered into a three-year credit agreement with BEC (the "BEC Facility") (see Note 4). The BEC Facility provides for a three-year term loan facility of $100,000,000 to fund the Company's acquisition of Republic and a revolving credit facility of $75,000,000 to fund the Company's working capital and other requirements. The entire amount outstanding under the BEC Facility may be accelerated if BEC's indebtedness is accelerated by its banks. The events which might result in such an acceleration include the consummation of BEC's merger with Viacom (see Note 15) without the receipt of a waiver from BEC's banks. The Company has not been informed as to whether such waiver will be granted by BEC's lenders. However, the Company is currently exploring and believes it can obtain credit arrangements with third parties under terms and conditions which are not materially different from those contained in the BEC Facility.
The Company believes that its financial condition remains strong and that it has the financial resources necessary to meet its anticipated capital requirements. In addition to cash provided by operating activities, and the issuance of Common Stock, the Company has sufficient resources available under its credit facility to meet its ongoing plans for the production and acquisition of film product and to take advantage of internal and external development and acquisition opportunities.
INFLATION
The Company anticipates that its business will be affected by general economic trends. During a period of high inflation, the Company believes that if costs increase, it should be able to pass such increases on to its customers.
RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1994, the Company adopted SFAS No. 112, "Employers' Accounting for Postemployment Benefits," and SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 112 will not have an effect on the Company's results of operations or financial condition because the Company does not provide such benefits. However, the adoption of SFAS No. 115 will require the Company to adjust the carrying value of a common stock investment to fair market value with a corresponding adjustment to its Shareholders' Equity (see Note 1).
ITEM 8: | 312667 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------
ITEM 7. | ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS - ----------------------------------------
(all amounts in millions of dollars)
Results of Operations - ---------------------
1993 Compared to 1992 ---------------------
1993 net sales increased $88.0 or 4.5% over levels reported for 1992. The increase for 1993 was principally attributable to higher sales volumes, particularly in Asia, offset slightly by lower selling prices, and unfavorable currency effects in Europe.
Manufacturing cost of sales, as a percent of net sales, was relatively unchanged for 1993 as compared to 1992.
Marketing and administrative expenses, as a percent of net sales, were 19.8% in 1993 compared to 21.0% in 1992. This decrease is attributable to lower freight costs, commissions and allowances.
Implant costs of $640.0 in 1993 and $69.0 in 1992 represent provisions for costs associated with breast implant litigation, claims and related matters, as further described in Note 2 of Notes to Consolidated Financial Statements. These costs were reported separately to better identify the Company's profitability from ongoing operations and the financial impact resulting from breast implant litigation.
Special items of $40.0 in 1992 relate to provisions for restructuring activities, consisting largely of costs associated with the cessation of manufacturing activities at a subsidiary in Brazil and costs involved in global expense reduction, including elimination of low-priority activities, redeployment of people and reduction in the value of affected facilities.
The Company incurred an operating loss in 1993 of $404.1, compared to operating income of $93.1 in 1992. Operating results in both years have been negatively impacted by breast implant related charges of $640.0 in 1993 and $69.0 in 1992. Operating results were also negatively impacted in 1992 due to special items of $40.0 described above.
Other income was $15.4 in 1993 compared to other expense of $20.6 in 1992. As a result of the turmoil in European financial markets in September 1992, the Company incurred losses in 1992 related to positions taken in several financial instruments. These losses were generated as the market values of these instruments were sensitive to movements in cross-currency exchange rates and interest rates in certain foreign markets. During September 1992, the Company offset these positions and reduced its exposure to the effects of further instability in the European markets.
Implant costs of $640.0 described above were offset by a related tax benefit of $225.0. Excluding the impact of this charge and the related tax benefit, the effective tax rate was 34.0% in 1993 compared to 20.2% in 1992. The higher effective rate in 1993 is due to lower foreign tax credits.
During 1992, the Company adopted Statements of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and No. 109, Accounting for Income Taxes. The impact of these changes, as further explained in Notes 11 and 13 of Notes to Consolidated Financial Statements, reduced 1992 net income by $111.9, $100.4 of which represented the cumulative effect of these changes for years prior to 1992.
1992 Compared to 1991 ---------------------
1992 net sales increased $110.3 or 6.0% over levels reported for 1991. The increase for 1992 was principally attributable to higher sales volumes. The effects of currencies strengthening in Europe and Asia have also contributed to this increase. Weak economic conditions in most industrialized countries were the major reasons for low volume growth in 1992. Economic conditions and competitive pressures limited opportunities for price improvements and selling prices were lower in 1992 than in 1991.
Manufacturing cost of sales, as a percent of net sales, was 68.7% in 1992 compared to 64.8% for 1991. These increases, in large part, reflect the effects of lower selling prices on products sold and growth in employee costs, the latter partially attributable to effects related to the adoption of Statement of Financial Accounting Standards No. 106 and to increases in staffing levels associated with the operation of new facilities. For 1992, manufacturing costs were also unfavorably affected by higher purchased material costs, faster sales growth in lower margin products and higher depreciation charges.
Marketing and administrative expenses, as a percent of net sales, were relatively unchanged for 1992 as compared to 1991.
Implant costs of $69.0 in 1992 and $25.0 in 1991 represent provisions for costs associated with discontinued breast implant products, as further described in Note 2 of Notes to Consolidated Financial Statements. These costs were reported separately to better identify the financial impact of the breast implant controversy and the Company's profitability from ongoing operations.
Special items of $40.0 in 1992 relate to provisions for restructuring activities, consisting largely of costs associated with the cessation of manufacturing activities at a subsidiary in Brazil and costs involved in global expense reduction, including elimination of low-priority activities, redeployment of people and reduction in the value of affected facilities. Special items of $29.0 in 1991 represent provisions for costs of certain legal contract disputes and recognition of partial impairment in the value of certain foreign assets.
Operating income for 1992 was down $105.5 or 53.1% from prior year levels. Results have been negatively impacted by charges relating to the breast implant controversy and restructuring activities, weak economic conditions, competitive pricing pressure and expense growth.
Other expense for 1992 increased significantly from levels for 1991. As a result of the turmoil in European financial markets in September 1992, the Company incurred losses related to positions taken in several financial instruments. These losses were generated as the market values of these instruments were sensitive to movements in cross-currency exchange rates and interest rates in certain foreign markets. During September 1992, the Company offset these positions and reduced its exposure to the effects of further instability in the European markets. The Company's use of interest and currency rate derivatives is described in Note 10 of Notes to Consolidated Financial Statements. Interest income was also down slightly from 1991 reflecting lower average invested cash balances and lower interest rates.
The effective tax rate in 1992 was 20.2%, compared to 27.9% for 1991. The lower effective rate in 1992 was due to higher levels of foreign tax credit utilization.
During 1992, the Company elected to adopt Statements of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and No. 109, Accounting for Income Taxes. The impact of these changes, as further explained in Notes 11 and 13 of Notes to Consolidated Financial Statements, reduced 1992 net income by $111.9, $100.4 of which represented the cumulative effect of these changes for years prior to 1992.
Credit Availability - -------------------
During 1993, the Company terminated a revolving credit agreement which was in place at December 31, 1992, and replaced it with a revolving credit agreement with 16 domestic and foreign banks which provides for borrowings on a revolving credit basis until November, 1997 of up to $400.0. At December 31, 1993, there was $150.0 outstanding under this facility. Availability of credit under this facility may be affected by certain debt restrictions and provisions as described in Note 8 of Notes to Consolidated Financial Statements.
Additionally, the Company has agreements in place whereby it may sell on an ongoing basis fractional ownership interests in a designated pool of U.S. trade receivables, with limited recourse, in amounts up to $65.0. As of December 31, 1993, the Company had no amounts outstanding under these agreements. Under other agreements, $63.2 of foreign trade receivables had been sold and remained uncollected at December 31, 1993.
The Company also has agreements with several banks whereby it may borrow up to $269.5 under short-term lines of credit. The Company pays a fixed service fee for certain of these facilities in lieu of any compensating cash balances. Included in short-term borrowings are amounts outstanding under these facilities at December 31, 1993, of $83.7.
The Company has registered with the Securities and Exchange Commission $400.0 of debt securities. As of December 31, 1993, $275.0 of these registered securities had been designated to medium-term note programs with $100.0 issued, and $125.0 had been issued in debentures.
During 1993, the Company obtained long-term financing totalling $58.8 ($28.6 of which is denominated in foreign currencies) bearing interest at rates ranging from 4.1% to 11.5% at December 31, 1993 and with maturities ranging from two to five years.
Management believes that, in light of the Company's positive operating cash flow, the credit facilities currently in place are adequate to meet the short-term financing needs of the Company. Management also believes that the Company will generate the financial liquidity required to meet ongoing operational needs and to participate in the breast implant litigation settlement currently being negotiated (as described in Note 2 of Notes to Consolidated Financial Statements). This belief is based on, among other things, management's estimate of future operational cash flows, its assessment that recovery of substantial amounts of settlement obligations from its insurance carriers is probable, and its evaluation of current financing arrangements.
Inflation - ---------
The impact of inflation on the Company's financial position and results of operations has been minimal. The Company expects that future impacts of inflation will be offset by increased prices and productivity gains.
Contingencies - -------------
For information regarding contingencies, including a discussion of breast implant litigation and the Company's environmental liabilities, see Note 2 of Notes to Consolidated Financial Statements.
Management Changes - ------------------
On June 25, 1993, the Company's Board of Directors elected Richard A. Hazleton, President of the Company, to the additional position of Chief Executive Officer. Keith R. McKennon, formerly Chief Executive Officer, continues as the Chairman of the Board of Directors.
On December 10, 1993, the Company's Board of Directors elected John W. Churchfield, formerly the Assistant Chief Financial Officer, to the position of Vice President for Planning and Finance and Chief Financial Officer. Edward Steinhoff, formerly Vice President for Finance and Chief Financial Officer, announced in early 1993 his intention to retire and retired December 31, 1993.
ITEM 8. | 29917 | 1993 |
ITEM 6. Selected Consolidated Financial Data
ITEM 7. | ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition
Financial Performance. In 1993, the Company's consolidated net income was $4.7 million, an increase of $.3 million from the $4.4 million earned in 1992. Earnings in 1992 decreased by $2.0 million, from the $6.4 million earned in 1991. Earnings per average common share outstanding in 1993 were $42.12, an increase of $2.46 from the $39.66 earned in 1992. Earnings per average common share for 1992 were $17.36 lower than 1991 earnings per share of $57.02. A discussion of the items causing the change in earnings is contained in the "Results of Operations."
The Company's interest coverage, as computed under the terms of its mortgage indenture, was 3.3 times for the current year as compared to 2.9 times in 1992 and 3.6 times in 1991. The after tax interest and preferred dividend coverage was 2.42 times in 1993 as compared to 2.29 times in 1992 and 2.82 times in 1991.
Events Affecting the Company.
During the third quarter of 1993, the Rockland County (NY) District Attorney charged a then Vice President of the Parent and the Company with grand larceny, commercial bribery and making illegal political contributions and commenced a related investigation of the Parent. Two other former employees of the Parent reporting to the Vice President were charged with grand larceny. The Board of Directors of the Parent promptly formed a Special Committee of outside directors (Special Committee), with authority to take any steps deemed necessary or desirable, to conduct an independent investigation into such matters, in order to determine to what extent there were any other improprieties and to make recommendations as to any necessary remedial measures. The Special Committee has retained investigative counsel and an accounting firm to assist its inquiry.
The New Jersey Board of Regulatory Commission (NJBRC) also began an investigation to determine the impact of these events on the Company's ratepayers. The Company is cooperating fully in the inquiries and has pledged to return to customers any funds that are discovered to have been misappropriated. Under an agreement reached with the NJBRC, the Company agreed to refund $94,100 to New Jersey ratepayers in February and March 1994 through reductions in the applicable fuel adjustment charges.
On November 4, 1993 the Parent signed a Joint Cooperation Agreement with the Rockland County District Attorney's office which creates an Inspector General's office within the Parent to monitor its efforts to implement and maintain programs to ensure the highest ethical standards of business conduct. The agreement also specified a number of other steps the Parent will undertake to aid in the on-going investigation and prevent any recurrence. As a result of the agreement and the Parent's continued cooperation with the inquiry, the District Attorney has agreed not to file any criminal charges against the Parent or any of its subsidiaries in connection with the current investigation.
The former officer of the Parent and the Company and two former employees of the Parent charged by the District Attorney subsequently pleaded guilty to all counts. The District Attorney's Office has identified $374,124 as representing the amount of consolidated funds misappropriated by these individuals. As part of their plea, the two former employees of the Parent agreed to a partial restitution agreement pursuant to which they will reimburse to the Parent and its subsidiaries a sum of $199,709 prior to their sentencing, scheduled for May 4, 1994.
The investigations being conducted by the Special Committee of the Board of Directors of the Parent and the District Attorney, along with those of the NJBRC, are still under way. The Parent and the Company intend to take all appropriate actions to protect the interests of its customers and shareholders. It is not possible to predict at this time the extent of additional refunds that may be required by the NJBRC, if any.
During 1993 the Company incurred expenses of $1.3 million for legal counsel, accountants, and other consultants in connection with the investigation and related matters. These activities are currently anticipated to continue through the first half of 1994. It is currently estimated that the Company will incur from $.7 to $1.3 million of expenses in 1994 to conclude the investigation. These expenditures are not recoverable from ratepayers. The Company will attempt to offset these costs to the extent possible by achieving savings in the cost of operations during the year.
During the fourth quarter, James F. Smith was terminated for cause as Chief Executive Officer of the Parent and the Company and removed as Chairman of the Board of Directors of the Parent, and Victor J. Blanchet, Jr. was appointed to serve as Acting Chief Executive Officer of the Parent and the Company.
In order to fully protect its interests the Parent, has initiated lawsuits in federal and state courts to recover misappropriated funds. In related activities, two lawsuits have been brought by shareholders and another by ratepayers seeking damages resulting from these events. For more information on these legal proceedings, refer to Note 10 of the Notes to Consolidated Financial Statements.
Rate Activities.
In January 1992, an increase in electric rates of $5.1 million was granted by the NJBRC in response to the Company's March 18, 1991 petition requesting a $12.9 million increase in base rates. This increase includes a 12% rate of return on equity. In addition, the NJBRC initiated a Phase II proceeding in this case to address the effect of tax legislation adopted June 1, 1991. That legislation changed the procedure under which certain taxes are collected from the State's utilities. Previously, the Company had been subject to an effective gross receipts and franchise tax of 12.5%, which the utilities paid in lieu of property taxes. The new tax is based upon the number of units of energy (kwh or therms) delivered by a utility rather than revenues. The legislation also requires that utilities accelerate payment to the State of New Jersey of the taxes collected. As a result, the Company is required to make additional tax payments of approximately $16 million during the period 1993-1994. On November 12, 1992, the NJBRC approved the recovery of the additional tax over a ten-year period. A carrying charge of 7.5% on the unamortized balance was also approved. The amount of unamortized accelerated payments is included in Deferred Revenue Taxes in the accompanying financial statements.
On February 26, 1993 the New Jersey Department of Public Advocate, Division of Rate Counsel ("Rate Counsel") filed a Notice of Appeal from the NJBRC Decision and Order with the Superior Court of New Jersey Appellate Division, stating as grounds for the appeal that the Decision is arbitrary and capricious and would result in unjust and unreasonable rates. On August 9, 1993, Rate Counsel filed its initial brief with regard to its appeal. Thereafter, on October 12, 1993, the Company filed its initial brief and on October 27, 1993, Rate Counsel filed its reply brief with regard to this matter. Oral argument was held on March 7, 1994, and on March 21, 1994 the Superior Court affirmed the NJBRC's December 30, 1992 Decision and Order.
Results of Operations
The discussion which follows identifies the principal causes of significant changes in the amount of revenues and expenses affecting net income, by comparing 1993 to 1992 and 1992 to 1991. The discussion should be read in conjunction with the Notes to Consolidated Financial Statements which immediately follow the financial statements contained in this Form 10-K Annual Report.
Changes in net income during the periods presented in the accompanying Consolidated Statements of Income and Retained Earnings are highlighted as follows:
Increase (Decrease) From Prior Year 1993 1992 (Thousands of Dollars) Utility Operations: Operating revenues $ 6,926 $ (385) Energy Costs (522) (2,720) Net revenues from utility operations 7,448 2,335 Other utility operating expenses 5,751 4,008 Diversified activities-net (661) (198) Income from Operations 1,036 (1,871) Other income and deductions (845) (49) Interest charges net of AFDC (84) 25 Net Income $ 275 $(1,945)
Utility Revenues. Revenues increased by 5.5% or $6.9 million, in 1993, after decreasing 0.3% or $0.4 million in 1992. These changes were
attributable to the following factors:
Increase (Decrease) From Prior Year 1993 1992 (Thousands of Dollars) Retail Sales: Base rates $ 4,847 $ 4,259 Fuel recoveries (1,311) (3,071) Sales volume 3,492 (1,566) Other operating revenues (102) (7) Total $ 6,926 $ (385)
Fuel recovery revenues represent amounts collected pursuant to the levelized fuel adjustment clause included in the Company's tariff schedule, as authorized by the NJBRC. During 1993, the fuel recovery rate fell to approximately 2.74 cents per kilowatt hour from the 2.94 cents per kilowatt hour recovered during 1992 and 3.23 cents per kilowatt hour during 1991.
Revenue increases due to higher sales volumes reflect an increase in kilowatt hour sales during 1993 of 3.6%. Total sales in 1993 amounted to 1,239.6 million kilowatt hours. During 1992 sales volumes totaled 1,196.2 million kilowatt hours or a 1.7% decrease over the 1991 level of 1,219.6 million kilowatt hours. The increase in 1993 was the result of the warmer weather during the summer months of 1993 compared to the same period of 1992, coupled with an increase in the average number of customers. The decrease in 1992 was primarily attributable to cooler summer weather, partially offset by the increase in number of customers compared to 1991.
Energy Costs. All of the energy requirements of the Company are furnished by its Parent pursuant to a contract approved by the FERC.
Energy costs are adjusted to match revenues recovered through the operation of the levelized electric energy adjustment clause. The cost of power purchased from the Parent decreased by .8% and 3.9% for the years 1993 and 1992, respectively. The components of the changes in electric energy costs are as follows:
Increase (Decrease) From Prior Year 1993 1992 (Thousands of Dollars)
Prices paid for purchased power $ (548) $ 2,259 Changes in kilowatt hours purchased 1,791 (1,462) Deferred fuel charges (1,765) (3,517) Total $ (522) $(2,720)
The average price paid per kilowatt hour purchased during 1993 amounted to 5.12 cents compared to 5.16 cents during 1992 and 4.99 cents during 1991. Any fluctuations in the price paid per kilowatt hour are reflective of the Parent's costs to generate or purchase electricity, particularly the cost of fuel used in electric production.
Other Utility Operating Expenses. The increases (decreases) in other operating expenses are presented in the following table:
Increase (Decrease) From Prior Year 1993 1992 (Thousands of Dollars)
Other operation & maintenance $ 2,994 $ 5,055 Depreciation 151 321 Taxes 2,606 (1,368) Total $ 5,751 $ 4,008
Other Operation and Maintenance. The cost of conservation programs increased other operation and maintenance expenses in 1993 by $2.9 million and 1992 by $3.1 million. These costs are recoverable in revenues on a current basis. The remaining increase in 1993 was the result of higher operation expenses associated with inflation. The increase in 1992 is primarily the result of an increase in the Company's circuit maintenance programs along with inflationary increases.
Depreciation. Depreciation expenses increased $0.2 million and $0.3 million in 1993 and 1992, respectively. These increases are the result of plant additions in both years.
Taxes. The Company's tax expense increased by $2.6 million in 1993 after decreasing by $1.4 million in 1992. Taxes other than income taxes increased $1.4 million in 1993 after a decrease of $0.4 million in 1992. The 1993 increase is the result of increases in gross receipts and franchise tax. Federal income tax expense increased by $1.2 million in 1993 following a $1.0 million decrease the year before. Changes in Federal income taxes are detailed in Note 2 of the Notes to Consolidated Financial Statements under the caption "Federal Income Taxes" in Part IV, Item 14 of this Form 10-K Annual Report.
Diversified Activities. The Company's diversified activities, which are conducted through it's wholly owned non-utility subsidiaries, consist of natural gas marketing and radio broadcasting activities.
Revenues from diversified activities increased $87.6 million and $88.4 million in 1993 and 1992, respectively. The increased revenues in both years is primarily the result of increased sales volumes from gas marketing activities. However, an extremely competitive market for non- utility gas sales in 1993 resulted in significantly lower gross profit margins on these sales when compared to 1992. This resulted in a decrease in operating income of $0.7 million in 1993 after a decrease of $0.2 million in 1992.
The increase in gas marketing payables and receivables are directly related to the favorable increase in customers and higher sales volumes. Gas marketing payables increase proportionately to gas marketing receivables.
A description of the non-utility subsidiaries of the Company is included in Part I, Item 1 of this Form 10-K Annual Report under the caption "Diversified Activities." The Company will continue to look to its gas marketing activities to increase operating results in the future while the Company's radio broadcasting activities have been, and will continue to be, affected by the economy.
Other Income, Deductions and Interest Charges. Other nonoperating income, net of deductions and interest charges, decreased by $0.9 million during 1993 after decreasing by $0.3 million during 1992. The most significant reason for the decrease was the cost of the investigation and related matters described under the caption "Events Affecting the Company" in this Item 7, which amounted to $1.3 million. The fluctuation in net nonoperating income is also a result of fluctuations in interest expense items as well as the change in allowance for funds used during construction from the previous year.
Liquidity and Capital Resources
Utility construction expenditures, net of AFDC, amounted to $6.5 million, $7.6 million and $8.5 million during 1993, 1992 and 1991, respectively. The expenditures represent fixed asset replacements and are predominantly associated with the Company's transmission and distribution systems. During that three year period, the total construction expenditures, including those from diversified activities, were financed with internally generated funds. The Company estimates that its 1994-1998 capital requirements, which include construction expenditures and funds required for debt maturities, will be as follows: 1994 - $6,291,000; 1995 - $9,220,000; 1996 - $8,007,000; 1997 - $8,890,000; and 1998 -$9,100,000. It is expected that these capital requirements will be financed with internally generated funds. Information regarding the Company's construction program is contained in Part 1, Item 1 of this Form 10-K Annual Report under the caption Construction Program and in Note 10 of the Notes to Consolidated Financial Statements - under the caption "Construction Program" in Part IV, Item 14 of this Form 10-K Annual Report.
At December 31, 1993, the Company had available bank lines of credit of $10.0 million, against which no short-term borrowings were outstanding. For additional information regarding the Company's short- term borrowings, see Note 7 of the Notes to Consolidated Financial Statements under the caption "Cash and Short Term Debt" in Part IV, Item 14 of this Form 10-K Annual Report.
The Company's capital structure at the end of 1993 was 67% common equity and 33% long-term debt. The Company was required under the terms of its Sixth Supplemental Indenture to make an annual sinking fund payment on June 14 of each year of $240,000 with respect to its Series "F" Bonds and, pursuant to its Seventh Supplemental Indenture, to make sinking fund payments of $333,000 on January 31 of each year with respect to its Series "G" Bonds. During 1992 and 1991 cash payments were made to satisfy both requirements and during 1993 both issues were redeemed. On February 25, 1993 the Company sold $20 million of First Mortgage 6% Bonds, Series I due 2000 (Series I Bonds). The Series I Bonds were sold at a discount to yield 6.11% to the public. The net proceeds to the Company from the sale of the Series I bonds were used to pay the principal and redemption premium on an aggregate of $16,017,000 of the Company's outstanding First Mortgage Bonds and for other corporate purposes. The principal amount and series of First Mortgage Bonds refunded on March 27, 1993 were: $5,000,000 of 9 1/8% bonds, Series D due 2000; $6,000,000 of 7 7/8% Bonds, Series E due 2001; $3,680,000 of 8.95% Bonds, Series F due 2004; and $1,337,000 of 10% Bonds, Series G due 1997. Cash payments totaling $333,000 were made to satisfy the Series G sinking fund requirement of the Company in 1993.
SRH and its subsidiaries also maintain certain lines of credit and undertake long and short-term borrowings or make investments from time to time. At December 31, 1993 SRH and its' subsidiaries had outstanding loans aggregating $2.9 million, the proceeds of which were used to make investments in broadcasting properties. In addition, O&R Energy, Inc., a subsidiary of SRH had an available line of credit and standby letters of credit which together amounted to $15.0 million and under which $1.2 million was outstanding at December 31, 1993. Non-utility temporary cash investments amounted to $685,000 at year end.
Credit Ratings
The credit ratings of the Company's First Mortgage Bonds are as follows:
Company First Mortgage Agency Bonds Moody's Investors Service, Inc. A2 Standard & Poor's Corporation A+
The Company's First Mortgage Bonds are not rated on a stand-alone basis. They are reviewed annually in conjunction with the debt, preferred stock and commercial paper ratings of the Parent. The ratings assigned to the Company's securities by the rating agencies are not a recommendation to buy, sell or hold the Company's securities, but rather are assessments of the credit-worthiness of the Company's securities by the rating agencies.
Other Developments
SFAS No. 112.
In November 1992 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 112 "Employers Accounting for Postemployment Benefits", (SFAS No. 112), which requires the recognition of postemployment benefits, such as salary continuation, severance pay, and disability benefits, provided to former or inactive employees on an accrual basis. The Company currently recognizes the cost of such benefits as they are paid. Adoption of SFAS No. 112 is mandatory for fiscal years beginning after December 15, 1993. The Company anticipates adopting this accounting standard in 1994; however, it does not expect adoption to have a material adverse effect on the Company's results of operations.
Inflation
The Company's utility revenues are based on rate regulation, which provides for recovery of operating costs and a return on rate base. Inflation affects the Company's construction costs, operating expenses and interest charges and can impact the Company's financial performance if rate relief is not granted on a timely basis. Financial statements, which are prepared in accordance with generally accepted accounting principles, report operating results in terms of historic costs and do not recognize the impact of inflation.
ITEM 8. | 84613 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The information called for by this Item appears under the heading "Financial Summary" (page of the Financial Supplement) and in Notes 5, 6, 9 and 16 to Grace's Consolidated Financial Statements (pages,, and of the Financial Supplement). In addition, Exhibit 12 to this Report (page of the Financial Supplement) contains the ratio of earnings to fixed charges and combined fixed charges and preferred stock dividends for Grace for the years 1989-1993.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information called for by this Item appears on pages to of the Financial Supplement.
ITEM 8. | 42872 | 1993 |
Item 6. Selected Financial Data.
The information contained in "Selected Financial Data" 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.
The information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference.
Item 8. | 2648 | 1993 |
36029 | 1993 |
||
Item 6. Selected Financial Data.
($ In Thousands, Except Per Unit Information)
Fiscal Years Ended December 31, 1993 1992 1991 1990 1989
Net Realized Gain (Loss) on Investments $ 10,605 $ (5,677) $ 1,968$ (15,142) $ 2,931
Net Change in Unrealized Appreciation of Investments 9,430 11,657 14,361 4,525 1,137
Net Increase (Decrease) in Net Assets Resulting from Operations 18,581 4,809 15,954 (9,976) 5,375
Cash Distributions to Limited Partners 15,600 9,000 6,000 - 12,000
Cumulative Cash Distributions to Limited Partners 42,600 27,000 18,000 12,000 12,000
Net Assets 112,671 109,690 113,881 103,927 113,903
Net Unrealized Appreciation of Investments 51,908 42,478 30,821 16,460 11,936
Purchase of Portfolio Investments8,050 13,781 9,845 7,790 21,088
Cumulative Cost of Portfolio Investments 110,682 102,633 88,852 79,006 71,217
PER UNIT OF LIMITED PARTNERSHIP INTEREST:
Net Realized Gain (Loss) on Investments $ 87 $ (47) $ 16 $ (125) $ 25
Net Increase (Decrease) in Net Assets Resulting from Operations 120 29 104 (65) 37
Cash Distributions 130 75 50 - 100
Cumulative Cash Distributions 355 225 150 100 100
Net Unrealized Appreciation of Investments 355 310 225 133 79
Net Asset Value, Including Net Unrealized Appreciation of Investments 852 862 908 854 919
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Liquidity and Capital Resources
During the year ended December 31, 1993, the Partnership invested $8 million in portfolio investments; $3.6 million in two new portfolio companies and $4.4 million in five existing portfolio companies. From its inception through December 31, 1993, the Partnership had invested $110.7 million in 58 portfolio investments. Additionally, subsequent to December 31, 1993, the Partnership had a commitment to make a follow-on investment of $1.1 million in Corporate Express, Inc. As of December 31, 1993, 26 of the Partnership's 58 portfolio investments had been fully liquidated. Portfolio investments sold and written-off through December 31, 1993 had a cost of $55.6 million and returned $46.6 million, resulting in a cumulative net realized loss of $9 million.
At December 31, 1993, the Partnership held $5.4 million in cash and short- term investments; $4 million in short-term securities with maturities of less than one year and $1.4 million in an interest-bearing cash account. It is anticipated that funds needed to cover future operating expenses will be obtained from the Partnership's existing cash reserves and from proceeds received from the future sale of portfolio investments.
Subsequent to the end of fiscal 1993, the Partnership sold or partially sold investments in three portfolio companies for $13.9 million. As a result, on March 2, 1994, the General Partners approved a cash distribution to Limited Partners of $16.2 million, or $135 per Unit. This distribution will be paid in May 1994 to Limited Partners of record on March 31, 1994 and will bring cumulative cash distributions paid to Limited Partners to $58.8 million, or $490 per $1,000 Unit.
Results of Operations
Net realized gain or loss from operations is comprised of 1) net realized gains or losses from portfolio investments sold and written-off and 2) net investment income or loss. For the year ended December 31, 1993, the Partnership had a net realized gain from operations of $9.2 million. In 1992, the Partnership had a net realized loss from operations of $6.8 million and in 1991, the Partnership had a net realized gain from operations of $1.6 million.
Realized Gains and Losses from Portfolio Investments - For the year ended December 31, 1993, the Partnership had a $10.6 million net realized gain from portfolio investments sold and written-off. During the year, the Partnership sold 525,000 common shares of Regeneron Pharmaceuticals, Inc. in the public market for $8.2 million, realizing a gain of $7.6 million. In January 1993, the Partnership sold its investment in Pyxis Corporation in a private transaction for $7.8 million, realizing a gain of $7.2 million. In February 1993, the Partnership sold 187,912 common shares of Ringer Corporation for $567,000, realizing a gain of $4,000. During the year, In-Store Advertising, Inc. ("ISA") filed for protection under Chapter 11 of the federal Bankruptcy Code resulting in the write-off of the Partnership's remaining $1.1 million investment in the company. The Partnership also received a final liquidation payment from InteLock Corporation resulting in the write-off of the Partnership's remaining $123,000 investment in the company. Additionally, the Partnership wrote-off its $2 million investment in Ogle Resources, Inc. ("Ogle") and the remaining $900,000 of its investment in Communications International, Inc. ("CII"). Several smaller portfolio transactions completed in 1993 resulted in an additional $46,000 net realized loss for the period.
For the year ended December 31, 1992, the Partnership had a $5.7 million net realized loss from portfolio investments sold and written-off. In February and March 1992, the Partnership sold its remaining 157,500 common shares of Everex Systems, Inc. in the public market for $1 million, realizing a gain of $371,000. The Partnership also sold 45,000 common shares of Regeneron Pharmaceuticals, Inc. in the public market for $627,000, realizing a gain of $575,000. In September 1992, the Partnership received 50,111 shares of Bolt Beranek and Newman Inc. common stock in connection with the termination of BBN Integrated Switch Partners, L.P. The shares were sold in the public market in October and November 1992 for $200,000 which resulted in a realized gain of $13,000. In May 1992, Allez, Inc. filed for protection under Chapter 11 of the federal Bankruptcy Code. As a result, the Partnership realized a loss from its $1.8 million investment in the company. The Partnership also realized losses of $1.1 million of its $1.3 million investment in InteLock due to the company's financial restructuring and continued operating difficulties. In October 1992, the Partnership sold its investment in R-Byte to Exabyte Corporation for $1.3 million, which resulted in a realized loss of $444,000. Also during 1992, the Partnership realized a loss of $1.1 million on its $2.3 million investment in ISA due to the continued depressed public market price of the company's common stock. The Partnership also realized losses of $919,000 on its $1.8 million investment in CII, $1.1 million on its $1.5 million investment in Target Vision, Inc. and $102,000 on its remaining investment in TCOM Systems, Inc. due to continued operational and financial difficulties at the companies.
For the year ended December 31, 1991, the Partnership had a $2 million net realized gain from investments sold and written-off. In November 1991, the Partnership sold 500,000 common shares of Regeneron in the public market for $9.2 million, realizing a gain of $9.0 million. In April 1991, the Partnership sold 30,000 common shares of Everex in the public market for $196,000, realizing a gain of $76,000. In January 1991, Ringer completed its acquisition of Safer, Inc. The Partnership sold its holdings of Safer for 275,317 common shares of Ringer. The transaction resulted in the Partnership realizing a loss of $2.2 million of its $3 million original investment in Safer. The Partnership realized additional losses during 1991 totaling $4.9 million from the full or partial write-off of four portfolio investments. S&J Industries, Inc. completed a restructuring that negatively affected the Partnership's investment in the company, resulting in the write-off of its $1.6 million investment. SF2 Corporation incurred substantial operating difficulties which led to a financial restructuring of the company. Consequently, the Partnership wrote-off its $1.9 million equity investment in SF2. The Partnership also wrote-off its $1.1 million investment in Touch Communications Incorporated which ceased operations in 1991. Additionally, the Partnership wrote-off its remaining $300,000 investment in The Computer-Aided Design Group, Inc. due to a financial restructuring of the company which negatively impacted the value of the Partnership's investment.
Investment Income and Expenses - Net investment loss (investment income less operating expenses) for the years ended December 31, 1993, 1992 and 1991 was $1.5 million, $1.2 million and $374,000, respectively. The increase in net investment loss for 1993 compared to 1992 primarily is attributable to a decrease in investment income, specifically, interest income earned from the Partnership's short-term investments and the write- off of $406,000 of accrued interest receivable related to the Partnership's promissory note due from Ogle in the 1993 period. The reduction in investment income in 1993 was partially offset by a decrease in the 1993 management fee, as discussed below. The increase in net investment loss for 1992 compared to 1991 primarily is attributable to a decrease in interest income earned in 1992 from the Partnership's short-term investments partially offset by a decrease in the 1992 management fee, as discussed below. Interest earned from short-term investments for the years ended December 31, 1993, 1992 and 1991 was $360,000, $805,000 and $1.9 million, respectively. The decrease for each consecutive year primarily is due to a reduction in funds invested in short-term investments and declining interest rates. At December 31, 1993, 1992 and 1991, funds invested in short-term securities totaled $5.4 million, $12 million and $32.8 million, respectively. Funds available for investment in short-term securities declined as idle funds were used to purchase venture capital investments.
The Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership. The Management Company receives an annual fee of 2.5% of the gross capital contributions to the Partnership, reduced by selling commissions, organizational and offering expenses paid by the Partnership, return of capital and realized capital losses, with a minimum fee of $200,000. Such fee is determined and payable quarterly. The management fee for the years ended December 31, 1993, 1992 and 1991 was $1.4 million, $1.7 million and $1.9 million, respectively. The management fee is expected to continue to decline in future periods as portfolio investments mature and capital is returned to Partners. The management fee and other operating expenses are paid with funds provided from operations. Funds provided from operations for the period were obtained from interest received from short-term investments, dividend and interest income from portfolio investments and proceeds from the sale of certain portfolio investments.
Unrealized Gains and Losses from Portfolio Investments - For the year ended December 31, 1993, the Partnership had a $20.8 million unrealized gain from the net upward revaluation of certain portfolio investments. This unrealized gain primarily is a result of the net upward revaluation of the Partnership's investments in Regeneron, CellPro, Incorporated and Corporate Express, Inc. during 1993. Additionally, during the year, the Partnership transferred $13.6 million from unrealized gain to realized gain primarily relating to the sale of its investments in Pyxis and Regeneron and transferred $2.2 million from unrealized loss to realized loss relating to the write-offs of its investments in CII, Ogle, InteLock and ISA, as discussed above. The $20.8 million unrealized gain offset by the $11.4 million net transfer from unrealized gain to realized gain, resulted in a $9.4 million increase in the Partnership's net unrealized appreciation of investments for 1993.
For the year ended December 31, 1992, the Partnership had a $6.8 million unrealized gain from the net upward revaluation of certain portfolio investments. This unrealized gain primarily resulted from the upward revaluation of the Partnership's investments in Pyxis and CellPro. Additionally, during the year, the Partnership transferred $4.9 million from unrealized loss to realized loss relating to the sale of Everex and the full or partial write-off of several other investments, as discussed above. The $6.8 million unrealized gain combined with the $4.9 million transfer from unrealized loss to realized loss resulted in an $11.7 million increase in the Partnership's net unrealized appreciation of investments for 1992.
For the year ended December 31, 1991, the Partnership had a $14.3 million unrealized gain from the net upward revaluation of certain portfolio investments. This unrealized gain primarily resulted from the upward revaluation of the Partnership's investment in Regeneron. Additionally, during the year, the Partnership transferred a net $56,000 from unrealized loss to realized loss relating to the sale and write-off of several investments, as discussed above. The $14.3 million unrealized gain combined with the $56,000 net transfer from unrealized loss to realized loss resulted in a $14.4 million increase in the Partnership's net unrealized appreciation of investments for 1991.
Net Assets - Changes in net assets resulting from operations is comprised of 1) net realized gains and losses from operations and 2) changes to net unrealized appreciation or depreciation of portfolio investments. For the year ended December 31, 1993, 1992 and 1991, the Partnership had a net increase in net assets resulting from operations of $18.6 million, $4.8 million and $16 million, respectively.
At December 31, 1993, the Partnership's net assets were $112.7 million, an increase of $3 million from $109.7 million at December 31, 1992. This increase resulted from the $18.6 million net increase in net assets resulting from operations for 1993 offset by the $15.6 million cash distribution to Limited Partners paid in May 1993.
At December 31, 1992, the Partnership's net assets were $109.7 million, a decrease of $4.2 million from $113.9 million at December 31, 1991. This decrease resulted from the $9 million cash distribution to Limited Partners paid in April 1992 exceeding the $4.8 million net increase in net assets resulting from operations for 1992.
At December 31, 1991, the Partnership's net assets were $113.9 million, an increase of $10 million from $103.9 million at December 31, 1990. This increase resulted from the $16 million net increase in net assets resulting from operations for 1991 offset by the $6 million cash distribution to Limited Partners paid in April 1991.
Gains and losses from investments are allocated to Partners' capital accounts when realized, in accordance with the Partnership Agreement (see Note 3 of Notes to Financial Statements). However, for purposes of calculating the net asset value per unit of limited partnership interest, net unrealized appreciation of investments has been included as if the net appreciation had been realized and allocated to the Limited Partners in accordance with the Partnership Agreement. Pursuant to such calculation, the net asset value per $1,000 Unit at December 31, 1993, 1992 and 1991 was $852, $862 and $908, respectively.
Item 8. | 789538 | 1993 |
ITEM 6. Selected Financial Data
The following table sets forth a consolidated summary of selected financial data for the company and its subsidiaries (all significant intercompany accounts have been eliminated) for each of the last ten years. In this table the years ended December 31, 1984 through 1987 have been restated to reflect the implementation of SFAS No. 97 in 1988. In addition, the years ended December 31, 1984 through 1991 have been restated to reflect the sale of Younkers, Inc. in 1992 and treatment of that entity as a discontinued operation. This summary should be read in conjunction with the related consolidated financial statements and notes thereto.
(Table following)
1 Operating income equals income from continuing operations before cumulative effect of change in accounting principles, excluding realized gains or losses (net of related income taxes) and excluding amortization of deferred policy acquisition costs related to realized gains and losses (net of related income taxes). Operating income in 1991 excludes the after-tax income effect ($10,259,000) ($(0.36) per share) of accrual for insurance guaranty fund assessments. 2 Excludes the cumulative effect of changes in the method of accounting for postretirement benefits (1992) and deferred income taxes (1991). 3 Includes the cumulative effect of changes in the method of accounting for postretirement benefits of $(4,678,000) ($(0.16) per share) in 1992 and deferred income taxes of $9,444,000 ($0.34 per share) in 1991. 4 Share and per share amounts have been restated to reflect the 2-for-1 stock splits as of May 12, 1993 and May 14, 1992 and the reversion of Class A and Class B stock to one class of common stock as of May 1, 1992.
1 Operating income equals income from continuing operations before cumulative effect of change in accounting principles, excluding realized gains or losses (net of related income taxes). 2 Excludes the cumulative effect of the change in the method of accounting for the participating line of business in 1988. 3 Includes the cumulative effect of change in the method of accounting for the participating line of business of $11,555,000 ($0.35 per share) in 1988. 4 Share and per share data amounts have been restated to reflect the 2-for-1 stock splits as of May 12, 1993 and May 14, 1992 and the reversion of Class A and Class B stock to one class of common stock as of May 1, 1992. Additionally, 1985 and prior years have also been restated to reflect the 50% stock dividend in December 1986.
ITEM 7. | ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this section is to discuss and analyze the company's consolidated financial condition, liquidity and capital resources and results of operations. This analysis should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this report. The company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of the company and its subsidiaries, all of which are wholly-owned at December 31, 1993. The company's retail subsidiary, Younkers, Inc. was sold through a public stock offering on April 29, 1992 and has been classified as a discontinued operation. The company's primary subsidiaries are Equitable Life Insurance Company of Iowa ("Equitable Life") and USG Annuity & Life Company ("USG").
FINANCIAL CONDITION
Investments
The company's total investments grew 27.5% in 1993 compared to 25.6% in 1992. This growth in the company's investment portfolio resulted from record sales of the company's insurance and annuity products. The company carefully monitors the growth of its insurance operations in order to maintain adequate capital ratios. The sale of 2,300,000 shares of the company's common stock in October 1993 generated net proceeds totalling $76,264,000, $70,000,000 of which has been contributed to the company's insurance subsidiaries to fund growth in these operations over the next several years. With the availability of this capital, the company has established a goal of growing assets at least 20% annually.
To support the company's annuities and life insurance products, cash flow was invested primarily in fixed income investments. At December 31, 1993, 99.7% of the company's investments, excluding policy loans, were in cash or fixed income investments. Fixed income investments consist of government and agency mortgage-backed securities (6.5%); investment grade corporate and conventional mortgage-backed securities, as determined by either Standard & Poor's Corporation ("Standard & Poor's") or Moody's Investors Service ("Moody's") (79.1%); below investment grade corporate securities (6.6%) and mortgage loans on real estate (6.3%).
The company reports its fixed maturity securities at amortized cost. The company purchases such investments with the intention to hold them to maturity. Several factors demonstrate the company's ability to hold investments until maturity. The company's insurance and annuity liabilities are long term by nature. The company has generally experienced low lapse rates on its insurance policies, and all whole life and annuity policies currently being sold have features that tend to discourage lapse or surrender of policies. In addition, one of the company's investment objectives is to manage its portfolio so that the duration of its assets is consistent with the duration of its liabilities.
In May 1993, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities", which changes the accounting treatment afforded the company's fixed maturity securities. This SFAS is discussed below under the caption "Emerging Accounting and Regulatory Issues."
At December 31, 1993, the ratings assigned by Standard & Poor's and Moody's to the individual securities in the company's fixed maturities portfolio are summarized as follows:
Note: Estimated market values of publicly traded securities are as reported by an independent pricing service. Market values of conventional mortgage-backed securities not actively traded in a liquid market are estimated using a third party pricing system, which uses a matrix calculation assuming a spread over U.S. Treasury bonds based upon the expected average lives of the securities. Market values of private placement bonds are estimated using a matrix that assumes a spread (based on interest rates and a risk assessment of the bonds) over U.S. Treasury bonds. Estimated market values of redeemable preferred stocks are as reported by the National Association of Insurance Commissioners ("NAIC").
Net unrealized appreciation of fixed maturity investments of $329,132,000 was comprised of gross appreciation of $354,088,000 and gross depreciation of $24,956,000 on the individual securities.
At December 31, 1993, below investment grade securities, using the higher rating by Moody's or Standard & Poor's, totalled $361,869,000, or 6.6% of the company's investment portfolio. Included in this total were $105,374,000 of securities, rated investment grade when purchased and later downgraded. The company estimates that the market value of its below investment grade portfolio was $371,370,000, or 102.6% of carrying value, at December 31, 1993.
Below investment grade securities have different characteristics than investments in investment grade corporate debt securities. Risk of loss upon default by the borrower is significantly greater with respect to below investment grade securities than with other corporate debt securities because below investment grade securities are generally unsecured and are often subordinated to other creditors of the issuer. Also, issuers of below investment grade securities usually have high levels of debt and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. The company attempts to reduce the overall risk in its below investment grade portfolio, as in all of its investments, through careful credit analysis, investment policy limitations, and diversification by company and by industry.
During 1993, the company purchased 31 below investment grade securities at a total cost of $187,162,000. At December 31, 1993 these securities were rated 2 or 3 by the NAIC and had an estimated market value of $185,047,000. The company intends to purchase additional below investment grade securities but it does not expect the percentage of its portfolio invested in below investment grade securities to increase significantly. During 1993, the company sold two below investment grade securities with a combined carrying value of $5,481,000. These sales resulted from a deterioration in the credit quality of one of the security's issuers and due to expectations that the other security would be called. Gains of $284,000 were realized as a result of these sales. Also during 1993, portions of 10 other issues with a combined carrying value of $51,318,000 were called or repaid. Gains of $3,539,000 were recognized on these disposals. At December 31, 1993, the company's total investment in below investment grade securities consists of investments in 81 issuers totalling $361,869,000, or 6.6% of the company's investment portfolio compared to 60 issuers totalling $236,080,000, or 5.5% of the portfolio at December 31, 1992.
The company analyzes its investment portfolio at least quarterly in order to determine if its ability to realize its carrying value on any investment has been impaired. If impairment in value is determined to be other than temporary (i.e. the company has doubt about an issuer's ability to comply on a timely basis with the payment provisions of the instrument), the company prepares an estimate of net realizable value by estimating expected future cash flows from the investment and, in turn, recognizes the impairment as a charge to realized gains and losses if the estimated nondiscounted cash flows from the investment are less than the carrying value of the investment.
One below investment grade security with a carrying value of $699,000 and an estimated market value of $160,000 was in default at December 31, 1993. During the second quarter of 1993, the company determined that the decline in value of this security was other than temporary. As a result of that determination, the company recognized a pre-tax loss of $6,443,000 to write the security down to its estimated net realizable value of $699,000. The company's estimates of future cash flows from this security indicate that the company will recover its remaining carrying value, and, consequently, no additional writedown of carrying value is deemed necessary. The carrying value of the fixed maturity investment considered to have an other than temporary impairment represented 0.1% of total stockholders' equity at December 31, 1993.
The use of nondiscounted cash flows to evaluate net realizable value may result in lower realized losses in the current period than if the company had elected to use discounting in its evaluation process. Additionally, the rate of return actually realized by the company on investments whose value suffers an impairment that is other than temporary is less than the yield to maturity at the date of original purchase. This lower rate of return results from a downward adjustment in expected cash flows from the investment. The yield recognized in future periods on these investments may also be less than yields recognized on other investments or those yields expected when the securities were originally purchased. The company will be required to use fair value or discounted cash flows in evaluating net realizable value when it adopts SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" on January 1, 1994. See Emerging Accounting and Regulatory Issues.
Below investment grade investments, as well as other investments, are monitored on an ongoing basis and future events may occur, or additional or updated information may be received, which may necessitate further write-downs of securities in the company's portfolio. Significant write-downs in the carrying value of investments could materially adversely affect the company's net income in future periods.
At December 31, 1993, the company's below investment grade portfolio had a yield to maturity of 9.7% compared to 8.4% for the company's corporate investment grade portfolio. A reduction in the amount of the company's investments in below investment grade securities could have a negative impact on the company's operating results. The size of such impact would depend on many factors, including the magnitude of the reduction, the yield of alternative investments, and the interest rate credited to policyholder account balances.
During 1993, investment grade corporate and conventional mortgage-backed securities with a combined carrying value of $891,511,000 were called or prepaid by their issuers. Aggregate pre-tax gains of $47,385,000 were realized due to these disposals. These gains are treated as realized gains on investments in the company's financial statements, and are not a part of investment income. Aggregate pre-tax gains from sales, calls, tender offers, prepayments and write-downs of fixed maturity investments totaled $41,754,000 in 1993 compared to $7,001,000 in 1992.
At December 31, 1993, the company's fixed maturity investment portfolio had a combined yield of 8.5% compared to 9.3% at December 31, 1992. Since new investment rates are lower than the company's current portfolio yield, the overall yield on the company's investment portfolio is declining as cash flows from insurance and annuity sales are invested at relatively lower rates. This decline in yield is compounded as investments in higher yielding securities are called or repaid by their issuers and proceeds from these early payments are invested at current rates. The impact of these declining portfolio yields on the company's operating results will depend upon the magnitude of the decline and the level of interest rates credited to policyholder account balances. At December 31, 1993, the average annual interest rate in effect for interest-sensitive products, including annuities, universal life, and participating life policies, was 6.2% compared to 7.1% at December 31, 1992.
Mortgage loans make up approximately 6.3% of the company's investment portfolio, as compared to an industry average of 14.8%, as reported in the 1993 ACLI Fact Book. During 1992, the company resumed active mortgage lending to broaden its investment alternatives and, as a result of this increase in lending activity, mortgages outstanding increased to $346,829,000 from $249,585,000 during 1993. The company expects this asset category to continue to grow over the next several years. The company's mortgage loan portfolio includes 244 loans with an average size of $1,421,000 and average seasoning of 11 years if weighted by the number of loans, and 5.7 years if weighted by mortgage loan carrying values. The company's mortgage loans are typically secured by occupied buildings in major metropolitan locations and not speculative developments, and are diversified by type of property and geographic location. At December 31, 1993, the yield on the company's mortgage loan portfolio was 9.0%.
Distribution of these loans by type of collateral and geographic location is as follows:
During 1993, the company determined that the carrying value of one of its mortgage loans exceeded its estimated net realizable value. As a result of that determination, the company recognized a pre-tax loss of $363,000 to reduce the carrying value of the loan to its estimated net realizable value of $1,300,000. At December 31, 1993, 0.5% of the commercial mortgage portfolio, or $1,904,000, was delinquent by 90 days or more. In addition, the company holds $15,718,000 in foreclosed real estate. The company does not expect to incur material losses from these investments since delinquent loans represent a small percentage of the portfolio. The company has been able to recover 87% of the principal amount of problem mortgages that have been resolved in the last three years.
In total, the company has experienced a relatively small number of problems with its total investment portfolio, with less than 1/20th of 1% of the company's investments in default at December 31, 1993. The company estimates its total investment portfolio, excluding policy loans, had a market value equal to 106.5% of carrying value for accounting purposes at December 31, 1993.
Other assets
Accrued investment income increased $14,376,000 during 1993 due to an increase in new fixed income investments and in the overall size of the portfolio. Notes and other receivables increased $12,230,000 primarily as a result of the "gross-up" of receivables for reserve credits on ceded reinsurance totalling $9,931,000 as required by SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." Deferred policy acquisition costs increased $95,075,000 over year-end 1992 levels as the deferral of current period costs (primarily commissions) incurred to generate insurance and annuity sales and premiums continued to exceed the amortization of costs deferred in previous periods. At December 31, 1993, the company had total assets of $6,431,435,000, an increase of 26.9% over total assets at December 31, 1992.
Liabilities
In conjunction with the volume of insurance and annuity sales and premiums, and the resulting increase in business in force, the company's liability for policy liabilities and accruals increased $1,178,579,000, or 26.7%, during 1993. Total consolidated debt decreased $5,294,000 with the December 1993 maturity of bonds totalling $10,500,000, partially offset by a $5,226,000 increase in commercial paper notes payable. Total consolidated debt amounted to $84,214,000 at December 31, 1993. Other liabilities increased $23,438,000 from year-end 1992 levels primarily as the result of an increase in liabilities for outstanding checks and draft accounts payable related to the company's asset retention program.
The company's insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In some states, such assessments are offset by reductions in future premium taxes. The company cannot predict whether and to what extent legislative initiatives may affect the right to offset. The amount of these assessments prior to 1991 was not material. Failures of substantially larger companies since 1990, could result in future assessments in material amounts. During 1991, the company established a reserve of $21,049,000 to cover such assessments, which was partially offset by $5,678,000 of expected related future premium tax credits. The company regularly reviews information regarding known failures and revises its estimate of future guaranty fund assessments accordingly. During 1993, this review caused the company to accrue and charge to expense an additional $2,109,000 to cover amounts not previously reserved. At December 31, 1993, the company has reserved $15,211,000 to cover estimated future assessments (net of related anticipated premium tax credits) and has established an asset totalling $8,309,000 for amounts expected to be recoverable through future premium tax offsets. The company believes this reserve is sufficient to cover expected future insurance guaranty fund assessments.
At December 31, 1993, the company had total liabilities of $5,903,473,000 compared to $4,693,073,000 at December 31, 1992, a 25.8% increase.
Equity
At December 31, 1993, stockholders' equity was $527,962,000, or $16.76 per share, compared to $373,801,000, or $12.89 per share, on a restated basis at year-end 1992. The ratio of consolidated debt to total capital was 13.8% at December 31, 1993, down from 19.3% at year-end 1992 as stockholders' equity increased and consolidated debt decreased. At December 31, 1993, there were 31,504,586 common shares outstanding compared to a restated 28,994,640 shares at December 31, 1992. This increase is primarily the result of the completion of an offering of 2,300,000 shares of common stock by the company on October 21, 1993. December 31, 1992 share and per share amounts have been restated to reflect the impact of a 2-for-1 stock split on June 1, 1993.
The effects of inflation and changing prices on the company are not material since insurance assets and liabilities are primarily monetary. One effect of inflation, which has been low in recent years, is a decline in purchasing power when monetary assets exceed monetary liabilities.
LIQUIDITY AND CAPITAL RESOURCES
The liquidity requirements of the company's subsidiaries are met by cash flow from insurance and annuity premiums, investment income, and maturities of fixed maturity investments and mortgage loans. The company primarily uses funds for the payment of insurance and annuity benefits, operating expenses and commissions, and the purchase of new investments. No material capital expenditures are planned.
The company issues short-term debt, including commercial paper notes, for working capital needs and to provide short term liquidity. At December 31, 1993 the company had $34,000,000 in commercial paper notes outstanding, an increase of $5,226,000 from December 31, 1992 as additional commercial paper was issued to fund short-term advances to the company's insurance subsidiaries to smooth timing differences between cash receipts and disbursements. On July 16, 1993, Duff & Phelps Credit Rating Co. announced that it had assigned a commercial paper rating of Duff 1 to the company's commercial paper. The company's commercial paper continues to be rated A1 by Standard and Poor's and P2 by Moody's. To enhance short term liquidity and back up its outstanding commercial paper notes, the company maintains a $100,000,000 credit agreement with five banks that terminates in May 1996.
To reduce the risk of rising short-term interest rates, the company had entered into interest rate swap agreements with three banks wherein the company agreed to pay a fixed rate of interest and received a floating short-term rate of interest tied to prime commercial paper or LIBOR rates. The total notional amount of these swap agreements was $50,000,000. The company terminated these swaps at a cost of $3,011,000 in the third quarter of 1993.
Since Equitable of Iowa Companies is a holding company, funds required to meet its debt service requirements, dividend payments and other expenses are primarily provided by its subsidiaries. The ability of the company's insurance subsidiaries to pay dividends and other distributions to the company is regulated by state law. Iowa law provides that an insurance company may pay dividends, without prior regulatory approval if, together with all dividends or distributions made during the preceding twelve month period, the dividends would not exceed the greater of (a) 10% of the insurer's statutory surplus as of the next preceding year-end; or (b) the statutory net gain from operations for the twelve month period ending as of the next preceding year-end. In addition, Iowa law provides that the insurer may only make dividend payments to its shareholders from its earned surplus (i.e., its surplus as regards policyholders less paid-in and contributed surplus). Equitable Life could pay dividends to the company without prior regulatory approval of approximately $39,335,000 during 1994.
The NAIC's risk-based capital requirements were adopted in December 1992 and require insurance companies to calculate and report information under a risk-based capital formula. These requirements are intended to allow insurance regulators to identify inadequately capitalized insurance companies based upon the type and mixture of risks inherent in the company's operations. The formula includes components for asset risk, liability risk, interest rate exposure and other factors. The company's insurance subsidiaries provided the required disclosures in their December 31, 1993 statutory financial statements. Amounts reported in these statutory financial statements indicate that the company's insurance subsidiaries have total adjusted capital (as defined in the requirements) which is well above all required capital levels.
The terms of the $100,000,000 line of credit agreement require the company to maintain certain consolidated tangible net worth levels. "Consolidated tangible net worth" is defined as consolidated stockholders' equity, less consolidated intangible assets. The most restrictive of these covenants requires the company to maintain consolidated tangible net worth equal to or in excess of the sum of (i) $280,000,000, plus (ii) 50% of consolidated net income from January 1, 1993 to the end of the most recent quarter, plus (iii) net proceeds from the issuance of stock from January 1, 1993 to the end of the most recent quarter. At December 31, 1993, $123,913,000 of retained earnings were free of restrictions and could be distributed to the company's public stockholders.
Developing and writing increased volumes of insurance and annuity business require increased amounts of capital and surplus for the company's insurance operations including amounts in excess of those which may be realized from operating results. The company may also expand its insurance operations through acquisition of blocks of business from other insurance companies, or through the acquisition of an insurance company, although no such acquisitions are currently planned. In recent periods the company has funded the growth of its insurance operations with the proceeds from the April 1992 sale of the company's former retail subsidiary. On April 29, 1992, the company sold its former retail subsidiary, Younkers, through a public stock offering and received net proceeds of approximately $50,000,000 after taxes. The company contributed $10,000,000 of these proceeds to its insurance subsidiaries in the fourth quarter of 1992 and $20,000,000 in the third quarter of 1993 to fund the growth in these operations.
On October 21, 1993, the company completed a stock offering of 3,273,200 shares to the public at a price of $35 per share. Included in this amount were 2,300,000 shares offered by the company and 973,200 offered by certain stockholders of the company. The company received net proceeds totaling $76,264,000 from the sale of its 2,300,000 shares after deduction of the underwriter's discount and expenses. The company did not receive any of the proceeds from the sale of shares by the selling stockholders. The company has contributed $70,000,000 of these proceeds to its insurance subsidiaries during 1993. Over time, further growth in the company's insurance operations may require additional capital although the company believes it now has sufficient capital resources to support growth in these operations for the next several years. The company's primary sources of capital are issuance of additional common stock or issuance of additional debt.
To improve the liquidity of the company's common stock, on April 29, 1993, the company's Board of Directors approved a 2-for-1 stock split of the company's common stock, payable on June 1, 1993 to holders of record as of May 12, 1993. The company's stockholder's also approved an increase in the number of authorized shares of its common stock from 35,000,000 to 70,000,000 and the Board adjusted the exercise price under the company's Rights Agreement to $100 per share (post split).
The company's insurance subsidiaries operate under the regulatory scrutiny of each of the state insurance departments supervising business activities in the states where each company is licensed. The company is not aware of any current recommendations by these regulatory authorities which, if they were to be implemented, would have a material effect on the company's liquidity, capital resources or operations.
RESULTS OF OPERATIONS - 1993 COMPARED TO 1992
Sales
Total life insurance and annuity sales, as measured by first year and single premiums, increased $236,777,000, or 26.7%, to $1,122,797,000 in the year ended December 31, 1993. Annuity sales increased $232,912,000, or 26.7%, to $1,104,222,000 in 1993. The company believes that its commitment to customer service, the quality of its investment portfolio and its overall financial strength attract consumers to its annuity products as consumers continue to seek a secure return on their retirement savings. First year and single life insurance premiums increased $3,865,000, or 26.3%, to $18,575,000 in the year ended December 31, 1993. Life insurance sales (at face amounts) during 1993 increased $18,549,000, or 1.3%, to $1,416,576,000 compared to 1992, as increased sales of the company's universal life products more than offset declines in sales of term life insurance products.
Revenues
Total revenues increased $114,594,000, or 25.0%, to $572,968,000, in 1993, compared to 1992. Universal life insurance and annuity product charges increased $3,869,000, or 12.7%, to $34,281,000, compared to the year ended December 31, 1992, as the company's marketing efforts continued to focus on the sale of deferred annuities and interest-sensitive life insurance products. Premiums from traditional life insurance products also improved during 1993, increasing by $3,848,000, or 8.9%, to $46,870,000, compared to 1992, as these products were made available to the company's insurance brokerage distribution system.
Net investment income increased $71,636,000, or 19.8%, to $434,069,000 in 1993, as the increase in invested assets more than offset the decline in portfolio yield. The average annualized yield on invested assets supporting policy accounts for interest-sensitive products, including annuities, universal life-type policies and participating life policies was 9.1% during 1993, compared to 9.7% during 1992. The company's total investment portfolio, excluding policy loans, had a yield to maturity of 8.5% at December 31, 1993, compared to 9.2% at December 31, 1992, reflecting a general decline in interest rates, and substantial principal repayments of investments. The effect of the decline in the portfolio yield on the company's future net income will depend on many factors, including the level of interest rates credited to policyholder account balances. During 1993, the company realized gains on the sale of investments of $41,985,000, compared to $8,164,000 in 1992, primarily resulting from calls and prepayments of fixed maturity investments. Included in these totals were write-downs of $6,806,000 in 1993 and $5,328,000 in 1992, to reduce the carrying value of various investments to estimated net realizable value.
Expenses
Total insurance benefits and expenses increased $66,054,000, or 18.6%, to $420,435,000 in 1993. Interest credited to universal life and annuity account balances increased $37,168,000, or 16.0%, to $268,992,000, in 1993, as a result of higher account balances associated with those products. The average annualized interest rate credited to policy accounts for interest- sensitive products, including annuities and universal life-type policies and participating life policies, was 6.6% for 1993 compared to 7.5% in 1992. The average annual interest rate in effect for those policies at December 31, 1993 was 6.2%, compared to 7.1% at December 31, 1992. The company's practice is to reduce rates credited to policy accounts as investment yields decline. Most of the company's interest-sensitive policies allow for interest rate adjustments at least annually.
Death benefits on traditional life products and benefit claims incurred in excess of account balances on universal life products increased $2,897,000, or 11.8%, to $27,536,000, while other benefits declined $8,129,000, or 20.1%, to $32,344,000 in 1993, due to lower lapses of the company's insurance policies. These changes were offset by a corresponding change in the reserve for future policy benefits and, therefore, had no material impact on net income.
The withdrawal ratio for the company's annuity products, as calculated by dividing average aggregate surrenders and withdrawals by average aggregate account balances, was 4.6% in 1993 compared to 6.3% in 1992. The 1992 annuity withdrawal rate included withdrawals resulting from the exercise of a "bailout" feature by policyholders which allowed them to withdraw their account balance without penalty as credited rates fell below predetermined levels. This "bailout" feature can only be exercised for a limited period, and less than 1% of remaining annuity liabilities are subject to a "bailout" feature. Excluding these "bailout" withdrawals, the 1992 withdrawal rate was 4.2%. Most of the company's annuity products have penalties or other features designed to discourage early withdrawals, and to allow the company to recover a portion of the expenses incurred to generate annuity sales in the event of early withdrawal. The company anticipates an increase in annuity withdrawals as this block of business matures. The company's lapse ratio for life insurance, measured in terms of face amount and using A. M. Best's formula, was 7.2% in 1993 compared to 8.4% in 1992.
Commissions increased $29,083,000, or 34.5%, to $113,450,000 in 1993, primarily because of increased sales of annuity products. This increase was offset by an increase in the deferral of such policy acquisition costs and thus had little impact on total insurance expenses. General insurance expenses increased $5,260,000, or 16.3%, to $37,554,000 related to increases in sales, assets and policies in force. The amortization of deferred policy acquisition costs increased by $21,902,000, or 108.6%, to $42,078,000 in 1993. During 1993, the estimate and timing of gross profits from certain universal life and annuity product lines changed, which, in accordance with SFAS No. 97, necessitated that the company recompute or "unlock" the amortization of deferred policy acquisition costs. This "unlocking" primarily resulted from realized investment gains leading to higher gross profits than originally expected. As a result, 1993 amortization was increased by $13,916,000, and amortization in future periods will be decreased.
Income
Operating income (income from continuing operations before cumulative effect of change in accounting principles, excluding realized gains and losses, net of related income taxes, and excluding amortization of deferred policy acquisition costs related to realized gains and losses, net of related income taxes) increased $19,602,000, or 39.8%, to $68,911,000 in 1993, or $2.33 per share, compared to $49,309,000, or $1.72 per share, in 1992. The company recognized realized gains on the sale of investments and deferred policy acquisition costs related to realized gains (net of related income taxes) as follows:
Income from continuing operations before the cumulative effect of change in accounting principle for postretirement benefits improved to $87,156,000, or $2.95 per share, in 1993, compared to $57,260,000, or $1.99 per share, in 1992. The company's discontinued retail operations contributed income of $1,924,000, or $0.07 per share, during 1992. During the fourth quarter of 1992, the company implemented a new accounting standard for postretirement benefits other than pensions and incurred a charge to earnings of $4,678,000, or $0.16 per share, which was treated as a cumulative effect of change in accounting principle. Net income was $87,156,000, or $2.95 per share, in 1993, compared to $54,506,000, or $1.90 per share, in 1992. 1992 per share amounts reported above have been restated to reflect the 2-for-1 stock split on June 1, 1993.
RESULTS OF OPERATIONS - 1992 COMPARED TO 1991
Sales
Total life insurance and annuity sales, as measured by first year and single premiums, increased $395,090,000, or 80.5%, to $886,020,000 in the year ended December 31, 1992. Annuity sales increased $409,505,000, or 88.7%, to $871,310,000 in 1992, compared to 1991. Annuity sales were positively impacted by the company's financial strength, low short-term interest rates which made annuity products more attractive than certain other savings options and availability of capital from the sale of the company's former retail department store subsidiary. First year and single life insurance premiums declined $14,415,000, or 49.5%, to $14,710,000 in the year ended December 31, 1992. Life insurance sales (at face amounts) during 1992 increased $259,779,000, or 22.8%, to $1,398,027,000, compared to 1991, as a result of increased sales of the company's term life insurance products.
Revenues
Total revenues increased $58,085,000, or 14.5%, to $458,374,000, in 1992, compared to 1991. Universal life insurance and investment product charges increased $1,387,000, or 4.8%, to $30,412,000, compared to the year ended December 31, 1991. Premiums from traditional life insurance products decreased $8,012,000, or 15.7%, to $43,022,000, compared to 1991, as the company's marketing efforts continued to focus on the sale of deferred annuities and interest-sensitive life insurance products. Over half of the decline in traditional insurance premiums resulted from the termination of all reinsurance obligations with the company's former subsidiary, Massachusetts Casualty Insurance Company, as the company refunded premiums of $4,759,000. This refund was offset by a release of related reserves and, therefore, had no effect on income.
Net investment income increased $50,616,000, or 16.2%, to $362,433,000 in 1992, as the increase in invested assets more than offset the decline in portfolio yield. The company's investment portfolio, excluding policy loans, had a yield to maturity of 9.2% at December 31, 1992, compared to 9.7% at December 31, 1991, reflecting a general decline in interest rates and a reduction in the percentage of the portfolio invested in below investment grade securities. During 1992, the company realized gains on the sale of investments of $8,164,000, compared to losses of $5,220,000 in 1991. Included in these totals were writedowns of $5,328,000 in 1992 and $3,763,000 in 1991, to reduce the carrying value of various investments to estimated net realizable value. The gains realized in 1992 primarily resulted from calls and prepayments of fixed maturity investments.
Expenses
Total insurance benefits and expenses increased $14,843,000, or 4.4%, to $354,381,000 in 1992. Interest credited to universal life and investment product account balances increased $40,414,000, or 21.1%, to $231,842,000, in 1992, as a result of higher account balances associated with those products. Death benefits on traditional life products and benefit claims incurred in excess of account balances on universal life products declined $4,819,000, or 16.4%, to $24,639,000, in 1992 as a result of favorable mortality experience. This favorable mortality experience increased after-tax earnings by approximately $1,600,000, or $0.11 per share, compared to 1991. Most of the company's new policies are treated as universal life or investment products for accounting purposes and changes in reserves for these products do not affect net income.
The withdrawal ratio for the company's annuity products was 6.3% in 1992 compared to 4.9% in 1991. The decline in general interest rates and the company's portfolio yield caused the company to reduce the rate of interest credited to its annuity account balances below "bailout" levels during 1992. As a result, $57,049,000, or 21% of annuity policies with a "bailout" feature, were surrendered during 1992, and were responsible for a significant portion of the increase in the overall withdrawal ratio for the company's annuity products. Excluding the surrenders on products with this bailout feature, the company's annuity withdrawal rate would have been 4.2%. The increase in annuity withdrawals did not have a material impact on earnings, since interest rates credited to new products sales were lower than on the "bailout" policies surrendered. As a result of the company's rate actions, less than 1% of annuity reserves are now subject to a "bailout" provision. The company's lapse ratio for life insurance, measured in terms of face amount and using A. M. Best's formula, was 8.4% in 1992 and 1991.
Commissions increased $40,583,000, or 92.7%, to $84,367,000 in 1992, primarily because of increased sales of annuity products. This increase was offset by an increase in the deferral of such policy acquisition costs and thus had little impact on total insurance expenses. General expenses declined $10,263,000, or 24.1%, to $32,294,000 in 1992. Expenses in 1991 included a $15,371,000 pre-tax expense incurred to establish a reserve for expected future insurance guaranty fund assessments. The amortization of deferred policy acquisition costs increased by $1,069,000, or 5.6%, to $20,176,000 in 1992. During the third quarter of 1992, the company recomputed or "unlocked" the amortization of deferred policy acquisition costs. This "unlocking" primarily resulted from higher interest margins in the current and future periods resulting in higher gross profits than originally expected and from a decline in the rate used to discount future gross profits. As a result, amortization of these costs was adjusted retrospectively and 1992 amortization was reduced by $1,570,000.
Income
Operating income (income from continuing operations before cumulative effect of change in accounting principles, excluding realized gains and losses, net of related income taxes and, in 1991, excluding the after-tax effect ($10,259,000) of accrual for insurance guaranty fund assessments) increased $9,188,000, or 22.9%, to $49,309,000 in 1992, or $1.72 per share, compared to $40,121,000, or $1.42 per share, in 1991. The company recognized realized gains on the sale of investments (net of related income taxes) of $7,951,000, or $0.27 per share, in 1992, compared to realized losses of $5,122,000, or $(0.19) per share, in 1991. As a result, income from continuing operations before cumulative effect of change in accounting principles improved to $57,260,000, or $1.99 per share, in 1992, compared to $24,740,000, or $0.87 per share, in 1991. Income from discontinued operations during 1992 amounted to $1,924,000, or $0.07 per share, which was comprised of a $3,182,000 operating loss (to the measurement date) and a $5,106,000 after-tax gain on disposal. The company reported income from discontinued operations during 1991 of $6,346,000, or $0.22 per share.
Net income was $54,506,000, or $1.90 per share, in 1992, compared to $40,530,000, or $1.43 per share, in 1991. During the fourth quarter of 1992, the company implemented SFAS No. 106, which changed the accounting treatment for postretirement benefits other than pensions. The company elected to recognize the cumulative effect (to December 31, 1991) of this change in accounting principle as a one-time charge to earnings. As a result, 1992 net income includes a loss of $4,678,000, or $(0.16) per share, for the after-tax effect of implementing this change in accounting principle. During the fourth quarter of 1991, the company implemented SFAS No. 109, which changed the accounting treatment for income taxes. The effect of implementing this change in accounting principle was to increase 1991 net income by $9,444,000, or $0.34 per share.
EMERGING ACCOUNTING AND REGULATORY ISSUES
SFAS No. 115. In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". SFAS No. 115 changes the accounting treatment afforded the company's fixed maturity investments by segregating fixed maturity securities into three accounts: held to maturity, available for sale and trading. Securities may be designated as held to maturity only if a company has the positive intent and ability to hold these securities to maturity. An enterprise may not classify a security as held to maturity if the enterprise has the intent to hold the security only for an indefinite period. Accounting for securities held to maturity would be unchanged and these securities would continue to be carried at amortized cost. Trading account and available for sale securities are to be carried at fair value (i.e. market value). Unrealized gains and losses on trading account securities are to be charged/credited to the income statement while unrealized gains and losses on available for sale securities (net of deferred policy acquisition costs and applicable deferred taxes) are to be charged/credited directly to stockholders' equity, much the same as the current accounting for equity securities. Transfers between categories are severely restricted. In addition, the Securities and Exchange Commission requires certain assets and liabilities, such as minority interests and deferred policy acquisition costs, to be adjusted at the same time unrealized gains and losses from available for sale securities are recognized in stockholders' equity. Such adjustments are to be made if those assets and liabilities would have been adjusted had the unrealized holding gains and losses actually been realized.
SFAS No. 115 is effective for fiscal years beginning after December 15, 1993, although the company had the option of adopting this standard on December 31, 1993. Retroactive application of this SFAS is not permitted. The company will adopt this SFAS on January 1, 1994.
The company currently is studying the new standard and planning for its implementation. Because of the severe restrictions imposed by SFAS No. 115 in defining held to maturity securities, the company may determine that it is appropriate to designate a portion of its investment securities as available for sale. The company currently estimates that 5%-15% of its fixed maturity securities may be so designated, although the final determination will depend upon estimates of factors such as interest rate levels, cash receipts and disbursements and tax law changes. The effect of the implementation of SFAS No. 115 on the company's financial statements cannot be determined at this time. Specific securities must be designated for each classification and such classifications cannot be determined until the company completes its analysis. The company does not expect to designate any securities as trading account securities. If all of the company's securities were classified as available for sale at December 31, 1993, stockholders' equity would have increased by approximately $148,217,000, or $4.70 per share, reflecting the unrealized appreciation in the value of the company's securities portfolio, net of adjustments to deferred policy acquisition costs and deferred taxes.
SFAS No. 114. In May 1993, the FASB also issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan". SFAS No. 114 applies to all loans except large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment, loans measured at fair value or at lower of cost or fair value, leases and debt securities as defined in SFAS No. 115. SFAS No. 114 requires that impaired loans be valued at the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. This SFAS is effective for fiscal years beginning after December 15, 1994, with earlier adoption encouraged.
SFAS No. 114 applies primarily to the company's mortgage loan portfolio. The company actively monitors this portfolio and evaluates the net realizable value of any loan which is deemed to be impaired. Net realizable value is assessed based upon current appraised value of the underlying collateral. If carrying value exceeds this estimated realizable value, carrying value is reduced to the estimated realizable value by a charge to earnings. As such, SFAS No. 114 does not represent a material change from the company's current accounting practices and the company does not expect SFAS No. 114 to have any material effect on the company's reported financial results.
Exposure Draft. On June 30, 1993, the FASB issued an Exposure Draft entitled "Accounting for Stock-based Compensation". If adopted as a SFAS in its present form, this exposure draft would require that compensation expense be recognized for all stock options in an amount equal to "fair value" on the date of grant. Fair value is to be calculated using an option pricing model or similar valuation technique that takes into effect: the option's exercise price, the expected term of the option, the current price of the underlying stock, expected dividends from the stock, the expected volatility of the stock and the expected risk-free rate of return during the term of the option. Recognition of compensation expense using this methodology is expected to be required for options granted after December 31, 1996 with pro-forma disclosure for options granted after December 31, 1993.
During the last three years the company has granted options for approximately 219,000 shares of common stock each year to key employees at option prices ranging from $4.97 to $36.75 per share. These options generally vest over a three to five year period. Option prices are equal to market value on the date of grant and the terms of the options are fixed. As a result, the company does not currently recognize compensation expense on these options. Calculation of the effect of the proposed SFAS has not been completed since the final form of such a SFAS and the company's response to such a requirement has not been determined.
Insurance Regulation. Currently, the company's insurance subsidiaries are subject to regulation and supervision by the states in which they are admitted to transact business. State insurance laws generally establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, establishing guaranty fund associations, licensing agents, approving policy forms, regulating premium rates for some lines of business, establishing reserve requirements, prescribing the form and content of required financial statements and reports, determining the reasonableness and adequacy of statutory capital and surplus and regulating the type and amount of investments permitted.
Recently, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government and the NAIC. Various states have considered or enacted legislation which changes, and in many cases increases, the states' authority to regulate insurance companies. Legislation is under consideration in Congress which could result in the federal government assuming some role in the regulation of insurance companies. The NAIC, in conjunction with state regulators, has been reviewing existing insurance laws and regulations. The NAIC recently approved and recommended to the states for adoption and implementation several regulatory initiatives designed to reduce the risk of insurance company insolvencies. These initiatives include new investment reserve requirements, risk-based capital standards and restrictions on an insurance company's ability to pay dividends to its stockholders.
A committee of the NAIC is developing proposals to govern insurance company investments scheduled for adoption as a model law by the end of 1994. While the specific provisions of such a model law are not known at this time, and current proposals are still being debated, the company is monitoring developments in this area and the effects any change would have on the company.
Federal Income Tax Legislation. In early August, the Omnibus Budget Reconciliation Act of 1993 was enacted. This law increases the marginal tax rate for all corporations from 34% to 35% retroactive to January 1, 1993. As a result of this legislation, the company's marginal tax rate has increased from 34% to 35%. This increase has been reflected in the company's financial statements for the year ended December 31, 1993 and was not material. Other than the increase in the marginal tax rate, the company does not believe that this law will have a material adverse effect on its business or financial condition.
Currently, under the Internal Revenue Code, income tax payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable federal income tax treatment may enhance the competitiveness of certain of the company's products as compared with other retirement savings products that do not offer such benefits. If the Code were to be revised to eliminate or reduce the tax deferred status of life insurance and annuity products, including the products offered by the company, market demand for some or all of the company's products could be adversely affected. The Omnibus Budget Reconciliation Act of 1993 did not affect the federal income tax treatment of life insurance and annuity products.
ITEM 8. | 225300 | 1993 |
Item 6 - Selected Financial Data
Pursuant to General Instructions G(2), information required by this Item is incorporated by reference from pages 66, 67 and 68 of the CoreStates Annual Report to Shareholders for the fiscal year ended December 31, 1993 (Exhibit 13 pages 75 through 77).
Item 7 | Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Pursuant to General Instructions G(2), information required by this Item is incorporated by reference from pages 18 through 40 of the CoreStates Annual Report to Shareholders for the fiscal year ended December 31, 1993 (Exhibit 13 pages 1 through 37).
Item 8 | 69952 | 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. | 41091 | 1993 |
ITEM 6. Selected Financial Data
Not Required. (3)
ITEM 7. | ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations Continuing Operations
Contracts receivable income represents income earned under an agreement with Xerox by which the Company purchases long-term accounts receivable associated with Xerox' sold equipment. These receivables arose from Xerox equipment being sold under installment sales and sales-type leases. In 1993, the Company purchased receivables from Xerox totaling $1,848 million compared to $1,964 million in 1992. Earned income from contracts receivable decreased in 1993 to $376 million from $389 million in 1992. The decreases in earned income is the result of lower purchases of contracts receivable in 1993 compared to 1992 due to weak United States sales early in 1993 because of reorganization of the Xerox United States Customer Operations sales force, as well as lower interest income earned on Xerox contracts receivable resulting from declining interest rates. Earned income from contracts receivable increased in 1992 to $389 million from $380 million in 1991. The increase reflected the growth of Xerox equipment sales financed through the Company in 1992 compared to 1991. In connection with the contracts receivable purchased from Xerox, the Company retains an allowance for losses at the time of purchase, which is intended to protect against future losses. Should any additional allowances be required, Xerox is required to provide such funding. The resultant effect is to relieve the Company of any exposure with regard to write-offs associated with the contracts receivable purchased from Xerox.
Interest expense was $209 million in 1993 compared to $212 million in 1992, a decrease of $3 million. The 1993 decrease resulted from lower interest rates partially offset with increased borrowings required to fund the Companys additional investment in contracts receivable. The $212 million of interest expense in 1992 was an increase of $12 million from the 1991 interest expense of $200 million. The 1992 increase in interest expense reflected increased borrowings required to fund the additional investment in contracts receivable. The Company intends to continue to match its contracts receivable and indebtedness to maintain the relationship between interest income and interest expense.
Operating and administrative expenses were $13 million for 1993, a decrease of $6 million from 1992. The decrease was due primarily to operating efficiencies associated with the administration of contracts receivable purchased from Xerox. Operating and administrative expenses increased to $19 million in 1992 compared to $16 million in 1991. This increase was due primarily to additional administrative costs associated with the increase in the volume of Xerox contracts receivable financed in 1992 compared to 1991.
The effective income tax rate for 1993 was 40.9 percent as compared with 39.9 percent and 40.2 percent for 1992 and 1991, respectively. The increase in the effective tax rates in 1993 compared to 1992 and 1991 is due primarily to the 1993 increase in the corporate federal income tax rates from 34 percent to 35 percent retroactive to January 1, 1993. (4)
Discontinued Operations
Since their discontinuance in 1990, the Company has made substantial progress in disengaging from the real-estate and third-party financing businesses. During the three years ended December 31, 1993, the Company received net cash proceeds of $2,089 million from the sale of discontinued business units and assets, from several asset securitizations and from run-off collection activities. The amounts received were consistent with the Company's estimates in the disposal plan and were primarily used to reduce the Company's short-term indebtedness. At December 31, 1993, the Company remains contingently liable for approximately $126 million under recourse provisions associated with the securitization transactions.
Since a portion of the remaining assets ($120 million) represents passive lease receivables, many with long-duration contractual maturities and unique tax attributes, the Company expects that the wind-down of the portfolio will be significantly slower in 1994 and future years, compared with 1993 and prior years. The Company believes that the liquidation of the remaining assets will not result in a net loss.
Additional information regarding discontinued operations is included in Note 2 to the Consolidated Financial Statements. (5)
Capital Resources and Liquidity
The Company's principal sources of funds are cash from the collection of Xerox contracts receivable and borrowings.
At December 31, 1993 the Company and Xerox have joint access to three revolving credit agreements totaling $3 billion with various banks, which expire from 1994 to 1998. The interest on amounts borrowed under these facilities is at rates based, at the borrower's option, on spreads above certain reference rates such as LIBOR and Federal funds rates.
Net cash used in operating activities was $48 million in 1993 compared with $23 million of cash used in 1992. The 1993 increase in cash used by operating activities is mainly attributable to the reduction in accounts payable and accrued liabilities due to timing of payments. Net cash used in operating activities was $23 million in 1992 compared with $161 million of cash provided by operating activities in 1991. The 1992 decrease in cash provided by operating activities is mainly attributable to the reduction in deferred income taxes payable which declined as a result of the Company's adoption of Statement of Financial Accounting Standards (SFAS) No. 109- "Accounting for Income Taxes" and sales of certain discontinued operation's assets.
Net cash provided by investing activities was $21 million in 1993 compared to $58 million of cash used in investing activities in 1992. The increase in cash provided by investing activities was the result of higher net collections from the Company's investment in contracts receivable in 1993, which was partially offset by lower net collections from discontinued operations. Net cash provided by investing activities during 1992 decreased $815 million from $757 million of cash provided by investing activities during 1991. The decrease resulted from lower net collections from the sale and run off activity of discontinued assets.
Net cash provided by financing activities was $26 million in 1993 compared to $79 million in 1992. The decrease in cash provided was the result of increased principal payments on the Company's long- term debt. Net cash provided by financing activities was $79 million during 1992, compared with $926 million of cash used in financing activities during 1991. The proceeds from the 1991 sales and asset securitizations of the third-party financing and leasing assets enabled the Company to reduce the short-term indebtedness of the Company more in 1991 than in 1992, and pay higher dividends in 1991 than in 1992. (6)
The Company believes that cash provided by continuing operations, cash available under its commercial paper program supported by its credit facilities, and its readily available access to the capital markets are more than sufficient for its funding needs. During 1994, new borrowing associated with the financing of customer purchases of Xerox equipment will continue. The timing, principal amount and form of new short- and long-term financing will be determined based upon the Company's need for financing and prevailing debt market conditions.
The Company intends to continue to match its contracts receivable and indebtedness to maintain the relationship between investment income and interest expense. To assist in managing its interest rate exposure, the Company has entered into a number of interest rate swap agreements. In general, the Company's objective is to hedge its variable-rate debt by paying fixed rates under the swap agreements while receiving variable-rate based payments in return. The Company has also entered into swap agreements that convert both fixed-and non-commercial paper based variable-rate interest payments into payments that are indexed to commercial paper rates.
During 1993, the Company entered into third-party interest rate swap agreements, which effectively converted $750 million of variable-rate debt into fixed-rate debt. These agreements mature at various dates through 1997 and resulted in a weighted average fixed-rate of 4.52 percent at December 31,1993. The Company also entered into third-party interest rate swap agreements, during 1993 which effectively converted $425 million of variable-rate debt into variable-rate debt that is indexed to the commercial paper rates. These agreements mature at various dates through 1997.
As of December 31, 1993 the Company's overall debt-to-equity ratio was 6.5 to 1. The Company declared aggregate dividends of $59 million, $85 million and $230 million during 1993, 1992 and 1991, respectively. The Company intends to maintain a debt-to-equity ratio of approximately 6.5 to 1 over time.
Pursuant to a Support Agreement between the Company and Xerox, Xerox has also agreed to retain ownership of 100 percent of the voting capital stock of the Company and to make periodic payments to the extent necessary to ensure that the Company's annual pre-tax earnings available for fixed charges equal at least 1.25 times the Company's fixed charges. (7)
ITEM 8. | 351936 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
"Selected Consolidated Financial Data" on page 25 of the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 15 through 24 of the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
ITEM 8. | 77098 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA:
Refer to page 63 of IBM'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:
Refer to pages 20 through 31 of IBM's 1993 Annual Report to Stockholders which are incorporated herein by reference.
On March 1, 1994, Loral Corporation completed its acquisition of the Federal Systems Company for $1.503 billion in cash. The amount of any gain resulting from this sale may be dependent on future performance of the Advanced Automation System contract for the Federal Aviation Authority and certain other open matters.
ITEM 8. | 51143 | 1993 |
Item 6. SELECTED FINANCIAL DATA
Selected Financial Data on pages 18 and 19 of the Annual Report for the year ended December 31, 1993, is incorporated by reference.
- 12 -
PART II (continued)
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Consolidated Results and Analysis on pages 18 and 19, Results by Business Segment on pages 20 through 31, Business Segment Data on pages 22 and 23, Supplemental Earnings Data on page 35 and Liquidity and Capital Resources and Inflation on pages 31 and 32 of the Annual Report for the year ended December 31, 1993, are incorporated by reference.
Item 8. | 17206 | 1993 |
Item 6. Selected Financial Data - --------------------------------
Item 7. | Item 7. Management's Discussion and Analysis - ---------------------------------------------
REGULATORY PROCEEDINGS
Retail settlement agreements
Effective November 1992 our state regulators, the Massachusetts Department of Public Utilities, approved a three-year settlement agreement. This agreement provides us with retail rate increases, allows for the recovery of demand side management (DSM) conservation program expenditures, specifies certain accounting adjustments and clarifies the timing and recognition of certain expenses. The agreement also sets a limit on our rate of return on common equity of 11.75% for 1993 through 1995, excluding any penalties or rewards from performance incentives.
The retail rate increases consist of a new annual performance adjustment charge effective November 1992 and two additional rate increases of $29 million effective November 1993 and November 1994. The performance adjustment charge varies annually based upon the performance of our Pilgrim Nuclear Power Station. This charge is further described in our discussion of financial condition.
Our 1993 results of operations were affected by the recovery of DSM program expenditures, accounting adjustments and timing and recognition of certain expenses as further described in the following Results of Operations section.
Our state regulators approved a previous three-year settlement agreement effective November 1989. That agreement also provided us with retail rate increases and specified certain accounting adjustments. The 1989 agreement primarily affected our results of operations through 1992.
RESULTS OF OPERATIONS
1993 VERSUS 1992
Earnings per common share were $2.28 in 1993 and $2.10 in 1992. The increase in earnings is primarily the result of an annual rate increase effective November 1992, lower purchased power expense due to a long-term contract expiration, no amortization of deferred cancelled nuclear unit costs and lower interest expense. These positive changes were partially offset by higher operations and maintenance expense and higher income tax and property tax expenses.
Operating revenues
Retail electric revenues increased $70.8 million. The November 1992 and 1993 rate increases resulted in $40.6 million of additional revenues in 1993. Fuel and purchased power revenues increased $29.5 million over 1992, partly due to lower revenues received from short-term power sales as discussed below.
We began recovery of certain demand side management program costs, lost base revenues and incentives in August 1992. Our 1993 revenues provided $45.9 million related to 1991, 1992 and 1993 DSM programs. Our 1992 revenues of $12.3 million related primarily to 1991 programs.
The decrease in wholesale and other revenues reflects an estimated provision for refunds to customers of approximately $8 million as a result of orders from our state regulators on our generating unit performance program.
Lower short-term power sales revenues were a result of changes in our generation availability and the needs of short-term power purchasers. All revenues from short-term sales serve to reduce fuel and purchased power billings to retail customers and have no effect on earnings.
Operating expenses
Fuel expense decreased $19.5 million primarily due to a 21.5% decrease in generation, resulting from planned overhauls of our fossil plants. Interchange purchases increased due to the lower generation, resulting in a $7.5 million net increase in purchased power expense. The net increase also reflects savings of approximately $10 million from a long-term purchased power contract that expired in October 1993. Both our fuel and purchased power expenses are substantially fully recoverable through fuel and purchased power revenues.
Other operations and maintenance expense increased 7.1% primarily due to increases in employee benefits and nuclear production expenses. Postretirement benefits expense increased by $7 million primarily as a result of the adoption of a new accounting standard and pension expense increased by $5 million; both are provided for in our 1992 settlement agreement and further explained in Note I to the consolidated financial statements. A refueling outage at Pilgrim Station in 1993 resulted in higher nuclear production expenses.
Depreciation and amortization expense increased in 1993 primarily due to a higher annual decommissioning charge for Pilgrim Station effective November 1992 provided by the 1992 settlement agreement. The new charge is based on a 1991 estimate of decommissioning costs as further discussed in Note D to the consolidated financial statements. In addition, the effect of lower depreciation rates implemented in accordance with the settlement agreement was offset by the effect of a higher depreciable plant balance.
In accordance with our 1992 settlement agreement we did not expense any of the $19 million of remaining deferred costs associated with the cancelled Pilgrim 2 nuclear unit in 1993. We will expense the remaining costs in 1994 and/or 1995.
Amortization of deferred nuclear outage costs includes amounts related to the 1993 and 1991 refueling outages at Pilgrim Station. In 1993 we deferred approximately $14 million of refueling outage costs. We began to amortize
these costs in June 1993 over five years are approved in the 1992 settlement agreement.
The increase in demand side management programs expense is consistent with the increase in DSM revenues. DSM expense includes some costs recovered over a twelve month period and other costs recovered over six years. We began to recover previously deferred DSM expenses in August 1992. In 1993 we expensed and collected from customers approximately $30 million of deferred 1991, 1992 and 1993 program costs. Over six years we are expensing and collecting from our customers $11 million of costs capitalized in 1992 and $37 million of costs capitalized in 1993. The 1993 expense related to these capitalized costs was $7 million.
Municipal property and other taxes increased in 1993 due to the absence of tax abatements. In 1992 property taxes were reduced by $10.4 million of tax abatements in accordance with our 1989 settlement agreement.
Our effective annual income tax rate for 1993 was 23.4% vs. 8.7% for 1992. Both rates were significantly reduced by adjustments to deferred income taxes of $20 million in 1993 and $23 million in 1992 made in accordance with the 1992 and 1989 settlement agreements. The 1992 rate was also reduced due to tax benefits of approximately $7 million resulting from mandated payments made in accordance with the 1989 agreement. Our adoption of a new accounting standard for income taxes in 1993 did not significantly affect earnings. We expect our effective tax rate to be close to the statutory rate in 1994.
Interest charges and preferred and preference dividends
Total interest charges decreased $3.8 million in 1993. Interest on long-term debt decreased primarily due to the refinancing of substantially all our first mortgage bonds in 1993 at lower interest rates, partially offset by higher amortization of redemption premiums. Other interest charges decreased due to a lower short-term debt level and lower short-term interest rates. Allowance for funds used during construction (AFUDC), which represents the financing costs of construction, decreased as a result of a lower AFUDC rate related to lower short-term interest rates.
Preferred and preference dividends decreased 5% due to the replacement of a preferred and a preference stock issue with less costly issues of preferred stock.
1992 VERSUS 1991
Earnings per common share were $2.10 in 1992 and $1.96 in 1991. The increase in earnings is primarily the result of a rate increase effective November 1991, incentive revenues earned from the performance of Pilgrim Station and lower income tax and interest expenses. These increases were partially offset by higher operations and maintenance and property tax expenses. We also had a one-time charge in 1992 for costs incurred for a deferred generating plant project.
Operating revenues
Retail electric revenues increased $27.7 million. We received a $25 million rate increase effective November 1991 as part of the 1989 settlement agreement. We also earned $8.2 million in incentive revenues in 1992 as a result of Pilgrim Station's capacity factor exceeding its target set in the agreement. Fuel and purchased power revenues decreased approximately $5 million due to higher purchased power costs more than offset by higher revenues received from short-term power sales as discussed below.
In 1992 we began to receive revenues for the recovery of certain DSM program costs, lost base revenues and incentives. The 1992 revenues relate primarily to 1991 DSM programs.
Our short-term power sales increased in 1992 as a result of our high generating unit availability and the greater power needs of other New England utilities. All revenues from short-term sales served to reduce fuel and purchased power billings to retail customers and had no effect on earnings.
Operating expenses
Purchased power expense increased $18 million in 1992 due to new long-term purchased power contracts. Both our fuel and purchased power expenses are substantially fully recoverable through fuel and purchased power revenues.
Other operations and maintenance expense increased 2.3% due primarily to increases in employee benefit expenses and bad debts.
Amortization of deferred nuclear outage costs in 1992 and 1991 includes amounts primarily related to the 1991 refueling outage at Pilgrim Station. In 1991 we deferred approximately $23 million of refueling outage costs. We began to expense these costs over five years in September 1991 as approved by our state regulators.
Municipal property and other taxes increased 21% primarily due to a reduction in residential and commercial real estate values caused by the depressed economy. This resulted in higher tax rates applied to our personal property values. In accordance with our 1989 settlement agreement, municipal property tax expenses were reduced by tax abatements of $10.4 million in 1992 and $13.6 million in 1991.
Our effective annual income tax rate for 1992 was 8.7% vs. 16.5% for 1991. Both rates were significantly reduced by adjustments to deferred income taxes of $23 million in 1992 and $13 million in 1991 made in accordance with the 1989 settlement agreement. We also received tax benefits in both years as a result of payments mandated by the agreement.
Other income and expense
In 1992 we expensed $8 million of costs previously invested in the proposed Edgar Energy Park generation project. This project was deferred indefinitely as additional generating capacity is not expected to be needed for several years.
Interest charges and preferred and preference dividends
Total interest charges decreased 4.6% primarily due to lower interest rates on our average short-term borrowings. AFUDC decreased 12.7% due to a lower AFUDC rate related to lower short-term interest rates.
Preferred and preference dividends decreased approximately $1 million primarily due to the replacement of two preference stock series with less costly issues of preferred stock.
Earnings per share
Net income increased 13%. However, earnings per common share for 1992 increased only 7%, reflecting an increase in the weighted average number of common shares outstanding primarily a result of our 1991 and 1992 common stock issuances.
FINANCIAL CONDITION
Our 1992 settlement agreement provides us with increased revenues from retail customers over the three-year period ending October 1995. Additionally, a long-term purchased power contract with annual charges of approximately $60 million expired in October 1993 with no related change in revenues. We are limited to an annual rate of return on equity during the three-year period of 11.75%, excluding any penalties or rewards from performance incentives.
Our continued ability to achieve or exceed the 11.75% rate of return on equity will be primarily dependent upon our ability to control costs and to earn performance incentives from generation performance mechanisms specified in both the 1989 and 1992 settlement agreements. The most significant impact that incentives can have on our financial results is based on Pilgrim Station's annual capacity factor. Effective November 1993 an annual capacity factor between 60% and 68% will provide us with approximately $45 million of revenues through the performance adjustment charge. For each percentage point increase in capacity factor above 68%, annual revenues will increase by $670,000. For each percentage point decrease in capacity factor below 60% (to a minimum of 35%) annual revenues will decrease by $770,000. Pilgrim's capacity factor for the performance year ending October 1994 is expected to be approximately 81% (assuming normal operating conditions), an increase over the 66% capacity factor achieved in the performance year ended October 1993, as no refueling outage is scheduled for 1994. We earned approximately $40 million in performance charge revenues in the performance year ended October 1993.
Our fossil generation unit performance can provide an increase or decrease of up to $4 million in revenues in each performance year, however, we do not expect any revenue adjustments from this mechanism.
LIQUIDITY
We meet our plant expenditure cash requirements primarily with internally generated funds. These funds (excluding payments made related to settlement agreements) provided for 74%, 90% and 89% of our plant expenditures in 1993, 1992 and 1991, respectively. Our current estimate of plant expenditures for 1994 is $233 million, including $20 million of nuclear fuel additions. These expenditures will be used primarily to maintain and improve existing transmission, distribution and generation facilities. We also estimate capitalizable DSM expenditures to be $38 million in 1994, which will be collected from customers over six years. We do not expect plant expenditures, excluding nuclear fuel and DSM, to vary significantly from the 1994 amount in the four years thereafter. We have long-term debt and preferred stock payment requirements of $2 million in 1994, $102.6 million in 1995, and $103.6 million per year in 1996 through 1998.
External financings continue to be necessary to supplement our internally generated funds, primarily the issuance of short-term commercial paper and bank borrowings. We currently have authority from our federal regulators to issue up to $350 million of short-term debt. We have a $200 million revolving credit agreement and arrangements with several banks to provide additional short-term credit on a committed as well as on an uncommitted and as available basis. At December 31, 1993 we had $204.1 million of short-term debt outstanding, none of which was incurred under the revolving credit agreement. In 1993 our state regulators approved a financing plan allowing us to issue up to $1.1 billion in securities through 1994 and to use the proceeds to refinance long-term securities and short-term debt. At December 31, 1993 we had $245 million remaining authorized to be issued under the plan which can be used to issue common stock, preferred stock and long-term debt. As a result of our refinancing activities in 1993 we expect to realize annualized savings of approximately $11.5 million. Refer to Note F to the consolidated financial statements for specific information relating to our recent financing activities.
OUTLOOK FOR THE FUTURE
Electricity sales
A significant portion of our electricity sales are made to commercial customers rather than industrial customers. As a result our sales have been only moderately impacted by the decline in the local Massachusetts economy. Our retail sales increased 1.2% in 1993 and we anticipate only slight growth in retail sales in the near term.
Implementation of DSM programs, which are designed to assist customers in reducing electricity use, will result in lower growth in electricity sales. The 1992 settlement agreement established annual DSM spending levels over $50 million through 1994. The agreement provides for collection from customers of certain costs primarily in the year incurred and others over a six-year period. We are also provided with incentives and recovery of lost revenues based on the actual reduction in customer electricity usage from these programs and a return on the costs that we recover over six years.
Competition
As we are operating in a time of increasing competition from other electric utilities and non-utility generators to sell electricity for resale, we have secured long-term power supply agreements with our four wholesale customers. Through these
agreements our rates are set principally through the year 2002. We also obtained a new wholesale customer in 1993 for which we will provide up to 30 megawatts of contract demand power for ten years beginning November 1994.
Our state regulators require utilities to purchase power from qualifying non-utility generators at prices set through a bidding process. In June 1993 our state regulators ordered us to purchase 132 megawatts of power from an independent power producer, starting as early as 1995. We oppose this order since we do not believe we need any new power for several years. In July 1993 we asked the Massachusetts Supreme Judicial Court to reverse the order. We are currently awaiting a decision from the court. In addition, our state regulators have created an integrated resource management (IRM) process in which electric utilities forecast their future energy needs and propose how they will meet those needs by balancing conservation programs with all other supplies of energy. We will submit an IRM filing in March 1994.
Direct competition with other electric utilities for retail electricity sales is still subject to substantial limitations, but these limitations may be reduced in the future. In 1993 we announced our goal of not seeking additional rate increases, other than those provided in the 1992 settlement agreement, for our residential, commercial and industrial customers until at least the year 2000. We plan to accomplish this by controlling costs and increasing operating efficiencies without sacrificing quality of service or profitability. The announcement reflects our strong commitment to be a competitively priced reliable provider of energy.
Non-utility business
In 1993 we created an unregulated subsidiary known as the Boston Energy Technology Group (BETG) following approval from our state regulators. We have authority to invest up to $45 million in this wholly-owned subsidiary over the next three years. BETG will engage in demand side management activities through its wholly-owned subsidiary Ener-G-Vision, Inc. and businesses involving electric transportation and the related infrastructure through its wholly-owned subsidiary TravElectric Services Corporation. We do not currently have a substantial investment in BETG and do not anticipate it significantly impacting our results of operations in the next several years.
In January 1994 BETG acquired a substantial majority interest in the assets of REZ-TEK International, Inc., a manufacturer of ozone water treatment systems. The new entity, which will be known as REZ-TEK International Corp., will continue the business of producing a system that treats cooling water used in commercial and industrial air conditioning systems in an energy efficient and environmentally sound manner.
OTHER MATTERS
Environmental
We are subject to numerous federal, state and local standards with respect to air and water quality, waste disposal and other environmental considerations. These standards can require that we modify our existing facilities or incur increased operating costs.
In 1991 we entered into a consent order with the Massachusetts Department of Environmental Protection (DEP) and other interested parties to undertake certain improvements in the emission control systems at New Boston Station. These
improvements included the replacement of four existing chimney stacks with two taller stacks in order to improve the air quality in the vicinity of the station, and the installation of low nitrogen oxides burners. The capital cost of these modifications along with other associated improvements has been approximately $78 million through 1993 with an additional $3 million expected to complete these projects in 1994.
New Boston Station has the ability to burn natural gas, oil or both. As part of the DEP consent order we also agreed to operate the station using natural gas as fuel for a minimum of nine months per year beginning in April 1992. Beginning in April 1995 we will be required to operate the station fueled exclusively by natural gas, except in certain emergency circumstances. We have made arrangements for a nine month supply of natural gas to the station until April 1995 and are currently in the process of negotiating with natural gas suppliers and transporters concerning the economics and availability of natural gas to New Boston on a year-round basis after that time. Year- round gas supplies are currently not available to the station and, as a result, the outcome of our negotiations with natural gas suppliers and transporters and the impact on the operation of New Boston Station are uncertain.
The 1990 Clean Air Act Amendments will require a significant reduction in nationwide emissions of sulfur dioxide from fossil fuel- fired generating units. The reduction will be accomplished by restricting sulfur dioxide emissions through a market-based system of allowances. We believe that we will have allowances issued to us that are in excess of our needs and which may be marketable. Any gain from the sale of these may be subject to future regulatory treatment. Other provisions of the 1990 Clean Air Act Amendments involve limitations on emissions of nitrogen oxides from existing generating units. Combustion system modifications made to New Boston and Mystic Stations, including the installation of the low nitrogen oxides burners at New Boston, will allow the units to meet the provisions of the 1995 standards. Depending upon the outcome of certain air quality modeling studies, additional emission reductions may also be required by 1999. The extent of any additional reductions and the cost of any further modifications is uncertain at this time.
State regulations revised in 1993 require that properties where releases of hazardous materials occurred in the past be further cleaned up according to a timetable developed by the DEP. We are currently evaluating the potential costs associated with the cleanup of sites where we have been identified as the owner or operator. There are uncertainties associated with these potential costs due to the complexities of cleanup technology, regulatory requirements and the particular characteristics of the different sites. We also continue to face possible liability as a potentially responsible party in the cleanup of certain other multi-party hazardous waste sites in Massachusetts and other states. At the majority of these other sites we are one of many potentially responsible parties and our alleged share of the responsibility is a small percentage. We do not expect any of our potential cleanup liabilities to have a material impact on financial condition, although provisions for cleanup costs could have a material impact on quarterly earnings.
We presently dispose of low-level radioactive waste (LLW) generated at Pilgrim Station at licensed disposal facilities in Barnwell, South Carolina. As a result of developments which have occurred pursuant to the Low-Level Radioactive Waste Policy Amendments Act of 1985, our continued access to such disposal facilities has become severely limited and significantly increased in cost. Refer to Note D to the consolidated financial statements for further discussion regarding LLW disposal.
In recent years a number of published reports have discussed the possibility that adverse health effects may be caused by electromagnetic fields (EMF) associated with
electric transmission and distribution facilities and appliances and wiring in buildings and homes. Some scientific reviews conducted to date by several state and federal agencies have suggested associations between EMF and such health effects, while other studies have not substantiated such associations. We support further research into the subject and are participating in the funding of industry sponsored studies. We are aware that public concern regarding EMF in some cases has resulted in litigation, in opposition to existing or proposed facilities before regulators, or in requests for legislation or regulatory standards concerning EMF levels. We have not been significantly affected to date by these developments and cannot predict their potential impact on us, however, we continue to closely monitor all aspects of the EMF issue.
Litigation
In March 1991 we were named in a lawsuit alleging discriminatory employment practices under the Age Discrimination in Employment Act of 1967 concerning 46 employees affected by our 1988 reduction in force. Legal counsel is vigorously defending this case. Based on the information presently available we do not expect that this litigation or certain other legal matters in which we are currently involved will have a material impact on our financial condition. However, an unfavorable decision ordered against us could have a material impact on quarterly earnings.
Labor negotiations
We began negotiations involving our labor contracts in early February 1994. These contracts expire on May 15, 1994. We anticipate favorable resolution of these negotiations prior to that date.
New accounting pronouncements
We will adopt Statement of Financial Accounting Standards (SFAS) No. 112, Employers' Accounting for Postemployment Benefits, and SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, in the first quarter of 1994. Refer to Notes I and J to the consolidated financial statements for further discussion of these pronouncements.
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A. SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Consolidation and Accounting
The consolidated financial statements include the activities of our wholly-owned subsidiaries, Harbor Electric Energy Company and Boston Energy Technology Group. All significant intercompany transactions have been eliminated.
We follow accounting policies prescribed by our federal and state regulators. We are also subject to the accounting and reporting requirements of the Securities and Exchange Commission. The financial statements comply with generally accepted accounting principles. Certain prior period amounts on the financial statements were reclassified to conform with current presentation.
2. Revenue Recognition
We record revenues for electricity used by our customers, but not yet billed, in order to more closely match revenues with expenses.
3. Forecasted Fuel and Purchased Power Rates
The rate charged to retail customers for fuel and purchased power allows for all fuel costs, the capacity portion of some purchased power costs and some transmission costs to be billed to customers monthly using a forecasted rate. The difference between actual and estimated costs is included in accounts receivable on our consolidated balance sheets until subsequent rates are adjusted. State regulators have the right to reduce our subsequent fuel rates if they find that we have been unreasonable or imprudent in the operation of our generating units or in purchasing fuel.
4. Depreciation and Nuclear Fuel Amortization
Our physical property was depreciated on a straight-line basis in 1993, 1992 and 1991 at composite rates of approximately 3.09%, 3.36% and 3.41% per year, respectively, based on estimated useful lives of the various classes of property. The cost of decommissioning Pilgrim Station, our nuclear unit, is excluded from the depreciation rates. When property units are retired, their cost, net of salvage value, is charged to accumulated depreciation.
The cost of nuclear fuel is amortized based on the amount of energy Pilgrim Station produces. Nuclear fuel expense also includes an amount for the estimated costs of ultimately disposing of the spent nuclear fuel and for the decontamination and decommissioning of the United States enrichment facilities used in the production of nuclear fuel. These costs are recovered from our customers through fuel charges.
5. Allowance for Funds Used During Construction (AFUDC)
AFUDC represents the estimated costs to finance plant expenditures. In accordance with regulatory accounting, AFUDC is included as a cost of utility plant. AFUDC is not an item of current cash income, but payment is received for these costs from customers over the service life of the plant in the form of increased revenues collected as a result of higher depreciation expense. Our AFUDC rates in 1993, 1992 and 1991 were 3.62%, 4.48%, and 6.85%, respectively, and represented only the cost of debt.
6. Cash and Cash Equivalents
Cash and cash equivalents are comprised of highly liquid securities with maturities of three months or less.
7. Allowance for Doubtful Accounts
Our accounts receivable are substantially all recoverable. This recovery occurs both from customer payments and from the portion of customer charges that provides for the recovery of bad debt expense. Accordingly, we do not maintain a significant allowance for doubtful accounts balance.
8. Deferred Debits
Deferred debits consist primarily of costs incurred which will be collected from customers through future charges in accordance with agreements with our state regulators. These costs will be expensed when the corresponding revenues are received in order to appropriately match revenues and expenses. A portion of these costs is currently being charged to and collected from customers.
9. Amortization of Discounts, Premiums and Redemption Premiums on Securities
We expense discounts, premiums, redemption premiums and related expenses associated with issuances of securities or refinancing of existing securities in equal annual installments over the life of the replacement securities subject to regulatory approval.
NOTE B. RETAIL SETTLEMENT AGREEMENTS
In 1992 and 1989 our state regulators, the Massachusetts Department of Public Utilities, approved three-year settlement agreements relating to our rate case proceedings. These agreements provided for retail rate increases, accounting adjustments and demand side management program expenditures; clarified the timing and recognition of certain expenses and set limits on our rate of return on common equity. Refer to Management's Discussion and Analysis for further information related to these settlement agreements.
The settlement agreements did not affect our contract or wholesale power rates charged to other utilities, which are regulated by our federal regulators, the Federal Energy Regulatory Commission.
NOTE C. INCOME TAXES
In the first quarter of 1993 we prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). This required us to change our methodology of accounting for income taxes from the deferred method to an asset and liability approach. The deferred method of accounting was based on the tax effects of timing differences between income for financial reporting purposes and taxable income. The asset and liability approach requires the recognition of deferred tax liabilities and assets for the future tax effects of temporary differences between the carrying amounts and the tax basis of assets and liabilities. In accordance with SFAS 109 we recorded a net regulatory asset of $26.9 million and a corresponding net increase in accumulated deferred income taxes as of December 31, 1993. The regulatory asset represents the additional future revenues to be collected from customers for deferred income taxes.
Accumulated deferred income taxes on our consolidated balance sheet at December 31, 1993 includes $587.8 million of gross deferred income tax liabilities net of $103.0 million of gross
deferred income tax assets. We have approximately $19 million of alternative minimum tax carryforwards available at December 31, 1993. The major components of accumulated deferred income taxes are a result of differences between book and tax expenses relating to property, plant and equipment.
Deferred income tax expense reflected in our consolidated income statements is incurred when certain income and expenses are reported on the tax return in different years than reported in the financial statements. Investment tax credits are included in income over the estimated useful lives of the related property.
NOTE D. ESTIMATED FUTURE COSTS OF DISPOSING OF SPENT NUCLEAR FUEL AND RETIRING NUCLEAR GENERATING PLANTS
The existing fuel storage facility at Pilgrim Station includes sufficient room for spent nuclear fuel generated through early 1995. We have a request for a license amendment pending before the Nuclear Regulatory Commission (NRC) to allow modification of the storage facility to provide sufficient room for spent nuclear fuel generated through the end of Pilgrim's operating license in 2012. The NRC is reviewing our request and we expect approval in 1994. At that time we will initially modify the facility to provide spent fuel storage capacity through approximately 2003. It is the ultimate responsibility of the United States Department of Energy (DOE) to permanently dispose of spent nuclear fuel as required by the Nuclear Waste Policy Act of 1982. We currently pay a fee of $1.00 per net megawatthour sold from Pilgrim Station generation under a nuclear fuel disposal contract with the DOE. The fee is collected from customers through fuel charges.
When Pilgrim Station's operating license expires in 2012 we will be required to decommission the plant. During rate proceedings we provided our regulators a 1991 study documenting a cost of $328 million to decommission the plant. The study is based on the "green field" method of decommissioning, which provides for the plant site to be completely restored to its original state. We are expensing these estimated decommissioning costs over Pilgrim's expected service life. The 1993 expense of approximately $13 million is included in depreciation expense on the consolidated income statements. We receive recovery of this expense from charges to our retail customers and from other utility companies and municipalities who purchase a contracted amount of Pilgrim's electric generation. The funds we collect from decommissioning charges are deposited in an external trust and are restricted so that they may only be used for decommissioning and related expenses. The net earnings on the trust funds, which are also restricted, increase the nuclear decommissioning fund balance and nuclear decommissioning reserve, thus reducing the amount to be collected from customers. The 1991 decommissioning study has been partially updated for internal planning purposes to evaluate the potential financial impact of long-term spent fuel storage options resulting from delays in DOE spent fuel removal on the estimated decommissioning cost. The partial update indicates an estimated decommissioning cost of approximately $400 million in 1991 dollars based upon a revised spent fuel removal schedule and utilization of dry spent fuel storage technology. We will continue to monitor DOE spent fuel removal schedules and developments in spent fuel storage technology along with their impact on the decommissioning estimate.
We are also an investor in two other domestic nuclear units. Both of these units receive through the rates charged to their customers an amount to cover the estimated cost to dispose of their spent nuclear fuel and to retire the units at the end of their useful lives.
We presently dispose of low-level radioactive waste (LLW) generated at Pilgrim Station at licensed disposal facilities in Barnwell, South Carolina. As a result of developments which have occurred pursuant to the Low-Level Radioactive Waste Policy Amendments Act of 1985, our continued access to such disposal facilities has become severely limited and significantly increased in cost. We have access to the South Carolina site through July 1994, but do not presently believe that disposal site access will be provided after that date. Although legislation has been enacted in Massachusetts establishing a regulatory method for managing the state's LLW including the possible siting, licensing and construction of a LLW disposal facility within the state, it appears unlikely that such a facility will be constructed in a timely manner. Pending the construction of a disposal facility within the state or the adoption by the state of some other LLW management method, we continue to monitor the situation and are investigating other available options, including the possibility of on-site storage.
NOTE E. CANCELLED NUCLEAR UNIT
In May 1982 we began to expense the cost of our cancelled Pilgrim 2 nuclear unit over approximately eleven and one-half years in accordance with an order received from state regulators. We did not expense any of these costs in 1993. Instead, the remaining balance of approximately $19 million at December 31, 1993 and 1992 will be expensed in 1994 and/or 1995 as approved by our state regulators in our 1992 settlement agreement.
NOTE F. CAPITAL STOCK AND INDEBTEDNESS
(a) In November 1991 our Articles of Organization were amended to increase authorized common stock from 50 million to 100 million shares and reduce the par value from $5 to $1 per common share.
(b) We used the net proceeds of the 1991 common stock issuance to retire $55 million of Series X, 11% first mortgage bonds.
(c) We used the net proceeds of the 1992 common stock issuance to reduce short-term debt.
(d) At December 31, 1993, the remaining authorized common shares reserved for future issuance under the Dividend Reinvestment and Common Stock Purchase Plan were 815,170 shares.
2. Cumulative Non-Mandatory Redeemable Preferred and Preference Stock
In June 1992 we issued 400,000 shares of 8.25% cumulative non-mandatory redeemable preferred stock at par. The stock is redeemable at $100 per share plus accrued dividends beginning in June 1997. These shares were sold in the form of 1.6 million depositary shares, each representing a one-fourth interest in a share of the preferred stock. We used the proceeds of this issue to fully retire the $1.46 series cumulative non-mandatory redeemable preference stock.
In May 1993 we issued 400,000 shares of 7.75% cumulative non-mandatory redeemable preferred stock at par. The stock is redeemable at $100 per share plus accrued dividends beginning in May 1998. These shares were sold in the form of 1.6 million depositary shares, each representing a one-fourth interest in a share of the preferred stock. We used the proceeds of this issue to fully retire the 8.88% series cumulative non-mandatory redeemable preferred stock.
3. Cumulative Mandatory Redeemable Preferred Stock
The 480,000 shares of our 7.27% sinking fund series cumulative preferred stock are currently redeemable at our option at $104.36. The redemption price declines annually each May to par value in May 2002. In May 1993 the stock became subject to sinking fund requirements to retire 20,000 shares at $100 per share plus accrued dividends each year through May 2002. In 1992 we purchased 20,000 shares at a discount on the open market which satisfied the mandatory sinking fund requirement for May 1993. Beginning in 1993, we have the non-cumulative option each May to redeem additional shares, not to exceed 20,000, for the sinking fund at $100 per share plus accrued dividends.
We are not able to redeem any part of our 500,000 shares of $100 par value 8% series cumulative preferred stock prior to December 2001. The entire series is subject to mandatory redemption in December 2001 at $100 per share, plus accrued dividends.
4. Long-Term Debt
Substantially all our property, plant, equipment, materials and supplies are subject to lien under the terms of our Indenture of Trust and First Mortgage dated December 1, 1940, and its supplements. Currently only the outstanding Series S and U first mortgage bonds are subject to the terms of the indenture.
The aggregate principal amounts of our first mortgage bonds, debentures, and sewage facility revenue bonds (including sinking fund requirements) due in 1994 and 1995 are $0 and $100.6 million, respectively, and $101.6 million per year in 1996 through 1998.
Our first mortgage bonds, Series S, adjustable rate due 2002, paid interest at 9.2% per year for the period January 15, 1993 through January 14, 1994. The rate is adjusted annually and is based upon the ten-year constant maturity Treasury rate as published by the Federal Reserve Board. The interest rate for the period January 15, 1994 through January 14, 1995 is 8.2%.
In September 1992 we issued $60 million of 8.25% debentures which mature in September 2022. The debentures are redeemable at prices decreasing from 103.78% of par beginning in September 2002, to 100% of par beginning in September 2012. We used the net proceeds from the sale to reduce short-term debt. In October 1992 we redeemed the remaining balance of $45 million Series X first mortgage bonds.
In February 1993 we issued $65 million of 6.8% debentures due in 2000. We used the proceeds of this issue to reduce short-term debt. These debentures are not redeemable prior to maturity.
In March 1993 we issued $650 million of debentures and used the proceeds to retire ten of twelve outstanding series of first mortgage bonds and reduce short-term debt. The debentures were issued in five separate series with interest rates ranging from 5.125% to 7.8% and maturing between 1996 and 2023. The 5 1/8% debentures due 1996, 5.70% due 1997, 5.95% due 1998 and 6.80% due 2003 are not redeemable prior to maturity. The 7.80% debentures due 2023 are first redeemable in March 2003 at a redemption price of 103.73%. The redemption price decreases annually each March to par value in March 2013. There is no sinking fund requirement for any series of the debentures.
In August 1993 we issued $100 million of 6.05% debentures due in 2000. We used the proceeds from this sale to reduce short-term debt. These debentures are not redeemable prior to maturity and have no sinking fund requirements.
We redeemed $50 million of 9.65% medium-term notes in September 1992 and $50 million of 9.75% medium-term notes in September 1993.
5. Sewage Facility Revenue Bonds
In December 1991, Harbor Electric Energy Company (HEEC), a wholly-owned subsidiary, issued $36.3 million of long-term sewage facility revenue bonds. The bonds are tax-exempt, subject to annual mandatory sinking fund redemption requirements and mature in the years 1995-2015. The weighted average interest rate of the bonds is 7.3%. A portion of the proceeds from the bonds was used to retire $21 million of short-term sewage facility revenue bonds at maturity. The remainder of the proceeds, which is on deposit with the trustee, is being used to finance the construction of HEEC's permanent substation located on Deer Island (in Boston Harbor) and to
fund an amount which must remain in reserve with the trustee. If HEEC should have insufficient funds to pay certain costs on a timely basis or be unable to meet certain net worth requirements, we would be required to make additional capital contributions or loans to the subsidiary up to a maximum of $7 million.
6. Short-Term Debt
We have arrangements with certain banks to provide short-term credit on both a committed and an uncommitted and as available basis. We currently have authority to issue up to $350 million of short-term debt.
We have a $200 million revolving credit agreement with a group of banks. This agreement is intended to provide a standby source of short-term borrowings. Under the terms of this agreement we are required to maintain a common equity ratio of not less than 30% at all times. Commitment fees must be paid on the unused portion of the total agreement amount.
NOTE G. FAIR VALUE OF SECURITIES
The following methods and assumptions were used to estimate the fair value of each class of securities for which it is practicable to estimate the value:
Nuclear decommissioning fund The fair value of $70.1 million is based on quoted market prices of securities held.
Cash and cash equivalents The carrying amount of $8.8 million approximates fair value due to the short-term nature of these securities.
Mandatory redeemable cumulative preferred stock, first mortgage bonds, sewage facility revenue bonds and debentures
NOTE H. COMMITMENTS AND CONTINGENCIES
1. Capital Commitments
At December 31, 1993, we had estimated contractual obligations for plant and equipment of approximately $71 million.
2. Lease Commitments
We will capitalize a portion of these lease rentals as part of plant expenditures in the future. Our total expense for both lease rentals and transmission agreements for 1993, 1992 and 1991 was $30 million, $30 million and $33.5 million, respectively, net of capitalized expenses of $5 million, $5 million, and $4.8 million, respectively.
3. Hydro-Quebec
We have an approximately 11% equity ownership interest in two companies which own and operate transmission facilities to import electricity from the Hydro-Quebec system in Canada, which is included in our consolidated financial statements. As an equity participant we are required to guarantee, in addition to our own share, the total obligations of those participants who do not meet certain credit criteria and are compensated accordingly. At December 31, 1993, our portion of these guarantees was approximately $22 million.
4. Yankee Atomic Electric Company
In February 1992 the Board of Directors of Yankee Atomic Electric Company (Yankee Atomic) decided to permanently discontinue power operation of the Yankee Atomic nuclear generating station and, in time, decommission that facility. We relied on Yankee Atomic for less than one percent of our system capacity. We have a 9.5% stock investment of approximately $2 million in Yankee Atomic.
In 1993 Yankee Atomic received approval from federal regulators to continue to collect its investment and decommissioning costs through July 2000, the period of the plant's operating license. The estimate of our share of Yankee Atomic's investment and costs of decommissioning is approximately $33 million as of December 31, 1993. This estimate is recorded on our consolidated balance sheet as a power contract liability in deferred credits. An offsetting power contract regulatory asset is included in deferred debits as we continue to collect these costs from our customers in accordance with our 1992 settlement agreement.
5. Nuclear Insurance
The federal Price-Anderson Act currently provides $9.4 billion of financial protection for public liability claims and legal costs arising from a single nuclear-related accident. The first $200 million of nuclear liability is covered by commercial insurance. Additional nuclear liability insurance up to approximately $8.8 billion is provided by a retrospective assessment of up to $75.5 million per incident levied on each of the 116 units licensed to operate in the United States, with a maximum assessment of $10 million per reactor per accident in any year. The additional nuclear liability insurance amount may change as new commercial nuclear units are licensed and existing units give up their licenses. In addition to the nuclear liability retrospective assessments, if the sum of all public liability claims and legal costs arising
from any nuclear accident exceeds the maximum amount of financial protection, each licensee can be assessed an additional five percent of the maximum retrospective assessment.
We have purchased insurance from Nuclear Electric Insurance Limited (NEIL) to cover some of the costs to purchase replacement power during a prolonged accidental outage at Pilgrim Station and the cost of repair, replacement, decontamination or decommissioning of our utility property resulting from covered incidents at Pilgrim Station. Our maximum potential total assessment for losses which occur during current policy years is approximately $14.6 million under both the replacement power and excess property damage, decontamination and decommissioning policies. All companies insured with NEIL are subject to retroactive assessments if losses are in excess of the total funds available to NEIL. While assessments may also be made for losses in certain prior policy years, we are not aware of any losses in those years which we believe are likely to result in an assessment.
6. Litigation
In March 1991 we were named in a lawsuit alleging discriminatory employment practices under the Age Discrimination in Employment Act of 1967 concerning 46 employees affected by our 1988 reduction in force. Legal counsel is vigorously defending this case. Based on the information presently available we do not expect that this litigation or certain other legal matters in which we are currently involved will have a material impact on our financial condition. However, an unfavorable decision ordered against us could have a material impact on quarterly earnings.
7. Hazardous Waste
State regulations revised in 1993 require that properties where releases of hazardous materials occurred in the past be further cleaned up according to a timetable developed by the Massachusetts Department of Environmental Protection. We are currently evaluating the potential costs associated with the cleanup of sites where we have been identified as the owner or operator. There are uncertainties associated with these potential costs due to the complexities of cleanup technology, regulatory requirements and the particular characteristics of the different sites. We also continue to face possible liability as a potentially responsible party in the cleanup of certain other multi-party hazardous waste sites in Massachusetts and other states. At the majority of these other sites we are one of many potentially responsible parties and our alleged share of the responsibility is a small percentage. We do not expect any of our potential cleanup liabilities to have a material impact on financial condition, although provisions for cleanup costs could have a material impact on quarterly earnings.
NOTE I. PENSIONS, OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
1. Pensions
We have a noncontributory funded retirement plan, with certain features that allow voluntary contributions. Benefits are based upon an employee's years of service and compensation during the last years of employment. Our funding policy is to contribute each year an amount that is not less than the minimum required contribution under federal law or greater than the maximum tax deductible amount. Plan assets are primarily equities, bonds, insurance contracts and real estate.
We changed our discount rate assumption to 7.0% for calculating pension cost effective January 1994.
2. Other Postretirement Benefits
In addition to pension benefits, we also currently provide health care and other benefits to our retired employees who meet certain age and years of service eligibility requirements. Effective January 1993 we adopted Statement of Financial Accounting Standards No. 106, Employer's Accounting for Postretirement Benefits Other Than Pensions (SFAS 106). This requires us to record a liability during the working years of employees for the expected costs of providing their postretirement benefits other than pensions (PBOPs). Prior to 1993 our
policy was to record the cost of PBOPs when paid. Our transition obligation on January 1, 1993 was approximately $183 million, which we elected to recognize over 20 years as permitted by SFAS 106. Our total cost of PBOPs under SFAS 106 in 1993 was approximately $28 million, an increase of approximately $18 million over costs incurred under our prior method of accounting for PBOPs. Our 1992 settlement agreement provides us with a phase-in of a portion of the increased costs and allows us to defer the additional costs in excess of the phase-in amounts to the extent that we fund an external trust. In December 1993 we deposited $18 million on a tax deductible basis into external trusts for the payment of PBOPs. Accordingly, in 1993 we recorded an expense of approximately $16 million, reflecting the amount of cost recovery from customers, and deferred approximately $12 million for future recovery. We capitalized approximately 19% of these costs.
We used an 8.0% weighted average discount rate and 4.5% rate of compensation increase assumption for calculating the transition obligation and the 1993 postretirement benefits cost. Our expected long-term rate of return on assets is 9.0%. We also assumed a 12.5% health care cost trend rate. Effective January 1, 1994 we changed the discount and health care cost trend rates to 7.0% and 9.0%, respectively, in order to more accurately estimate our future benefit payments. The health care cost trend rate is assumed to decrease by one percent each year to 5% in 1998 and years thereafter. Changes in the health care cost trend rate will affect our cost and obligation amounts. For example, a one percent increase in the rate would increase the total service and interest costs in 1993 by approximately 16% and would increase the accumulated obligation at December 31, 1993 by approximately 13%.
The trust assets consist of money market funds at December 31, 1993.
3. Postemployment Benefits
Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits, will be effective for the first quarter of 1994. This statement will require us to record a liability computed on an actuarial basis for the estimated cost of providing postemployment benefits. Postemployment benefits provided to former or inactive employees, their beneficiaries and covered dependents include salary continuation, severance benefits, disability-related benefits (including workers' compensation), job training and counseling and continuation of health care and life insurance coverage. We currently recognize
the cost of these benefits primarily as claims are paid. We do not anticipate a material effect on net income from adopting this statement.
NOTE J. NEW ACCOUNTING PRONOUNCEMENT
We will adopt Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, in the first quarter of 1994. This statement may require us to classify the investments in our nuclear decommissioning fund on our consolidated balance sheet based on how long we intend to hold the individual securities. These investments may be classified as "available for sale" and we may also be required to report any unrealized gains and losses on the investments as a separate component of shareholders' equity. We do not expect the adoption of this statement to have a material effect on shareholders' equity.
NOTE K. LONG-TERM POWER CONTRACTS
1. Long-Term Contracts for the Purchase of Electricity
We purchase electric power under several long-term contracts for which we pay a share of the generating unit's capital and fixed operating costs through the contract expiration date. The total cost of these contracts is included in purchased power expense in our consolidated income statements. Information relating to these contracts as of December 31, 1993 is as follows:
Our total fixed and variable costs for these contracts in 1993, 1992 and 1991 were approximately $225 million, $217 million and $154 million, respectively. Our minimum fixed payments under these contracts for the years after 1993 are as follows:
2. Long-Term Power Sales
Under these contracts, the utilities pay their proportional share of the costs of operating Pilgrim Station and associated transmission facilities. These costs include operation and maintenance expenses, insurance, local taxes, depreciation, decommissioning and a return on capital.
Electricity sales and revenues are seasonal in nature, with both being lower in the spring and fall seasons. Quarterly earnings for 1993 reflect a change in the months for which certain customers were billed at higher rates as mandated by the DPU. These customers were billed at these higher rates in July through October in 1992 and in June through September in 1993. The change in billing increased second quarter earnings and reduced fourth quarter earnings by approximately $0.23 per share in 1993.
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 - ------------------------------------------------------------
(a) Identification of Directors - --------------------------------
See "Election of Directors - Information about Nominees and Incumbent Directors" on pages 1 through 4 of the definitive Proxy Statement dated March 17, 1994 incorporated herein by reference.
(b) Identification of Executive Officers - -----------------------------------------
The information required by this item is included at the end of Part I of this Form 10-K under the caption Executive Officers of the Registrant.
(c) Identification of Certain Significant Employees - ----------------------------------------------------
Not applicable.
(d) Family Relationships - -------------------------
Not applicable.
(e) Business Experience - ------------------------
For information relating to the business experience during the past five years and other directorships (of companies subject to certain SEC requirements) held by each person nominated to be a director, see "Election of Directors - Information about Nominees and Incumbent Directors" on pages 1 through 4 of the definitive Proxy Statement dated March 17, 1994, incorporated herein by reference.
For information relating to the business experience during the past five years of each person who is an executive officer, see Executive Officers of the Registrant in this Form 10-K.
(f) Involvement in Certain Legal Proceedings - ---------------------------------------------
Not applicable.
(g) Promoters and Control Persons - ----------------------------------
Not applicable.
Item 11. Executive Compensation - --------------------------------
See "Director and Executive Compensation" on pages 5 through 11 of the definitive Proxy Statement dated March 17, 1994, incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners - ----------------------------------------------------
To the knowledge of management, no person owns beneficially more than five percent of the outstanding voting securities of the Company.
(b) Security Ownership of Management - -------------------------------------
See "Stock Ownership by Directors and Executive Officers" on pages 4 through 5 of the definitive Proxy Statement dated March 17, 1994, incorporated herein by reference.
(c) Changes in Control - -----------------------
Not applicable.
Item 13. Certain Relationships and Related Transactions - --------------------------------------------------------
Not applicable.
Part IV -------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------
All other schedules are omitted since they are not required, not applicable, or contain only information which is otherwise provided in the financial statements or notes in Item 8. | 13372 | 1993 |
Item 6.SELECTED FINANCIAL DATA - --------------------------------------------------------------------------------
AEGCO. Omitted pursuant to Instruction J(2)(a).
AEP. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the AEP 1993 Annual Report (for the fiscal year ended December 31, 1993).
APCO. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the APCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
CSPCO. Omitted pursuant to Instruction J(2)(a).
I&M. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the I&M 1993 Annual Report (for the fiscal year ended December 31, 1993).
KEPCO. Omitted pursuant to Instruction J(2)(a).
OPCO. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the OPCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
Item 7. | Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION - --------------------------------------------------------------------------------
AEGCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the AEGCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
AEP. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the AEP 1993 Annual Report (for the fiscal year ended December 31, 1993).
APCO. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the APCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
CSPCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the CSPCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
I&M. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the I&M 1993 Annual Report (for the fiscal year ended December 31, 1993).
KEPCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the KEPCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
OPCO. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the OPCo 1993 Annual Report (for the fiscal year ended December 31, 1993).
Item 8. | 857571 | 1993 |
Item 6. Selected Consolidated Financial Data - ------- ------------------------------------
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and notes thereto included in this report.
Item 7. | Item 7. Management's Discussion and Analysis of Financial - ------- ------------------------------------------------- Condition and Results of Operations -----------------------------------
Results of Operations 1993 Compared to 1992 - -------------------------------------------
Earnings from continuing operations in 1993 increased $57 million to $127 million. The increase is attributable to the acquisition of Bredero Price, improved earnings in Oilfield Services and Engineering Services operations and changes implemented to reduce costs associated with retiree medical benefit plans.
Revenues increased from $3.8 billion to $4.2 billion. The consolidation of Dresser-Rand's financial statements in 1993 was the primary reason for the increase. In 1992, Dresser-Rand was accounted for using the equity method.
Earnings from operations were $219 million in 1993 compared to $126 million in 1992. Both 1993 ($74.1 million) and 1992 ($70.0 million) included Special Charges. The 1993 charge was primarily due to the settlement of the Parker & Parsley litigation ($65 million) while in 1992 the charges were mainly attributable to restructuring, particularly the Ingersoll-Dresser Pump joint venture. Excluding the Special Charges, Earnings from Operations were $293 million in 1993 and $196 million in 1992. In 1993, Earnings from Operations included 100% of Dresser-Rand's results, which added $46 million compared to 1992. In addition, the Company and its joint ventures amended retiree medical benefit plans, thereby reducing the related 1993 expense by some $26 million compared to 1992. Also during 1993, Ingersoll-Dresser Pump Company
Results of Operations 1993 Compared to 1992 (Continued) - -------------------------------------------------------
sold the inventory the Company contributed to the joint venture, allowing the release of the associated LIFO inventory reserves of $21 million. This gain is reflected as a component of the earnings from the joint venture. See the Industry Segment Analysis beginning on page 15 for a discussion of the results for each segment.
Other income increased from $18 million in 1992 to $32 million in 1993 because of a $13 million gain resulting from a plan change in retiree medical benefits for younger employees. Reduced interest expense resulting from the redemption of sinking fund debentures in 1992 was offset by interest on debt incurred to finance acquisitions.
The effective tax rate declined to 33% in 1993 from 45% in 1992 as a result of reduced losses in foreign countries with no tax benefit, increased utilization of foreign tax credits and a $9 million benefit associated with a change in the tax rate from 34% to 35%.
The consolidation of Dresser-Rand in 1993 resulted in an increase in minority interest representing our partner's 49% share of Dresser-Rand's earnings.
Results of Operations 1992 Compared to 1991 - -------------------------------------------
Earnings from continuing operations were $70 million in 1992, down from $132 million in 1991. The decrease reflected the after-tax special charge of $50 million for restructuring and the increased expense for retiree medical benefits of $21 million net of tax.
Revenues declined to $3.8 billion from $4.0 billion in 1991, with slightly lower revenues in each segment accounting for the reduction.
Earnings from operations before Special Charges in 1992 of $196 million were $51 million lower than the $247 million recorded in 1991. The change in accounting for retiree medical benefits in 1992 accounted for $32 million of the reduction. See the Industry Segment Analysis beginning on page 15 for a discussion of the results for each segment.
Other income amounted to $18 million in 1992 versus net expense of $2.3 million in 1991. The redemption of high rate sinking fund debentures reduced interest expense by $8 million. Also in 1992, the Company sold a partial interest in M. W. Kellogg's United Kingdom subsidiary resulting in a $15.5 million gain.
The effective tax rate increased to 45% in 1992 from 38% in 1991. A reduction in utilization of foreign tax credits and increased foreign losses with no corresponding tax benefit caused the increase.
Results of Operations 1992 Compared to 1991 (Continued) - -------------------------------------------------------
In 1992, the Company spun-off its industrial products operations (INDRESCO) and made the decision to dispose of its Environmental Products business. The results of these operations are reflected as Discontinued Operations in the 1992 and 1991 financial statements.
In 1992, the Company adopted two new accounting standards relating to retiree medical benefits and income taxes. The combined net effect of these changes was a one time non-cash charge of $394 million or $2.91 per share, which is reflected as the Cumulative Effect of Accounting Changes in the 1992 Statement of Earnings.
Legal and Environmental Matters - -------------------------------
During 1993, the Company settled litigation involving Parker & Parsley for a cash payment of $58 million. See Note L - Commitments and Contingencies for further discussion of this settlement and other pending legal matters. Note L also includes disclosure of environmental clean-up situations in which the Company is involved.
Cash Flow and Financial Position - --------------------------------
Dresser's overall financial position remains strong at October 31, 1993. During 1993, the Company redeemed the last of its 11-3/4% debentures and issued $300 million of 6.25% Notes due 2000. The ratio of debt to total capitalization was 36%, which is consistent with the Company's objective of 35% debt and 65% equity. Available cash and short-term credit lines, combined with cash provided by operations, should be adequate to finance known requirements.
Cash provided by operations before payments associated with the Parker & Parsley settlement of $58 million was adequate to cover capital expenditures of $140 million and dividends of $82 million. The proceeds from the $300 million of 6.25% Notes issued during the year, together with $200 million of commercial paper borrowings, was used to finance the acquisition of Bredero Price and TK Valve ($267 million), repay long-term debt ($80 million) and pay the settlement of the Parker & Parsley litigation ($58 million).
Capital expenditures increased in 1993 by $51 million to $140 million. Most of the increase was due to the consolidation of Dresser-Rand in 1993. Dresser- Rand's capital expenditures amounted to $58 million in 1993 compared to the Pump Operations capital expenditures of $13 million in 1992. Capital expenditures planned for 1994 approximate $140 million.
Industry Segment Analysis - -------------------------
See details of financial information by Industry Segment on pages 18 to 20.
Oilfield Services Segment - -------------------------
Consolidated revenues in 1993 included $209 million from the operations of Bredero Price and TK Valve, which were acquired in early 1993. Excluding revenues of the acquired operations, segment revenues in 1993 were essentially unchanged from 1992. The favorable impact of higher North American drilling activity on the sales volume of M-I Drilling Fluids (owned 64% by Dresser), Guiberson AVA Division and Security Division was substantially offset by the impact of lower international drilling activity.
Excluding the operating profit of Bredero Price and TK Valve, 1993 operating profit of consolidated operations increased $16 million or 93% over 1992. Higher M-I Drilling Fluids profit reflected higher domestic sales volume and the benefit of operating cost reductions for a full year. Operating profit improved in both the Security and Guiberson AVA divisions.
Oilfield Services results in 1992 were significantly affected by lower U.S. drilling activity compared to 1991. Consolidated revenues were down 13% from 1991, resulting in operating profit $45 million under 1991. Operating expense reductions made during 1992 only partly offset the impact of lower sales volume in M-I Drilling Fluids, Security Division and Guiberson AVA Division. In 1992, special charges of $17 million were recorded for restructuring to reduce consolidated oilfield services operations to a size appropriate to the lower level of domestic exploration, drilling and production activity.
Western Atlas International, owned 29.5% by Dresser, benefited from better North American activity and continuing expanded international markets in 1993. On 10% lower revenues, the Company's share of operating profit increased to $39 million or 11% from 1992, which showed a similar increase over 1991. The Company has agreed to sell its interest in Western Atlas International to the majority partner in early 1994 for $558 million.
The merger of Dresser with Baroid, a worldwide supplier of oilfield services and equipment with sales of $850 million, will significantly expand the Company's range of products and services to Oilfield customers. See Note R to Consolidated Financial Statements for information which gives effect to the merger.
Industry Segment Analysis (Continued) - -------------------------------------
Hydrocarbon Processing Industry Segment - ---------------------------------------
Changes in ownership and the formation of a major joint venture have significantly affected the comparison of revenues and operating profit in the Hydrocarbon Processing Segment. Dresser increased its ownership in Dresser-Rand Company from 50% to 51% as of October 1, 1992. As a result, Dresser-Rand is included as a consolidated subsidiary in 1993 and as a major joint venture in 1992 and 1991. Ingersoll-Dresser Pump Company was formed as of October 1, 1992 with Dresser owning 49%. Ingersoll-Dresser Pump is included as a major joint venture in 1993. Dresser's Pump business, which was transferred to Ingersoll- Dresser Pump, is included as consolidated Pump Operations in 1992 and 1991.
Revenues for 1993 of consolidated operations other than Dresser-Rand and Pump Operations decreased 4% from 1992. A 12% decrease in sales in the Valve and Controls Division was primarily due to depressed market conditions in key international markets and to the strength of the dollar compared to other currencies.
Operating profit of the consolidated operations other than Dresser-Rand and Pump Operations of $128 million was 2% under 1992. A strong performance in 1993 by the Wayne Division with earnings up $15 million from 1992 offset a 23% decline for Valve and Controls. Earnings in international markets, principally Europe, were down in 1993 compared to the prior year. Also, inventory reductions in 1992, which resulted in a favorable LIFO impact of $9 million, did not recur in 1993.
In 1992, consolidated sales excluding Dresser-Rand and Pump Operations were down slightly from 1991 with no significant changes in any one division. Earnings in 1992 increased $13 million compared to 1991. Strong earnings for the Wayne Division, improvements in the Instrument and Valve and Controls divisions and the LIFO benefit referred to above were the primary reasons for the increase.
Dresser-Rand, reported as a consolidated operation in 1993, had sales of $1.1 billion, which were 13% lower than in 1992. In 1992, sales which were not included in Dresser's consolidated revenues increased from $1.2 billion in 1991 to $1.3 billion. Operating profit for each of the last three years was $90 million in 1993, $86 million in 1992 and $94 million in 1991. Expenses associated with the change in accounting for retiree medical costs reduced earnings by $14 million and $20 million in 1993 and 1992, respectively, compared to 1991.
Industry Segment Analysis (Continued) - -------------------------------------
Hydrocarbon Processing Industry Segment (Continued) - ---------------------------------------------------
Ingersoll-Dresser Pump Company operated at break-even in 1993, as the joint venture with Ingersoll-Rand rationalized the operations of the two former separate businesses. Also a significant portion of the joint venture's market is the European Community, which was in the midst of a recession in 1993. Operating profit for 1993 consists primarily of a $21 million release of LIFO inventory reserves related to inventory contributed to the joint venture by the Company, which was sold to third parties during the year. The Company's separate Pump Operations contributed earnings of $32 million and $36 million in 1992 and 1991, respectively.
Special charges of $7 million were recorded in 1993 related to plant closing and other restructuring in the Wayne and Valve and Control operations, primarily in Europe, and similar actions at Dresser-Rand. In 1992, special charges related to the restructuring of Pump Operations ($35 million) and restructuring and special warranty claims in other Hydrocarbon Processing operations ($14 million).
Engineering Services Segment - ----------------------------
Revenues in 1993 of $1.2 billion decreased 22% from 1992. In 1992, revenues were 2% under 1991. The decline in revenues reflected reduced hydrocarbon processing activity in certain international areas and slow growth and project delays in the U.S. In 1991, revenues included a $22 million payment received by The M. W. Kellogg Company for its retained interest in a foreign project.
Engineering Services operating profit in 1993 increased $8 million from 1992; in 1992 operating profit was $15 million over 1991. In 1992, M. W. Kellogg realized a $15 million gain from the sale of a partial interest in its U.K. subsidiary. Operating profit in 1991 included the $22 million in revenue for the retained interest in a foreign project. Increased operating profit on lower revenues is due to enhanced gross margins on large international projects involving technologies in which M. W. Kellogg possesses expertise.
Backlog of Unfilled Orders - --------------------------
INDUSTRY SEGMENT FINANCIAL INFORMATION - COVERED BY REPORT OF INDEPENDENT ACCOUNTANTS
The following financial information by Industry Segment for the years ended October 31, 1993, 1992 and 1991 is an integral part of Note P to Consolidated Financial Statements.
The Company increased its ownership in Dresser-Rand Company from 50% to 51% as of October 1, 1992. As a result, Dresser-Rand is included as a consolidated subsidiary in 1993 and as a major joint venture operation in 1992 and 1991. Ingersoll-Dresser Pump Company was formed as of October 1, 1992 with the Company owning 49%. Ingersoll-Dresser is included as a major joint venture investment in 1993. The Company's Pump business that was transferred to Ingersoll-Dresser is included as Pump Operations in 1992 and 1991.
INDUSTRY SEGMENT FINANCIAL INFORMATION - COVERED BY REPORT OF INDEPENDENT ACCOUNTANTS (CONTINUED)
INDUSTRY SEGMENT FINANCIAL INFORMATION - COVERED BY REPORT OF INDEPENDENT ACCOUNTANTS (CONTINUED)
Item 8. | 30099 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth summary consolidated financial information of the Company, for the years and dates indicated (information related to the statements of income and, in 1993, the balance sheet, have been reclassified for discontinued operations):
Results for 1993 and 1992 include pre-tax income of approximately $9 million and $25 million, respectively, as a result of gains associated with the sale of common stock through public offerings by equity affiliates and, in 1992, a prepayment premium related to the redemption of debentures held by the Company. This income was largely offset by costs and expenses related to cost-reduction initiatives, the restructuring of certain operations and product lines, adjustments to the carrying value of certain long-term assets, and other costs and expenses.
Results for 1993 were reduced by a charge of approximately $.03 per common share reflecting the increased 1993 federal corporate income tax rate related to adjusting deferred tax balances as of December 31, 1992 for the higher income tax rate.
Results for 1993 are before the effect of a $5.8 million pre-tax extraordinary charge ($3.7 million after-tax or $.06 per common share) related to the early extinguishment of subordinated debt (see the Note to the Company's Consolidated Financial Statements captioned "Long-Term Debt," included in Item 8 of this Report). 1993 results are also before an after-tax charge of approximately $22 million ($.39 per common share) related to the disposition of a segment of the Company's business (see the Note to the Company's Consolidated Financial Statements captioned "Discontinued Operations," included in Item 8 of this Report). Net income for 1993 before preferred stock dividends was $47.6 million or $.57 per common share.
Income from continuing operations per common share in 1993 is presented on a fully diluted basis. Primary earnings from continuing operations per common share were $.97 in 1993. For years 1989 through 1992, the assumed conversion of dilutive securities is anti-dilutive.
Income from continuing operations before extraordinary loss attributable to common stock was $56.0 million and $29.7 million after preferred stock dividends in 1993 and 1992, respectively.
Results for 1991 include the effect of charges for restructurings and other costs, aggregating approximately $41 million pre-tax, which reduced operating profit by $27 million, income from continuing operations before extraordinary income by $27 million and earnings per common share by $.45.
Loss from continuing operations attributable to common stock in 1991 was $20.0 million after preferred stock dividends.
Results for 1990 include the effect of charges for restructurings and other costs, aggregating approximately $40 million pre-tax, which reduced operating profit by $38 million, income from continuing operations before extraordinary income by $26 million and earnings per common share by $.35.
Net loss in 1990 was $18.6 million or $.25 per common share after inclusion of extraordinary income of $8.2 million or $.11 per common share related to the early extinguishment of debt.
Results for 1989 include the effect of charges for restructurings and other costs, aggregating approximately $54 million pre-tax, which reduced operating profit by $39 million, income from continuing operations before extraordinary income by $36 million and earnings per common share by $.45.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
MASCOTECH
Masco Corporation undertook a major corporate restructuring during 1984, transferring its Products for Industry businesses to the Company at their historical net book value. MascoTech became a separate public company in mid-1984, when Masco Corporation distributed common shares of MascoTech as a special dividend to its shareholders. At December 31, 1993, Masco Corporation owned approximately 42 percent of MascoTech Common Stock.
In 1993 the Company changed its name to MascoTech, Inc. from Masco Industries, Inc. to reflect the significance of technology in the design, engineering and manufacturing of many of the Company's products.
CORPORATE DEVELOPMENT
Since mid-1984, the Company has acquired a number of businesses for approximately $650 million in cash and Company Common Stock. These acquisitions have contributed significantly to the more than tripling of the sales volume of the Company during this time. The Company has invested more than $1.2 billion in capital expenditures and acquisitions combined to build up the Company's technological positions in its industrial markets.
Since late 1988 the Company has divested several operations as part of its long-term strategic plan to de-leverage its balance sheet and focus on its core operating capabilities. The Company's divestiture activity included several businesses transferred to its equity affiliate, TriMas Corporation ("TriMas"), and in late 1993 the announcement of the Company's plan to dispose of its energy-related business segment. In addition to its continuing common equity ownership interest in TriMas (43 percent at December 31, 1993), the Company has realized cash proceeds of approximately $400 million through December 31, 1993 from its divestiture activity which has been applied to reduce the Company's indebtedness.
In early 1993, the Company acquired from Masco Corporation 10 million shares of Company Common Stock, $77.5 million of the Company's 12% Exchangeable Preferred Stock held by Masco Corporation, and Masco Corporation's holdings of Emco Limited ("Emco") common stock and convertible debentures. In exchange, Masco Corporation received from the Company $87.5 million in cash, $100 million of the Company's 10% Exchangeable Preferred Stock (subsequently redeemed in 1993) and seven-year warrants to purchase 10 million shares of Company Common Stock at $13 per share. As part of this transaction, as modified in late 1993, Masco Corporation agreed to purchase from the Company, at the Company's option through March, 1997, up to $200 million of subordinated debentures. As a result of these transactions, the Company owns approximately 43 percent of the outstanding common stock and convertible debentures of Emco, a major, publicly traded, Canadian-based manufacturer and distributor principally of building and other industrial products with annual sales of approximately $800 million in 1993.
DISCONTINUED OPERATIONS
In late November, 1993, the Company adopted a formal plan to divest its energy-related business segment which consisted of seven business units. Accordingly, the applicable financial statements and related notes have been reclassified to present such energy-related segment as discontinued operations and include a 1993 fourth quarter charge of approximately $22 million after-tax to reflect the estimated loss from the disposition of this segment. During 1993, two energy-related business units were sold for approximately $93 million, including the sale of one business unit to the Company's equity affiliate, TriMas, for $60 million. The remaining five energy-related business units had net assets at December 31, 1993 of approximately $68 million (adjusted to reflect the anticipated loss upon disposition, net of tax benefit) and are expected to be disposed of during 1994.
Net sales attributable to the discontinued operations during 1993 (through the decision to discontinue), 1992 and 1991 were $192 million, $202 million and $201 million, respectively. The discontinued operations had operating profit of approximately $6 million, $3 million and $1 million in 1993, 1992 and 1991, respectively.
PROFIT MARGINS -- CONTINUING OPERATIONS
Operating profit margin from continuing operations was nine percent in 1993, eight percent in 1992 and three percent in 1991. The increase in the operating profit margin from continuing operations in 1993 compared with the previous two years is primarily attributable to increased sales volumes in the Transportation-Related Products segment, and from the benefits of internal cost reductions and restructuring initiatives undertaken in recent years. Margins in 1993 related to the Company's Specialty Products segment continue to be hampered by the depressed industry conditions affecting the construction and defense markets that the Company serves. Operating profit from continuing operations was reduced by significant charges aggregating approximately $27 million in 1991. These charges reflect expenses related to the discontinuance of product lines, costs related to the restructuring of several businesses and other expenses. Of these charges, approximately $15 million in 1991 relate to the Company's automotive vehicle conversion business, which has been restructured and returned to profitability. In addition, margins from continuing operations were negatively impacted in 1991 as a result of reduced sales volumes in certain of the Company's Transportation-Related Products operations, due to production cutbacks by automotive customers, and in virtually all of the Company's other product groups due to recessionary market conditions.
CASH FLOWS AND CAPITAL EXPENDITURES
Net cash flow from operating activities, including discontinued operations, increased to $100 million in 1993 from $58 million in 1992 principally as a result of improved operating performance. In 1993, the Company received approximately $210 million from the issuance of equity (6% Dividend Enhanced Convertible StockSM -- the "DECS") and $93 million from the sale of two energy-related businesses. These proceeds were applied to reduce the Company's indebtedness. The Company redeemed $100 million of non-convertible preferred stock for cash and, in early 1993, the Company invested $87.5 million as described in Corporate Development.
During 1991 and 1992, the Company received approximately $260 million in cash from the disposition of its investment in Masco Capital (during 1991 the Company had advanced Masco Capital approximately $44 million to fund debt repayment obligations and working capital requirements) and from the early redemption by TriMas, including a prepayment premium, of TriMas' subordinated debentures held by the Company. These proceeds were applied to reduce the Company's indebtedness in late 1991 and 1992.
From January 1, 1991 to December 31, 1993, the Company repaid or repurchased over $380 million, net, of its outstanding debt, and an additional $187 million of convertible debt was converted to Company Common Stock.
The Company has substantial new business opportunities over the next few years in its Transportation-Related Products segment which are anticipated to require an increase from the recent level of capital expenditures and increased working capital needs.
INVENTORIES
The Company's investment in inventories decreased to $140 million at December 31, 1993. This decrease was the result of the sale during 1993 of a portion of the Company's energy-related segment and the reclassification of the remaining inventories in the energy-related segment at December 31, 1993 into net assets of discontinued operations. The Company's continued emphasis on inventory management, utilizing Just-In-Time (JIT) and other inventory management techniques has contributed to higher inventory turnover rates in recent years.
FINANCIAL POSITION AND LIQUIDITY
During 1993, the Company's financial position was substantially improved as the Company's equity increased by approximately $314 million while its total indebtedness decreased by approximately $339 million. This improvement in financial position resulted from the Company's positive operating performance, the issuance of the DECS, the conversion of the Company's previously outstanding convertible debt into Company Common Stock and from the collection of $93 million of proceeds related to the sale of two of the Company's energy-related businesses. The Company also redeemed its $100 million of 10% Exchangeable Preferred Stock with significantly lower cost bank borrowings, and invested $87.5 million as part of the transactions whereby it acquired the Emco holdings.
The Company's financial flexibility and liquidity were also substantially improved during 1993. In September, 1993, the Company entered into a new $675 million revolving credit agreement, replacing a prior bank agreement which required principal payments commencing September 30, 1993. Amounts outstanding under this new agreement are due in January, 1997; however, under certain circumstances the due date may be extended until July, 1998. In addition, the Company in early 1994 sold $345 million of 4 1/2% Convertible Subordinated Debentures due 2003. The proceeds from this offering were used to redeem $250 million of 10 1/4% Subordinated Notes (called in late 1993 for redemption on February 1, 1994) and to retire other indebtedness. The Company at December 31, 1993 had cash and cash investments of $83 million.
As a result of the above mentioned transactions, the Company's debt as a percent of debt plus equity was reduced to 54 percent at December 31, 1993 from 76 percent at December 31, 1992. In addition, the Company's annual financing costs have been reduced by approximately $20 million after-tax. As of December 31, 1993, adjusted on a pro forma basis for the issuance in early 1994 of the 4 1/2% Convertible Debentures, the Company had floating rate debt of approximately $213 million (at a current interest rate of approximately 4%) and $578 million of fixed rate debt (at a weighted average interest rate of under 7%).
At December 31, 1993 current assets, which aggregated approximately $556 million, were approximately three times current liabilities. In addition, the Company has significant financial assets, including 20 percent or more ownership positions in the securities of three publicly traded companies with an aggregate carrying value of approximately $137 million. This compares with an aggregate quoted market value at December 31, 1993 (which may differ from the amounts that would have been realized upon disposition) of approximately $524 million.
The Company's cash, additional borrowings available under the Company's new revolving credit agreement and anticipated internal cash flow are expected to provide sufficient liquidity to fund its near-term working capital and other investment needs. The Company believes that its longer-term working capital and other general corporate requirements, including the retirement of Senior Subordinated Notes maturing in 1995, will be satisfied through its internal cash flow, proceeds from the early 1994 issuance of the 4 1/2% Convertible Debentures, divestiture of the remaining businesses in the energy-related segment, other nonstrategic operating assets and certain additional financial assets and, to the extent necessary, future financings in the financial markets.
GENERAL FINANCIAL ANALYSIS
1993 versus 1992 -- Continuing Operations
In 1993, net sales from continuing operations increased nine percent to $1.58 billion from $1.46 billion in 1992. Income from continuing operations in 1993, after preferred stock dividends, was $56.0 million or $.91 per common share, assuming full dilution, compared with income from continuing operations, after preferred stock dividends, of $29.7 million or $.49 per common share in 1992.
Including the results of discontinued operations and the loss upon disposition of those businesses, and an extraordinary loss ($3.7 million after-tax) related to the early extinguishment of debt, earnings
for 1993 after preferred stock dividends were $.57 per common share, compared with earnings, after preferred stock dividends, of $.48 per common share in 1992.
Sales of Transportation-Related Products increased 13 percent, principally due to increased levels of automotive production. Sales also benefitted from new product introductions which were partially offset by the phase-out of existing programs, including the mid-1993 completion of the Company's conversion program for the Ford Mustang convertible. Operating profit in 1993 for Transportation- Related Products increased to $160 million from $124 million in 1992. Operating margins, in 1993, continued to be favorably impacted by higher sales volumes for most of the Company's Transportation-Related Products. Margins in both 1993 and 1992 have benefitted from the internal cost reductions and restructuring initiatives that the Company has undertaken in recent years.
Sales of Specialty Products in 1993 decreased approximately two percent from 1992 levels reflecting the continued unfavorable market conditions for the Company's Architectural and Defense Products. Operating profit declined to $1 million in 1993 from $5 million in 1992 as the result of the $4 million operating loss for Architectural Products in 1993. This loss was principally the result of costs and expenses related to the consolidation of certain operating activities, start-up costs associated with a new manufacturing process and the unfavorable conditions existing in the markets served by these products.
Other expense, net decreased to $25 million in 1993 from $44 million in 1992. Other expense, net in 1993 benefitted from reduced interest expense resulting from a reduction in debt and lower interest rates; and from increased equity and interest income from affiliates related primarily to the Company's Emco holdings. Additionally, 1993 and 1992 results benefitted from gains from sales of marketable securities of approximately $11.5 million and $4.0 million, respectively.
Other expense, net for 1993 and 1992 include gains aggregating approximately $13 million and $25 million pre-tax, respectively. These gains resulted from the sale of stock through public offerings by equity affiliates (including in 1993, affiliate shares held by the Company) and, in 1992, a prepayment premium related to the redemption of debentures held by the Company. The Company's equity affiliates may, from time to time, issue additional common equity depending upon their financing requirements. This income was largely offset by costs and expenses related to cost reduction initiatives, the restructuring of certain operations and product lines, adjustments to the carrying values of certain long-term assets and other costs and expenses.
Earnings in 1993 were reduced by an extraordinary charge of $3.7 million after-tax related to the early extinguishment of debt. Although the federal statutory corporate tax rate increased in 1993, the Company's effective tax rate on income from continuing operations declined slightly in 1993 as compared with 1992. This decrease was the result of the relationship of substantially higher pre-tax income in 1993 to certain book expenses that are not deductible for tax purposes and to the Company's foreign and state tax expenses. In addition, the application of the increased tax rate to deferred tax balances at December 31, 1992 resulted in a 1993 third quarter one-time charge of approximately $.03 per common share.
1992 versus 1991 -- Continuing Operations
In 1992, net sales from continuing operations increased 15 percent to $1.46 billion from $1.27 billion in 1991. Income from continuing operations in 1992, after preferred stock dividends, was $29.7 million or $.49 per common share, compared with a loss from continuing operations, after preferred stock dividends, of $20.0 million or $.33 per common share in 1991.
Sales of Transportation-Related Products increased 21 percent due to a modest improvement in levels of automotive production, increased market penetration and the inclusion of a full year of Creative Industries Group sales. Excluding the acquisition of Creative Industries Group, 1992 Transportation-Related Products sales would have increased 16 percent. Operating profit in 1992 for Transportation-Related Products increased 68 percent to $124 million from $74 million in 1991.
Operating margins, in 1992, were favorably impacted by higher sales volumes for most of the Company's Transportation-Related Products. In addition, 1992 margins have benefitted from the internal cost reductions and restructuring initiatives that the Company has undertaken in recent years.
Sales of Specialty Products were generally unchanged from 1991, as a seven percent increase in sales of Architectural Products was substantially offset by reduced sales of Other Specialty Products. Operating profit for Specialty Products in 1992 was $5 million compared with an operating loss of $15 million in 1991. This improvement resulted principally from improved operating performance of the Architectural Products group which had operating profit of $2 million in 1992 compared with a loss of $16 million in 1991. The 1991 Architectural Products group results were impacted by $8 million of charges related to discontinuance of product lines, restructuring costs and other expenses.
Other expense, net decreased to $44 million in 1992 from $56 million in 1991. Other expense, net in 1992 benefitted from reduced interest expense resulting from a reduction in debt and lower interest rates. This was partially offset by reduced interest income as a result of the redemptions of TriMas subordinated debentures previously held by the Company and lower income from sales of marketable securities.
Other expense, net for 1992 benefitted from the inclusion of income aggregating approximately $25 million pre-tax in the second quarter resulting from a prepayment premium related to the redemption by TriMas of the subordinated debentures held by the Company, and from the change in the Company's common equity ownership interest in TriMas. This income was substantially offset by costs and expenses aggregating approximately $21 million pre-tax in the second quarter (of which $15 million is included in other expense) related to the restructuring of certain operations, and for adjustments to the carrying values of certain long-term assets. Other expense, net in 1991 benefitted from the inclusion of an approximate $22 million gain related to the disposition of certain operations and reduced interest expense, principally as a result of lower interest rates. Additionally, net gains from sales of marketable securities, including the effect of valuation allowances, aggregated approximately $12 million in 1991.
The Company's effective tax rate exceeds the statutory rate primarily as a result of the impact of state taxes and nondeductible amortization.
ITEM 8. | 745448 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The financial information for the five years ended December 31, 1993, appearing on page 1 of UNR Industries, Inc. 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.
Management's Discussion and Analysis of Results appearing on pages 29 through 31 of UNR Industries, Inc. 1993 Annual Report to Stockholders is incorporated herein by reference.
ITEM 8. | 315641 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item appears in the 1993 Annual Report at pages 40 and 41 under the caption, "Historical Financial Summary," and is incorporated by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information required by this item appears in the 1993 Annual Report at pages 23 through 25 under the caption, "Management's Discussion," and is incorporated by reference.
ITEM 8. | 41499 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
The information appearing in the Annual Report under the caption SELECTED FINANCIAL DATA is incorporated herein by this reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information appearing in the Annual Report under the caption MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS is incorporated herein by this reference.
ITEM 8. | 855433 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------
WORLDCORP, INC. AND SUBSIDIARIES Selected Financial Data (in thousands except per share data)
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 presented below relates to the operations of WorldCorp, Inc. ("the Company") as reflected in its consolidated financial statements. These statements primarily include the accounts of the contract flight operations of World Airways, Inc. ("World Airways") and Key Airlines, Incorporated ("KeyAir") until October 23, 1992 when WorldCorp sold 100% of KeyAir. WorldCorp also has an ownership interest in US Order, Inc. ("US Order"), a developmental stage company, which has developed a patented order and payment system ("ScanFone(R)") which facilitates the purchase of goods and services from the home. On July 1, 1992, the Company increased its ownership to 51%. In December 1993, US Order completed a $12.0 million private equity placement. As a result of this transaction, WorldCorp currently owns 46% of the voting stock of US Order. WorldCorp has an option through December 15, 1994, to purchase additional shares of the capital stock of US Order for consideration equal to $5.0 million, which if exercised, would increase its voting ownership percentage to 79%. US Order's results of operations are consolidated in the accompanying financial statements for the period subsequent to July 1, 1992.
GENERAL
In 1993, WorldCorp operated in two business areas: air transportation services and transaction processing. WorldCorp's air transportation subsidiary, World Airways, is a leading worldwide provider of air transportation for commercial and government customers. WorldCorp's transaction processing business consists of its 46% ownership of the voting stock of US Order and 100% ownership of WorldGames. US Order develops and sells patented, automated ordering systems with residential and commercial applications. WorldGames is the sole licensee of ScanFone(R) technology for applications in the gaming industry.
World Airways was a wholly-owned subsidiary of the Company in 1993. In February 1994, the Company sold 24.9% of its ownership to MHS Berhad, a Malaysian aviation company (see "Liquidity and Capital Resources").
AIR TRANSPORTATION SERVICES - ---------------------------
World Airways is a contract air carrier that charges customers based on a block hour basis rather than a per seat or per pound basis as do scheduled passenger carriers or overnight express carriers. A "block hour" is defined as the elapsed time computed from the moment the aircraft moves at its point of origin to the time it comes to rest at its destination. Fluctuations in flight revenues are not necessarily indicative of true growth because of shifts in the mix between full service contracts and basic contracts. Under the terms of full service contracts, World Airways is responsible for all costs associated with operating these contracts and receives a higher rate per hour. Under the terms of basic contracts, World Airways provides only certain services associated with the contract including aircraft, crews, insurance, and maintenance. World Airways typically charges a lower rate per hour for basic contracts since the customer is responsible for other operating costs. For this reason, it is important to measure pure growth through block hours flown rather than actual revenues earned. Typically, U.S. military contracts are full service contracts where the rate paid is set annually and consists of all flying costs, including fuel and ground handling of the aircraft and cargo. World Airways, as a matter of policy, includes fuel cost adjustment mechanisms in full service contracts, thus minimizing the risk of fuel price volatility to World Airways.
Customers - ---------
World Airways' business relies heavily on its U.S. Air Mobility Command ("AMC"), Malaysian Airline System Berhad ("MAS") and P.T. Garuda Indonesia ("Garuda") contracts, which provided 24%, 17% and 21%, respectively, of consolidated revenues in 1993, and 19%, 16%, and 16%, respectively, of total block hours. During 1992, AMC, MAS, and Garuda contracts provided 41%, 24%, and 13%, respectively, of consolidated revenues, and 31%, 29%, and 11%, respectively, of total block hours. The loss of any of these contracts or a substantial reduction in business from any of these contracts, if not replaced, would have a material adverse effect on the Company's revenues and financial condition.
AMC has awarded contracts to World Airways since 1956. World Airways' current annual contract with AMC will expire in September 1994. The minimum contract amount for 1994 of $20.4 million is a 68% increase over
1993, and will be augmented by further expansion business. Expansion business totalled 161% of the minimum contract amount for 1993 and 53% for 1992. World Airways cannot determine how any future cuts in military spending may affect future operations with AMC.
World Airways has provided service to MAS since 1981, transporting passengers for the annual Hadj pilgrimage as well as providing aircraft for integration into MAS' scheduled passenger and cargo operations. The current MAS contract, which was entered into in 1992, expires in 1996. In 1992, the government of Malaysia instructed the Malaysian Hadj Board (which in turn instructed MAS) to competitively rebid the contract for the 1993 Hadj. MAS rebid the contract for the 1993 Hadj and World Airways was again selected to provide 1993 Hadj service to MAS. World Airways' management believes that its contract with MAS through 1996 is a legally binding obligation. MHS Berhad, which recently acquired 24.9% of World Airways, is in the process of acquiring 32% of MAS from the Malaysian government.
World Airways has provided service to Garuda since 1988 under an annual contract. World Airways will provide six aircraft for the 1994 Garuda Hadj operations. In addition, World Airways has provided aircraft for Garuda's cargo operations.
TRANSACTION PROCESSING SERVICES - -------------------------------
US Order is a leading provider of interactive transaction services to the home and the only company with a screen-based telephone that is fully operational with a broad menu of available services. Transaction services are currently offered via screen-based telephones, although the Company expects to offer its bill pay services via personal computers and touch tone telephones using audio response units in 1994. Longer term, the Company plans to develop the capability to support services offered via interactive cable, video games control units, and personal digital assistants. Services currently offered by US Order include bank account inquiry, funds transfer, bill payment, catalog shopping, home delivery of groceries and restaurant meals, and enhanced telephone services. Future services are expected to encompass a greatly expanded set of applications. The Company generates revenues through the monthly fees charged to customers for its screen-based telephone ("ScanFone(R)") and transaction services used, as well as the fees paid to the Company by service providers.
RESULTS OF OPERATIONS
1993 COMPARED WITH 1992 - -----------------------
Operating Revenue - -----------------
In 1993, operating revenues increased $2.3 million (1%) to $202.7 million primarily due to an increase in block hours flown. Block hours increased five percent to 23,462 in 1993 from 22,263 in 1992. Due to peak airlift requirements of World Airways' customers for the 1992 Hadj pilgrimage, certain flights were subcontracted to other carriers which resulted in $11.5 million of revenue in 1992 with no corresponding block hours flown. This was not necessary in 1993. This increase was partially offset by a five percent decrease in revenue per block hour to $8,589 in 1993 from $8,996 in 1992. Block hours under full service contracts were 85% of total block hours in 1993 and 84% in 1992.
Aircraft capacity, the number of days that the Company's aircraft are available for service (including days in maintenance), increased to 8.8 available aircraft per day in 1993 from 7.2 in 1992. This increase was offset by a 13% decrease in daily aircraft utilization to 7.3 hours from 8.4 hours. Aircraft utilization is measured by the total block hours that the Company's aircraft were in use divided by the number of days that the aircraft were available for service (including days in maintenance). Included in other revenues in 1992 is $4.1 million related to settlements of contract claims from AMC.
Operating Expenses - ------------------
Flight costs increased $10.6 million (20%) due to costs associated with the integration of MD-11 aircraft (see "Capital Plans"). The Company maintained the maximum number of crews available during the first six months of 1993 in order to support intensive crewmember training for the MD-11 aircraft while maintaining the previous year's
level of flight operations. This resulted in higher crew costs than normal given the low level of utilization during the first quarter of 1993.
Maintenance costs decreased by $5.8 million (17%) due to lower maintenance costs for new MD-11 aircraft and lower engine overhaul repair expense for the DC10-30 fleet. Maintenance cost per block hour was $1,222 in 1993 compared with $1,548 in 1992. The reduced maintenance costs are due, in part, to guarantees and warranties received from the engine and aircraft manufacturers of the MD-11 aircraft. Because the MD-11 is a relatively new aircraft, cost experience on the maintenance of the aircraft is unavailable. Therefore, the Company is, in part, relying on manufacturers' guidelines to estimate future maintenance costs on the MD-11 aircraft.
Aircraft costs increased by $17.1 million (49%) in 1993. This increase was primarily due to a $20.5 million increase in rent cost associated with the delivery of four MD-11 aircraft during March and April 1993. In July 1993, two DC10-30 aircraft were returned to their lessors, resulting in a $1.5 million early termination payment of which $1.1 million was expensed in 1993. Partially offsetting these increases was a reduction of $5.4 million in rent costs associated with the return of the two DC10 aircraft and short-term aircraft leases not required in 1993.
Fuel costs increased by $2.9 million (8%) due to the increase in block hours flown and a small increase in fuel prices paid per gallon.
Flight operations subcontracted to other carriers decreased by $10.3 million (89%). In 1992, World Airways subcontracted a portion of its AMC contract award in order to redeploy one of its aircraft for commercial passenger flying. This was not necessary in 1993.
Depreciation and amortization increased $0.4 million (7%) due to the purchase of spare parts for MD-11 aircraft integrated into the fleet in 1993.
Selling and administrative costs increased $2.2 million (12%) primarily as a result of a $0.9 million settlement associated with the return of a DC10-30 aircraft, increased legal fees, and the formation of World Flight Crew Services, a new subsidiary of WorldCorp.
Loss on Sale of Key Airlines - ----------------------------
On October 23, 1992, WorldCorp sold 100% of the outstanding common stock of KeyAir. Loss on sale of KeyAir in 1993 primarily consists of the write-off of a $0.3 million uncollateralized line of credit and $0.3 million drawdown of a letter of credit.
Transaction Processing-US Order - -------------------------------
On July 1, 1992, the Company purchased an incremental 6% of the preferred stock of US Order for $1.0 million which increased the Company's ownership in US Order to 51%. Accordingly, US Order's results of operations are consolidated in the accompanying financial statements beginning on July 1, 1992. In December 1993, US Order completed a $12.0 million private equity placement. Following this transaction, WorldCorp owns 46% of the voting stock of US Order. WorldCorp has an option through December 15, 1994 to purchase additional shares of the voting stock of US Order for consideration equal to $5.0 million, which would increase its ownership of the voting stock to 79%. The accompanying statements of operations include 59% of the results of operations of US Order beginning December 1993. This 59% is based on liquidation preferences. In 1993, the Company recorded $9.2 million of losses (net of minority interest) relating to US Order, compared to $2.4 million of losses in 1992. This $6.8 million increase resulted primarily from an increase in overhead costs associated with expanded research and development and the writedown of an older generation of terminal components.
Non-Operating Items - -------------------
Interest income decreased as a result of lower investment balances and lower interest rates in 1993. Interest expense decreased $0.1 million in 1993 as a result of partially replacing the 13 7/8% Subordinated Notes ("the Notes") with the 7% convertible debentures (the "Debentures") and lower debt balances. Offsetting these decreases was interest associated with MD-11 rotables financing, aircraft rent deferrals, and a bank line of credit.
1992 COMPARED WITH 1991 - -----------------------
Operating Revenue - -----------------
On October 23, 1992, WorldCorp sold 100% of the outstanding common shares of its wholly-owned subsidiary, KeyAir, to Savannah Aviation Group ("SAG"). Accordingly, KeyAir's net loss for the period January 1, 1992 through October 23, 1992 is reflected in the accompanying financial statements under the caption "Loss from operation of Key Airlines". The Consolidated Statement of Operations for 1991 has not been reclassified to conform with the 1992 presentation. The following consolidated financial information presents 1991 results of operations of KeyAir in a manner consistent with the 1992 presentation.
This financial information is presented to facilitate a comparative analysis of the ongoing operations of the Company and is used as the basis for Management's Discussion and Analysis of Financial Condition and Results of Operations presented below.
In 1992, revenue decreased $26.3 million (12%) to $200.4 million. Block hours decreased 13% from 25,570 in 1991 to 22,263 in 1992. Due to peak airlift requirements of World Airways' customers for the 1992 Hadj pilgrimage, certain flights were subcontracted to other carriers which resulted in $11.5 million of revenue in 1992 with no corresponding block hours flown. Excluding this revenue, operating revenue decreased $36.5 million. This decrease is due to a shift from military flying in support of Operation Desert Storm in 1991 to commercial passenger flying at lower revenue rates in 1992. Revenue also decreased as a result of a shift to more basic contracts in 1992. Full service block hours represented 84% of total DC10 block hours in 1992 compared with 92% of DC10 block hours in 1991. In addition, revenue decreased as a result of lower block hour rates received for full service contracts in 1992. Included in other revenues in 1992 is $4.1 million related to settlements of contract claims from the AMC.
World Airways' block hour decrease is primarily due to a decrease in aircraft utilization. Aircraft utilization is measured by the total block hours that the Company's aircraft were in use divided by the number of days that the
aircraft were available for service including days in maintenance. World Airways' aircraft utilization decreased 13% from 9.6 hours per day in 1991 to 8.4 hours per day in 1992.
World Airways' DC10 aircraft capacity remained essentially the same in 1992 as compared with 1991. Aircraft capacity is defined as the number of days that the Company's aircraft are available for service including days in maintenance. In 1991, World Airways operated four DC10-10 aircraft under various lease terms and one DC10-30 aircraft under a short-term lease. The four DC10-10 aircraft were returned to their lessors at various times in 1991 and 1992. These aircraft were replaced with two DC10-30 passenger aircraft integrated into World Airways' fleet in April 1992. Also, two DC10-30 passenger aircraft were operated under short-term leases beginning in May 1992 to meet peak airlift requirements of World Airways' customers for the 1992 Hadj pilgrimage. These factors combined to create a 1% decrease in DC10 aircraft capacity in 1992.
Operating Expenses - ------------------
Flight costs decreased $3.0 million. This decrease is due to lower variable costs associated with the 13% decrease in DC10 block hours flown and a shift to more basic contracts in 1992.
Maintenance costs decreased $11.0 million. This decrease is primarily due to ongoing cost control efforts (specifically, material, component repair costs and parts rental charges), and the return to their lessors of four DC10-10 aircraft which, historically, have been more costly to maintain. World Airways maintenance costs also decreased as a result of the 13% decrease in DC10 block hours flown. Total World Airways maintenance expense was $1,548 per block hour in 1992 compared to $1,779 per block hour in 1991.
Aircraft costs increased $0.4 million. DC10 aircraft rent decreased $0.3 million primarily due to the replacement of four DC10-10 and one DC10-30 aircraft with four DC10-30 aircraft. Aircraft hull insurance increased $0.7 million as a result of increases in insured values due to replacing DC10-10 aircraft with DC10-30 aircraft and increases in insurance rates charged.
Depreciation expense increased $0.9 million primarily as a result of adding leasehold improvements and rotables relating to two DC10-30 aircraft integrated into World Airways' fleet in April 1992.
Fuel costs decreased $13.9 million as a result of the 13% decrease in DC10 block hours flown and the decrease in fuel costs since the end of the Persian Gulf War.
Due to peak airlift requirements of World Airways' customers for the 1992 Hadj pilgrimage, certain other flights were subcontracted to other carriers which resulted in expenses of $11.6 million.
Selling and administrative costs decreased $1.4 million primarily due to the World Airways' Profit Sharing Bonus Plan (the "Plan") expense being included in flight costs in 1992 and included in selling and administrative costs in 1991. Through 1991, payments under the Plan were first made to individuals who were entitled to repayment of wage concessions from December 1, 1982 through January 31, 1985. With the payment of the 1991 Plan expense amount, all wage concession amounts have been repaid. Beginning in 1992, amounts expensed pursuant to the Plan are for profit sharing and are paid to current employees, primarily crewmembers.
Loss (Income) From Operation of Key Airlines - --------------------------------------------
Operating results of Key Airlines decreased to a loss of $6.0 million in 1992 from income of $0.2 million in 1991. This is partially due to ten months of activity in 1992 compared with twelve months of activity in 1991. This $6.2 million decrease is primarily attributable to a 10% decrease in block hours flown combined with a 20% decrease in revenue yield per block hour. KeyAir's revenue decreased $15.0 million in 1992. In 1991, KeyAir's customers consisted of tour operators and the U.S. military which typically guaranteed payment for blocks of seats or for the full aircraft on a point-to-point basis. In 1992, KeyAir operated its Caribbean Connection service based on a hub and spoke system and sold tickets to individual passengers directly, through travel agencies, or through tour operators. As a result, in 1992, KeyAir experienced an overall increase in expenses directly attributable to this new type of flying. For example, expenses associated with KeyAir's headquarters in Savannah, Georgia increased, and advertising expense, credit card and bank fees, travel agent commissions, and reservations systems costs all increased in 1992 or were not incurred in 1991.
Loss on Sale of Key Airlines - ----------------------------
Loss on sale of Key Airlines consists principally of the non-cash write- down of the B727 aircraft and related rotables to estimated net realizable values and the write-off of the remaining goodwill associated with the purchase of KeyAir in 1987.
Transaction Processing - US Order - ---------------------------------
On July 1, 1992, the Company purchased an incremental 6% of the preferred stock of US Order, a transaction processing company, for $1.0 million which increased the Company's ownership in US Order to 51%. Accordingly, US Order's results of operations are consolidated in the accompanying financial statements for the period subsequent to July 1, 1992. For the six months ended December 31, 1992, US Order incurred operating costs of $4.0 million. To date, US Order has generated limited revenue through the rental of ScanFones(R) and transaction processing fees.
Non-Operating Items - -------------------
Interest expense decreased primarily as a result of the redemption of $48.8 million of 13 7/8% Subordinated Notes (the "Notes") partially offset by the issuance of $65.0 million of 7% Convertible Debentures (the "Debentures") in May 1992. Interest expense also decreased as a result of the settlement, in January 1992, of World Airways' litigation with the State of California Franchise Tax Board, decreases in variable interest rates, the payoff of World Airways' short- term line of credit for most of the year, and the paydown of B727-100 aircraft debt. Interest income decreased as a result of lower investment balances held in 1992 and lower interest rates. In 1992, the gain on investments consists primarily of a $1.1 million gain on sales of bonds and the termination of an interest rate swap agreement, reduced by a $0.9 million loss from WorldCorp's equity investment in US Order. During the first six months of 1992, WorldCorp's investment in US Order was recorded using the equity method of accounting. Accordingly, WorldCorp's share of US Order's losses were recorded as a loss on investments. In 1991, loss on investments primarily result from the sale of high-yield securities held in the Company's investment portfolio. In 1992, $48.8 million of the face value of the Notes were repurchased at a loss of $3.3 million. In 1991, $10.3 million of the Notes were repurchased at an average of 60% of face value resulting in a gain of $3.5 million.
During the fourth quarter of 1991, World Airways settled litigation with the State of California Franchise Tax Board (the "Board") concerning assessments of deficiencies in state franchise taxes for the years 1973-75 and 1978. The Board had asserted a total tax deficiency of approximately $2.4 million and accrued interest of approximately $5.9 million. World Airways settled this case with the Board and reversed a previously recorded liability which resulted in a non-operating gain of $5.5 million, net of legal expenses.
LIQUIDITY AND CAPITAL RESOURCES
The Company's air transportation subsidiary operates in a very challenging business environment. The combination of a generally weak economy, reduced military spending, and the depressed state of the airline industry and the economy has adversely affected the Company's operating performance. The Company is highly leveraged primarily due to losses sustained by World Airways' scheduled operations between 1979 and 1986, debt restructurings in 1984 and 1987, and losses the Company incurred in 1990, 1992, and 1993. The Company has historically financed its working capital and capital expenditure requirements out of cash flow from operating activities, secured borrowings, and other financings from banks and other lenders.
Cash Flows from Operating Activities - ------------------------------------
During 1993, operating activities used $8.6 million compared to $17.5 million in the prior year. Excluding the non-cash loss on the sale of KeyAir in 1992, losses in 1993 were $14.2 million higher than 1992. The increased losses were offset by the deferral of certain aircraft rental payments, an increase in accounts payable and a decrease in accounts receivable. Accounts receivable decreased due to lower levels of military flying in the fourth quarter of 1993.
Cash Flows from Investing Activities - ------------------------------------
Cash flows from investing activities used $14.6 million in 1993 as compared to $4.4 million in 1992 resulting primarily from the purchase of spare parts for the MD-11 aircraft in 1993, partially offset by proceeds received from the disposal of DC10 and B727 rotable spare parts.
Cash Flows from Financing Activities - ------------------------------------
In 1993, financing activities provided $26.4 million compared to providing $12.9 million in the prior year. In 1992, the Company received $62.9 million from the sale of the Debentures and used $47.1 million of these proceeds to repurchase the 13 7/8% Notes. In 1993, the Company financed $19.1 million of spare parts related to the integration of the MD-11 aircraft, and entered into a $20.0 million credit facility. The Company made debt payments of approximately $28.7 million in 1993 compared to $10.3 million in 1992. This $18.4 million increase primarily relates to the repayment of the Company's two bank lines of credit. The US Order private placement (see "Financing Developments") and the exercise of options and warrants of the Company provided $8.4 million in 1993.
Capital Plans - -------------
World Airways plans to exit higher cost DC10 aircraft and ultimately standardize its fleet around the MD-11 aircraft. In October 1992 and January 1993, World Airways signed a series of agreements to lease seven new MD-11 aircraft for initial lease terms of two to five years. As of March 25, 1994, World Airways has taken delivery of four passenger MD-11 aircraft and is scheduled to take delivery of one freighter MD-11 in April 1994, and two convertible MD-11s in 1995. Two of the passenger MD-11 aircraft replaced the two passenger DC10-30 aircraft which were integrated into World Airways' fleet in April 1992 and returned to McDonnell Douglas in July 1993. The delivery of the convertible MD-11s is expected to occur approximately six months after the end of the lease in 1994 of three DC10-30 convertibles.
World Airways made $20.7 million of capital expenditures and cash deposits for MD-11 integration in 1993, of which $19.1 was financed. World Airways estimates that its required capital expenditures for MD-11 integration will be approximately $7.3 million in 1994 and $9.8 million in 1995. As of December 31, 1993, the Company holds approximately $14.7 million of aircraft spare parts and transaction processing terminals currently available for sale. The Company anticipates proceeds from the sale of these assets to be approximately $7.5 million in 1994.
US Order's working capital and capital expenditure requirements for 1994 are expected to be approximately $8.0 million. As of December 31, 1993, WorldCorp had invested $18.1 million of funds in US Order. US Order is currently seeking a private equity placement for up to $8.0 million with financial and strategic partners. However, there can be no assurance that such financing will be obtained. WorldCorp does not plan to provide additional financing to US Order in 1994.
On December 7, 1993, World Airways entered into a $20.0 million revolving line of credit borrowing arrangement. This credit facility is collateralized by aircraft spare parts and certain receivables. $4.4 million of these proceeds were used to repay the outstanding balance on the $5.0 million revolving line of credit borrowing arrangement which expired in 1993.
Financing Developments - ----------------------
In its most recent Form 10-Q filing, the Company stated management would take several steps to add to its cash reserves. As of this date, the Company has closed certain transactions and executed agreements covering other transactions which, in aggregate, have significantly increased the cash reserves of WorldCorp, World Airways, and US Order.
First, on October 30, 1993, WorldCorp, Inc., World Airways, Inc., and MHS Berhad entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") pursuant to which MHS, subject to satisfactory completion of its due diligence investigations, agreed to purchase 24.9% of World Airways' common stock for $27.4 million in cash. Under this Agreement, World Airways would receive upon closing (the "Closing") $12.4 million to fund its working capital requirements. The remaining $15.0 million (less a $2.7 million deposit received in December
1993) would be paid to WorldCorp to add to its cash reserves. At the time of the signing of the Stock Purchase Agreement, World Airways was a wholly-owned subsidiary of WorldCorp. On February 28, 1994, WorldCorp, World Airways, and MHS concluded the transaction according to the terms described above. As a result of this transaction, WorldCorp will recognize a gain of approximately $27.0 million in the first quarter of 1994.
Second, World Airways finalized an agreement with a financial institution for a $20.0 million credit facility collateralized by certain receivables and spare parts. This agreement contains certain covenants related to World Airways' financial condition and operating results. Approximately $10.8 million of the proceeds from this transaction were used to retire existing obligations. The balance was added to cash reserves. As of March 24, 1994, $0.8 million of the $8.0 million portion of the credit facility collateralized by receivables was utilized.
Third, on November 8, 1993, World Airways completed negotiations for $14.7 million of lease payment deferrals and related financings for eight of its nine aircraft in 1993. The ninth aircraft was returned to the lessor in October 1993. Additionally, World Airways received a permanent reduction in the lease rate for one DC10 aircraft, the only DC10 that will remain on long-term lease after September 1994. In 1993, $6.6 million of the deferrals were repaid. The remaining deferrals are scheduled to be repaid beginning in the second quarter of 1994, and bear interest at rates ranging from 7% to 12%.
Fourth, in December 1993, US Order completed a private equity placement with financial and strategic partners for $12.0 million, of which WorldCorp invested $1.7 million. As a result of this transaction, WorldCorp owns 46% of the voting stock of US Order. WorldCorp has an option through December 15, 1994, to purchase additional shares of capital stock of US Order for consideration equal to $5.0 million, which if exercised, would increase its ownership percentage of the voting stock to 79%. US Order is currently seeking a private equity placement for up to $8.0 million with other financial and strategic partners.
Fifth, in October and November 1993, the Company received $2.6 million of new equity investment through a series of warrant exercises by Ganz Capital Management.
Finally, WorldCorp is seeking to place privately two securities of US Order that it currently holds: a $3.5 million increasing rate note with warrants in US Order, and $7.5 million of non-convertible preferred stock with warrants in US Order. No assurances can be made that the Company will be successful in placing these securities.
The Company believes that the combination of the financings consummated to date and the operating and additional financing plans described above will be sufficient to allow the Company to meet its operating and capital requirements during 1994.
BUSINESS TRENDS
The Company is highly leveraged primarily due to losses sustained by World Airways' scheduled operations between 1979 and 1986, debt restructurings in 1984 and 1987 and losses the Company incurred in 1990, 1992, and 1993. In addition, the Company incurred substantial debt and operating lease commitments during 1993 in connection with acquiring MD-11 aircraft and related spare parts. As a result, in the second half of 1993, the Company took several steps to improve its liquidity, including: negotiating rent deferrals on eight aircraft and the early return to the lessor of another aircraft, arranging a $20.0 million accounts receivable and aircraft parts financing, and consummating the sale of 24.9% of World Airways.
The Company's air transportation business is highly seasonal. Typically, World Airways experiences reduced demand during the first quarter for passenger and cargo services relative to other times of the year. World Airways generally experiences stronger results in the second and third quarters due to demand for commercial passenger services including the annual Hadj pilgrimage. Fourth quarter results depend upon the overall world economic climate and global trade patterns.
Since the end of the Persian Gulf War, soft demand and weakening yields have adversely effected worldwide cargo and passenger markets. In management's view, block hours flown are a critical indicator of the airline's profitability. In order for World Airways to achieve positive operating results and meet its requirements under certain financing agreements, it will be necessary to increase block hours flown from 1993 levels. In response, World
Airways has significantly increased its worldwide sales and marketing presence by 1) selling 24.9% of its equity to MHS Berhad solidifying a marketing alliance with a leading aviation company in Malaysia, 2) recruiting three active outside board members with experience in worldwide aviation and travel services, and 3) increasing its internal sales and marketing staff from two to seven executives. These actions were taken with the objective of increasing World Airways' flying levels. The fourth quarter of 1993 was the first recent quarter where flying level trends turned positive, increasing by 40% over the prior year's fourth quarter. Also, in the first quarter of 1994, management expects flying levels to be up more than 20% compared to 1993 levels. Management believes that positive trends will continue for the second and third quarters. Fourth quarter 1994 flying levels will largely depend upon global trade demand for cargo and the placement of at least two MD-11 passenger aircraft under longer-term contracts.
On February 28, 1994, WorldCorp, World Airways, and MHS concluded the 24.9% sale of World Airways' common stock for $27.4 million in cash. WorldCorp will recognize a gain of approximately $27.0 million from this transaction in the first quarter of 1994. The Company has an objective to replicate a similar investment with strategic partners in Latin America.
US Order is a provider of interactive transaction processing services to the home and the only company with a screen-based telephone that is fully operational with a broad menu of available services. US Order, however, is a development stage company and expects to continue to incur losses in 1994 and has significant working capital and capital expenditure requirements for 1994 (see "Liquidity and Capital Resources" and "Capital Plans").
US Order's Regional Bell Operating Company (RBOC) strategy has evolved from a joint marketing relationship to a value-added reseller relationship for the RBOC's enhanced caller services such as Caller ID. This evolution has taken place as a result of the RBOC's increased focus on video and cable television interactivity. In particular the video focus by Bell Atlantic led to the termination of the Bell Atlantic joint marketing agreement with US Order in March 1994 as Bell Atlantic consolidated its efforts in the video arena. Because screen-based telephones greatly improve the ease of use of enhanced telephone services such as Caller ID, strategic relationships with RBOCs are developing along this track.
US Order's product offering to financial institutions have expanded in 1994. In addition to pursuing joint marketing alliances, US Order will also provide bill payment services to financial institutions through existing Audio Response Units, commonly known as touch tone or telephone banking services. The company is currently negotiating agreements with several major banks to offer these services in 1994. Later in 1994, US Order expects to offer similar "back end" bill payment support via personal computers.
US Order is also significantly expanding its direct sales of screen-based telephones and interactive services to consumers. In October 1993, US Order announced its next generation screen-based telephone, PhonePlus /TM/, which it expects to have available to consumers in the third quarter of 1994. As in the cellular telephone industry, the price of the telephone will be related to the length and type of service contract the consumer chooses.
OTHER MATTERS
On August 11, 1992, WorldCorp, World Airways, and certain other commercial paper customers of Washington Bancorporation ("WBC") were served with a complaint by WBC as debtor-in-possession by and through the Committee of Unsecured Creditors of WBC (the "Committee"). The complaint arises from investment proceeds totaling $6.8 million received by WorldCorp and World Airways from WBC in May 1990 in connection with the maturity of WBC commercial paper. The Committee seeks to recover this amount on the grounds that these payments constituted voidable preferences and/or fraudulent conveyances under the Federal Bankruptcy Code and under applicable state law. On June 9, 1993, the Company filed a motion to dismiss this litigation and intends to vigorously contest the claim. No assurances can be given of the eventual outcome of this litigation.
World Airways' cockpit and flight attendant crewmembers are covered by collective bargaining agreements which expired in July 1992. World Airways is currently in negotiations with the International Brotherhood of Teamsters ("Teamsters") to develop new agreements for cockpit and flight attendant crewmembers. World Airways and the Teamsters jointly requested the assistance of a federal mediator to facilitate negotiations between World Airways and its cockpit crewmembers. The outcome of the negotiations cannot be determined at this time.
WorldCorp has never paid any cash dividends and does not plan to do so in the foreseeable future. Both the 13 7/8% Subordinated Notes Indenture and the indenture pursuant to which the Debentures were issued (the "Indentures") restrict the Company's ability to pay dividends or make other distributions on its common stock. In addition, the Indentures originally restricted the ability of World Airways to pay dividends other than to the Company. In 1994, however, the Company received approval from the holders of the Indentures to allow World Airways to pay dividends to parties other than the Company.
The $20 million credit facility also contains restrictions on World Airways' ability to pay dividends. Under this agreement, World Airways cannot declare, pay, or make any dividend or distribution in excess of the lesser of $4.5 million or 50% of net income for the previous six months. In addition, World Airways must have a cash balance of at least $7.5 million immediately after giving effect to such dividend.
All of the funds from operations are generated by the Company's subsidiaries. The ability of the Company and its subsidiaries to pay principal and interest on their respective short and long-term obligations is substantially dependent upon the payment to the Company of dividends, interest or other charges by its subsidiaries and upon funds generated by the operations of the subsidiaries.
As of December 31, 1993, the Company had net operating loss carryforwards, investment tax credit carryforwards, and alternative minimum tax credit carryforwards of $137.2 million, $9.6 million, and $2.2 million, respectively (the "Carryforwards"). The availability of net operating loss and tax credit carryforwards to reduce the Company's future federal income tax liability is subject to limitations under the Internal Revenue Code of 1986, as amended (the "Code"). Generally, these limitations restrict availability of net operating loss and tax credit carryforwards upon an ownership change. In August 1991, the Company experienced an ownership change, and the use of $72.6 million of net operating loss carryforwards available to the Company from losses generated prior to the ownership change, plus the tax credit carryforwards described above, are limited to approximately $6.3 million annually (the "Limitation"). As a result of the transaction with MHS in February 1994, however, the Carryforwards will be split into two components: those generated solely by World Airways, and those generated by the remaining entities of the controlled group. As a result, approximately $84.8 million of the consolidated net operating loss carryforward will no longer be available to offset federal taxable income reflected on future consolidated tax returns. Instead, the $84.8 million will be available to World Airways on a separate company basis (subject to the Limitation). World Airways will also retain sole use of the $9.6 million investment tax credit carryforward and the $2.2 million alternative minimum tax credit carryforward to reduce its future federal income tax liability, subject to limitations under the Code.
ITEM 8. | 811664 | 1993 |
Item 6. Selected Financial Data.
Information required to be furnished in response to this Item is submitted as Exhibit EX-13 incorporated herein by reference.
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Information required to be furnished in response to this Item is submitted as Exhibit EX-13 incorporated herein by reference.
Item 8. | 18808 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA
The information required by this Item is incorporated herein by reference to the Selected Financial Data on page 25 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 this Item is incorporated herein by reference to pages 26-40 in the Company's 1993 Annual Report to Shareholders.
ITEM 8. | 95304 | 1993 |
Item 6. Selected Financial and Operating Data
MICHIGAN BELL TELEPHONE COMPANY (Dollars in Millions)
1993 1992 1991 1990 1989 Revenues Local service . . . . . $1,092.1 $1,168.6 $1,097.7 $1,093.0 $1,082.8 Interstate network access . . 512.6 479.4 474.0 496.2 453.5 Intrastate network access . . 201.5 199.9 182.0 186.4 173.8 Long distance . . . . . . . . 695.8 591.6 582.7 605.3 570.2 Other . . . . . . . . . . . 244.8 239.4 238.9 237.0 234.9 2,746.8 2,678.9 2,575.3 2,617.9 2,515.2
Operating expenses . . . . . 2,152.3 2,103.1 2,043.7 2,038.2 1,957.0 Operating income . . . . . 594.5 575.8 531.6 579.7 558.2 Interest expense . . . . . . . 106.2 109.6 125.3 116.9 117.2 Other (income) expense, net . . . 4.6 9.4 (5.0) (3.8) (3.5) Income taxes . . . . . . . . . 140.5 130.6 120.8 140.8 126.9 Income before cumulative effect of change in accounting principles . . . . . . . . . . 343.2 326.2 290.5 325.8 317.6 Cumulative effect of change in accounting principles . . . -- (448.4) -- -- -- Net income (loss) . . . . . . $ 343.2 $ (122.2) $ 290.5 $ 325.8 $ 317.6
Total assets . . . . . . . . 5,259.2 5,289.9 5,251.8 5,192.8 5,001.1
Telecommunications plant, net . 4,382.8 4,456.1 4,446.5 4,410.4 4,398.3 Capital expenditures . . . . 452.1 523.3 542.2 530.1 501.6 Long-term debt . . . . . . . $1,132.4 $1,085.1 $1,071.0 $1,202.8 $1,174.4
Debt ratio . . . . . . . . . 46.3% 46.4% 41.9% 41.3% 41.3% Pre-tax interest coverage . . 5.74 4.88 4.12 4.70 4.58 Return to average equity * . . . 19.6% (7.1)% 14.0% 16.0% 16.0% Return on average total capital * 13.2% (0.6)% 11.0% 12.2% 12.2% Customer lines at end of year (in thousands) . . . . . . . 4,563 4,431 4,314 4,242 4,150 % Customer lines served by digital electronic offices . . 68% 53% 49% 44% 39% % Customer lines served by analog electronic offices . . . . . 31% 46% 49% 52% 56%
Employees at end of year . . . . 14,561 15,142 15,836 16,234 16,785 Customer lines per employee . . . 313 293 272 261 247 Local calls per year (in millions) # . . . . . 14,198 14,555 14,136 14,072 12,679 Calls per customer line . . . . . . . . . . . . 3,112 3,285 3,277 3,317 3,055
* After cumulative effect of change in accounting principles.
# Effective August 1991 (MPSC NO.U9004), certain local calls from private line circuits were reclassified to Access Service. The years 1989-1991 have been restated to be on a comparable basis.
XXX BEGIN PAGE 15 HERE XXX
Item 7. | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in millions)
Following is a discussion and analysis of the results of operations of the Company for the year ended December 31, 1993 and for the year ended December 31, 1992, which is based on the Statements of Income and Reinvested Earnings on page 23 Other pertinent data are also given in Selected Financial and Operating Data on page 14.
Results of Operations
REVENUES
Revenues increased $67.9 or 2.5% due to the following:
Increase 1993 1992 (Decrease) %Change Local service . . . . . . . . . . $1,092.1 $1,168.6 ($76.5) (6.5%)
The decrease of $76.5 was primarily due to a $119.9 reclassification, at the Company's initiative, of certain measured interzone messages from the local service category to the long distance service category. Without the reclassification, local service would have increased $43.4. This was comprised of $37.6 in volume increases attributable to continued growth in central office custom features and public telephone revenues, and a 3.0% increase in access lines to 4,562,740 from 4,431,174 in the prior year. An additional $5.7 increase resulted from rate changes which consisted of an increase in certain operator assisted services, custom calling features, and the expiration of temporary customer credits in effect during 1992.
Increase 1993 1992 (Decrease) %Change Access service Interstate access . . . $512.6 $479.4 $ 33.2 6.9% Intrastate access . . . $201.5 $199.9 $ 1.6 0.8%
Interstate access increased $33.2 due to a $16.7 reduction in support payments made to the National Exchange Carrier Association, volume of business increases of $11.3, and a $10.6 increase related to anticipated settlements with other telecommunications providers. These increases were partially offset by $6.0 in rate reductions.
The intrastate access increase of $1.6 was mainly the result of the effect of higher calling volumes of $11.3 and true-ups and settlements with other local exchange carriers of $5.2. These increases were offset by $10.8 in rate reductions and $3.3 in various claims and settlements with interexchange carriers.
Increase 1993 1992 (Decrease) %Change Long distance services . . . . $695.8 $591.6 $104.2 17.6%
The increase in long distance revenues of $104.2 is primarily the result of the $119.9 reclassification related to local service revenues discussed above. Without this reclassification, long distance revenues would have decreased $15.7. Volume increases of $46.9 were more than offset by shifts to discount calling plans of $42.6 and rate reductions totaling $19.3.
XXX BEGIN PAGE 16 HERE XXX
Increase 1993 1992 (Decrease) %Change Other revenues . . . . . . . $244.8 $239.4 $5.4 2.3%
An increase of $5.4 was primarily due to growth in nonregulated revenues (primarily inside wiring services) of $8.7 and $2.2 in Ameritech Publishing, Inc. license fees. This was reduced by a $6.3 increase in uncollectibles resulting from increased write- offs.
OPERATING EXPENSES
The Company has changed the presentation of its operating expenses in the Statements of Income and Reinvested Earnings to facilitate a better understanding of its operating results. Prior year amounts have been reclassified to conform with this presentation.
Operating expenses increased $49.2 or 2.3% primarily due to the following:
Increase 1993 1992 (Decrease) %Change Depreciation . . . . . . . . . $543.3 $520.7 $22.6 4.3%
Depreciation expense increased $22.6 due mainly to a $13.4 increase in intrastate rates resulting from the Company's ongoing review of the lives of its property. In addition, a $15.6 increase resulted from the continued expansion of the plant investment base. These increases were partially offset by a $6.7 reduction caused by the expiration of FCC-authorized inside wire and reserve deficiency amortization schedules.
Increase 1993 1992 (Decrease) %Change Employee-related expenses. . . . . . . . . $705.8 $701.8 $4.0 0.6%
The $4.0 increase in employee-related expenses was due to increases of $16.3 in basic wage rates, $5.7 in the provision for team awards and bonus payments, and $5.0 in other employee- related costs, mainly tuition aid and technical training fees, relocation costs and travel expenses. Offsetting these increases were reductions of $21.5 due to lower force levels than the previous year. The remaining offset was primarily due to lower overtime payments recorded in 1993. The Company's total employee count was 14,561 as of December 31, 1993, compared to 15,142 at December 31, 1992.
Increase 1993 1992 (Decrease) %Change Taxes other than income taxes . . . . . . . . . . . $132.2 $144.1 ($11.9) (8.3%)
The decrease in taxes other than income taxes is due to a $13.2 reduction made to the provision for property taxes to recognize the impact of new state legislation enacted in December 1993 which lowers property tax millage rates in Michigan for December 31, 1993 assessments. Partially offsetting this reduction was a $1.9 increase in other taxes, primarily Michigan single business tax expense, resulting from higher 1993 business volumes.
XXX BEGIN PAGE 17 HERE XXX
Increase 1993 1992 (Decrease) %Change Other operating expenses. . . . . . . $771.0 $736.5 $34.5 4.7%
The growth reported in this category was due to increases of $28.7 in payments for services provided by affiliated companies due in part to a transfer of certain work functions to Ameritech Services, Inc. (a subsidiary jointly owned by the Company and the other four Ameritech landline telephone companies)("ASI"), $8.7 in higher advertising costs, a $5.7 increase in expenses paid to other carriers for access, and a $2.5 increase in the provision made for potential claims and settlements with interexchange carriers. Partially offsetting these increases was a $10.8 decrease resulting from the effects of the work force resizing provision reflected in 1992 results.
OTHER INCOME AND EXPENSES Increase 1993 1992 (Decrease) %Change Interest Expense . . . . . . $106.2 $109.6 $(3.4) (3.1)%
The decrease in interest expense is attributable primarily to $3.8 in tax and other settlements made in 1992. In addition, interest related to debt decreased $.9 due to lower composite interest rates on short-term debt. These decreases were partially offset by $1.7 of interest related to the 1990 incentive regulation plan.
Increase 1993 1992 (Decrease) %Change Other expense, net . . . . . . $4.6 $ 9.4 $(4.8) (51.1)%
The $4.8 decrease is primarily the result of $4.0 in higher earnings from ASI in which the Company has a 26% ownership interest. In addition, other expenses were $4.1 lower: $2.4 in lower 1993 costs related to the early retirement of debt, and $1.7 from a 1992 write-off of relocation work performed but not collectible. These reductions in expense were partly offset by a $3.1 increase in 1993 contributions, primarily new commitments to education in the form of educational grants.
Increase 1993 1992 (Decrease) %Change Income taxes . . . . . . .. . $140.5 $130.6 $9.9 7.6%
The income tax increase of $9.9 was the net effect of several items. There were increases of $9.4 due to higher pre-tax income, $9.0 in adjustments to the provision for future settlements, and $6.1 due to the change to the new 35% tax rate. These were somewhat offset by a one-time $6.8 reduction caused by adjusting the SFAS Nos. 106 and 112 deferred tax asset to reflect the change in tax rate, and a $6.5 true-up in the investment-related components of the 1992 tax provision. The remaining offset is due mainly to a $2.0 increase in investment tax credits amortized in 1993.
XXX BEGIN PAGE 18 HERE XXX
OTHER INFORMATION
Changes in Accounting Principles
Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." The new accounting method is essentially a refinement of the liability method already followed by the companies of Ameritech Corporation ("Ameritech", the Company's parent) and, accordingly, did not have a significant impact on the Company's financial statements upon adoption.
As more fully discussed in Note (C) to the financial statements, effective January 1, 1992, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and SFAS No. 112, "Employers Accounting for Postemployment Benefits". The cumulative effect of these accounting changes was recognized in the first quarter of 1992 as a change in accounting principles of $448.4, net of a deferred income tax benefit of $225.1.
Regulatory Environment
Customer demand, technology, and the preferences of policy makers are all converging to increase competition in the local exchange business. The effects of increasing competition are apparent in the marketplace the Company serves. For example, certain large telecommunications providers have recently announced their intentions to provide full local exchange service. Additionally, increasing volumes of intraLATA long distance services purchased by large and medium sized business customers are sold by carriers other than the Company.
Recognizing this trend, the Company's regulatory/public policy activities are focused on achieving a framework that allows for expanding competition while providing a fair opportunity for all carriers, including the Company, to succeed. The cornerstone of this effort is Ameritech's "Customers First Plan" that was filed with the FCC on March 1, 1993. In a subsequent filing with the U.S. Department of Justice, Ameritech proposed that the Customers First Plan be implemented on a trial basis beginning in January 1995 in Illinois and other states thereafter.
The Customers First Plan proposes to open all of the local telephone business in the Company's service area to competition. In exchange, Ameritech has requested three regulatory changes. First, Ameritech has requested relief from the Modification of Final Judgment ("MFJ") interLATA ban. Such relief would mean that the Company would be allowed to offer all long distance services. Second, Ameritech has requested a number of modifications in the FCC's price cap rules. These modifications would apply only to Ameritech, including the Company, and would eliminate any obligation to refund, in the form of its share of future rate reductions, its share of interstate earnings in excess of 12.25%. The modifications would also provide the Company increased ability to price its interstate access services in a manner appropriate to competitive conditions. Third, Ameritech has requested FCC authority to collect in a competitively neutral manner, the social subsidies currently embedded in the rates that the Company charges long distance carriers for access to the local network.
The Michigan Public Service Commission ("MPSC") adopted an incentive regulation plan on March 13, 1990. The incentive regulation plan, which became effective April 1, 1990, was terminated as of December 31, 1991, having been found inconsistent with the Michigan Telecommunications Act ("MTA") effective January 1, 1992. Through the end of 1991, after 21 months under the plan, the Company had recognized a liability of $8.2 for potential sharing of profits with customers. In September 1992, the Company increased this provision to $10.5 in accordance with a tentative agreement reached with the MPSC staff. In January 1993, the MPSC issued an order approving the agreement but also providing that interest be accrued on the $10.5 at 9% per annum since January 1, 1992. As of December 31, 1993, the total liability related to ratepayer sharing is $12.2.
XXX BEGIN PAGE 19 HERE XXX
In response to the January 1993 order, the Company filed its proposed plan in February 1993 for the matching of shareable earnings to benefit education. This plan proposed to match the original $10.5 plus interest with an equal amount if all amounts would be available for and dedicated to educational telecommunications services. In December 1993, the MPSC issued an order approving an agreement reached between the Company, intervenors, and the MPSC staff, establishing two separate funds dedicated to educational telecommunications projects: the ratepayers' portion and the Company's matching fund. As of December 31, 1993, the amount recorded to recognize the matching portion is $11.3.
A three-member Michigan Council on Telecommunications Services for Public Education ("Council") was established to review and make recommendations on all projects funded by the ratepayers' portion. The Company retains control over how the matching funds are expended, which may be in the form of capital, expense or in-kind services, but agrees to work with the Council in making those determinations.
IntraLATA Long Distance Service Order
On July 31, 1992, MCI Telecommunications Corporation ("MCI") filed a complaint with the MPSC seeking "1+" intraLATA dialing parity for all toll competitors of the Company, alleging that current dialing arrangements violated the Michigan Telecommunications Act. Callers in Michigan must currently dial "10" plus a three digit access code to use the services of the Company's intraLATA toll competitors.
The MPSC dismissed MCI's complaint finding no statutory violations. However, as a result of subsequent proceedings in the case, on February 24, 1994, the MPSC issued an order requiring the implementation of "1+" intraLATA toll dialing parity in Michigan. The MPSC order requires dialing parity to be implemented concurrently with the termination of prohibitions against the Company's ability to offer interLATA service, but in no event later than January 1, 1996. The order also requires the establishment of an industry task force to consider all issues involved in the implementation of intraLATA dialing parity. The task force will develop a deployment schedule, identify the costs for deployment, and determine the methodology to recover those costs. The task force is required to file a report with the MPSC no later than September 23, 1994, setting forth its findings and recommendations.
The Company believes that the MPSC has not considered all relevant factors in rendering its decision on intraLATA parity. Accordingly, the Company has filed a petition for a rehearing with the MPSC as a first step in bringing further clarification to the issues.
In 1993 the Company recorded $695.8 of long distance revenue, of which approximately $634.0 resulted from intraLATA message and unidirectional long distance services. Customer response to dialing parity and the effect on the Company's intraLATA long distance revenue is uncertain. However, it is estimated that approximately 50% of any long distance revenue lost, which could be significant, would be offset by additional access revenue.
Effects of Regulatory Accounting
The Company presently gives accounting recognition to the actions of regulators where appropriate, as prescribed by Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" ("SFAS No. 71"). Under SFAS No. 71, the Company records certain assets and liabilities because of actions of regulators. Further, amounts previously charged to operations for depreciation expense reflect estimated useful lives and methods prescribed by regulators rather than those that might otherwise apply to unregulated enterprises. In the event the Company determines that it no longer meets the criteria for following SFAS No. 71, the accounting impact to the Company would be an extraordinary noncash charge to operations of an amount which could be material. Criteria that give rise to the discontinuance of SFAS No. 71 include (1) increasing competition which restricts the Company's ability to
XXX BEGIN PAGE 20 HERE XXX
establish prices to recover specific costs, and (2) a significant change in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews these criteria to ensure that continuing application of SFAS No. 71 is appropriate.
Status of new business units
In February 1993, following a year-long examination of its business called "Breakthrough Leadership," Ameritech announced it would restructure its business into separate units organized around specific customer groups - such as residential customers, small businesses, interexchange companies and large corporations - and a single unit that will run Ameritech's network in Illinois, Indiana, Michigan, Ohio and Wisconsin. The Ameritech Bell Companies will continue to function as legal entities owning current Bell company assets in each state. The network unit will provide network and information technology resources in response to the needs of the other business units. This unit will be the source of network capabilities for products and services offered by the other business units and will be responsible for the development and day-to-day operation of an advanced information infrastructure.
All of the market units and the network unit are currently operational. Ameritech has developed a new logo and is marketing all of its products and services under the single brand name "Ameritech."
Digital Video Network
In January 1994, Ameritech announced a program to launch a digital video network upgrade that is expected, by the end of the decade, to make available interactive information and entertainment services, as well as traditional cable TV services, to approximately six million Ameritech customers. The Company has filed an application with the FCC seeking approval of the program. The application reflects capital expenditures of approximately $55.0 over the next three years. The Company may also, depending on market demand, make additional capital expenditures under this program. The Company anticipates that its capital expenditures for the program will be funded without an increase in its recent historical level of capital expenditures.
Termination of publishing services contract
On September 9, 1993, Ameritech Publishing exercised its right to terminate its publishing services contract (the "Agreement") with the Company, effective September 8, 1994, or such other mutually acceptable date. Pursuant to the Agreement, which became effective on January 1, 1991, the Company granted a license and provides billing, collection and other services to Ameritech Publishing, and Ameritech Publishing provides directory services for the Company. Ameritech Publishing is a wholly-owned subsidiary of the Company's parent, Ameritech Corporation. The Agreement's initial term was to have been five years, subject, however, to either party's right to terminate on not less than twelve months' prior notice. In 1993, the Company earned fees of approximately $132.7 from Ameritech Publishing and paid Ameritech Publishing approximately $19.8 for services rendered.
The Company has begun negotiations with Ameritech Publishing for a new contract. While the Company cannot predict at this time the specific terms and conditions of any new contract it may negotiate with Ameritech Publishing, it anticipates that annual payments from Ameritech Publishing under a new contract could be significantly less than current annual payments under the Agreement. A new contract with Ameritech Publishing could also vary from the Agreement as to duration, services to be provided by the parties, and other provisions.
XXX BEGIN PAGE 21 HERE XXX
Property Tax Litigation
The Company has disputed the manner of assessment of its property taxes in Michigan. In August of 1993, the Michigan Supreme Court agreed to hear certain issues associated with that dispute which involves the 1984-1986 tax years. If the Company is successful in its arguments, it will receive a refund of overpayment of property taxes. If unsuccessful, the Company may be subject to an additional, and possibly substantial, tax liability for those years beyond 1986. An opinion of the court could be issued by the end of 1994. Management of the Company believes that the ultimate resolution of this case will not have a material adverse effect on the Company's financial position or results of operations.
Workforce Resizing
On March 25, 1994, Ameritech announced that it will reduce its nonmanagement workforce by 6,000 employees by the end of 1995, including approximately 1,560 at the Company. Under terms of agreements between Ameritech, the Communications Workers of America ("CWA") and the International Brotherhood of Electrical Workers ("IBEW"), Ameritech is implementing an enhancement to the Ameritech pension plan by adding three years to the age and net credited service of eligible nonmanagement employees who leave the business during a designated period that ends in mid-1995. In addition, Ameritech's network business unit is offering financial incentives under the terms of its current contracts with the CWA and IBEW, to selected nonmanagement employees who leave the business before the end of 1995.
The above actions will result in a charge to first quarter 1994 earnings of approximately $137.8 or $89.2 after tax. A significant portion of the program cost will be funded by Ameritech's pension plan, whereas financial incentives to be paid from Company funds are estimated to be approximately $36.9. Settlement gains, which result from terminated employees accepting lump-sum payments from the pension plan, will be reflected in income as employees leave the payroll. The Company believes this program will reduce its employee-related costs by approximately $78.0 on an annual basis upon completion of this program.
The reduction of the workforce results from technological improvements, consolidations and initiatives identified by management to balance its cost structure with emerging competition
XXX BEGIN PAGE 22 HERE XXX
Item 8. | 65622 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA Incorporated herein by reference to "Financial and Operating Record" appearing on pages 30 and 31 of the Annual Report. ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Incorporated herein by reference to "Business and Financial Review" appearing on pages 9 to 14 of the Annual Report. ITEM 8. | 743368 | 1993 |
ITEM 6 -- SELECTED FINANCIAL DATA
"Historical Financial Summary," appearing on pages 20 and 21 of the Annual Report, is incorporated herein by reference.
ITEM 7 | ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
"Financial Review," appearing on pages 22 through 24 of the Annual Report, is incorporated herein by reference.
ITEM 8 | 25506 | 1993 |
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data is derived from the audited consolidated financial statements of the Company. It should be read in conjunction with the Company's consolidated financial statements and the related notes and with management's discussion and analysis of financial condition and results of operations and other detailed information included elsewhere herein.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the Company's financial condition and results of operations as of and for the years ended December 31, 1993, 1992, and 1991 should be read in conjunction with the consolidated financial statements of the Company and detailed information presented elsewhere herein.
OPERATING RESULTS
Consolidated net income in 1993 increased 22.2% to $53,039,000 from $43,402,000 in 1992 and $29,124,000 in 1991, while net income per share in 1993 increased 17.9% to $4.15 from $3.52 in 1992 and $2.39 in 1991. Earnings results for 1993 were positively affected in the net amount of $1,659,000 or $.13 per share due to the cumulative effect of changes in accounting principles implemented during the first quarter of the year. The earnings results for 1993 represent a historic high for income before income taxes and net income. Some of the factors affecting the favorable level of earnings were a $12,785,000 (8.9%) increase in net interest income, a $3,222,000 (17.0%) increase in service charges on deposit accounts, a $1,966,000 (10.6%) increase in service charges, commissions and fees, a $14,898,000 (226.7%) increase in loan sales and servicing income, and a $7,953,000 (77.6%) decrease in the provisions for loan losses. These increased contributions to income were partially offset by a $13,223,000 (20.0%) increase in salaries and benefits, a $6,263,000 (9.6%) increase in all other operating expenses, excluding a one-time expense of $6,022,000, and a $3,518,000 (16.6%) increase in income taxes.
The Company's earnings for the year ended December 31, 1993 were negatively affected by a one-time expense of $6,022,000 in the first quarter related to the early extinguishment of debt consisting of floating rate notes and industrial revenue bonds. The expense is included in other operating expenses. This expense consisted of marking to market an interest rate exchange agreement entered into several years ago in conjunction with the issuance of long-term floating rate notes and writing off deferred costs associated with the notes and bonds.
The Financial Accounting Standards Board (FASB) issued SFAS No. 109, "Accounting for Income Taxes," which establishes financial accounting requirements for the effects of income taxes. The statement requires a change from the deferred method of accounting for income taxes to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Under SFAS No. 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.
Effective January 1, 1993, the Company adopted SFAS No. 109 and reported the cumulative effect of the change in the method of accounting for income taxes in the 1993 consolidated statement of income. The cumulative effect of such change in accounting method increased net income for the year ended December 31, 1993 by $7,419,000.
The FASB issued SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," in December 1990. Under SFAS No. 106, the cost of postretirement benefits other than pensions must be recognized on an accrual basis as employees perform services to earn the benefits. Many of the provisions and concepts of SFAS No. 106 are similar to current standards on accounting for pensions. The provisions of SFAS No. 106 are effective for fiscal years beginning after December 15, 1992. The Company has made it a practice to provide certain health care benefits for retired employees. The level of benefits to be paid to employees retiring in the future was also modified in 1992 to require greater contributions from the employee at retirement and a cap on the amount of retiree premiums that will be paid by the Company. Employees hired after December 31, 1992 are not entitled to retiree health benefits.
Effective January 1, 1993, the Company adopted SFAS No. 106 and reported the cumulative effect of the change in the method of accounting for postretirement benefits other than pensions in the 1993 consolidated statement of income. The cumulative effect (transition obligation) of such change in accounting method decreased pretax and after-tax net income by $5,760,000 and $3,631,000, respectively.
The FASB issued SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in May 1993. Under SFAS No. 115, certain debt securities, depending on the intention of the holder, and equity securities are designated as trading securities and are marked to market through income, certain debt and equity securities are designated as available for sale and are marked to market through the equity accounts, and certain debt securities are designated as held to maturity and carried at amortized cost.
Effective December 31, 1993, the Company adopted SFAS No. 115 and classified its securities according to the pronouncement. The change in the method of accounting for securities had no effect on income for 1993 and resulted in an increase of $432,000 in equity as of December 31, 1993.
EARNINGS PERFORMANCE
NET INTEREST INCOME, MARGIN, AND INTEREST RATE SPREADS
Net interest income is the difference between the total interest income generated by earnings assets and the total interest cost of the funds used to finance assets. Net interest income is the largest component of the Company's revenue. The Company's taxable-equivalent net interest income increased by 8.9% to $160,129,000 in 1993 as compared to $147,060,000 in 1992 and $133,813,000 in 1991. The Company attempts to minimize interest rate movement sensitivity through the management of interest rate maturities and to a much lessor extent the use of off-balance sheet arrangements such as interest rate caps, floors, and interest rate exchange contract agreements. During 1993, the Company had income of $291,000 from the use of such off-balance sheet arrangements compared to income to the Company of $9,000 in 1992 and a cost to the Company of $875,000 in 1991. The Company intends to continue to use such off-balance sheet arrangements to the extent necessary to minimize its exposure to changes in prevailing interest rates.
Net interest margin is a measure of the Company's ability to generate net interest income and is computed by expressing net interest income (stated on a fully taxable-equivalent basis) as a percentage of earning assets. The Company's net interest margin was 4.11% for 1993 as compared to 4.49% in 1992 and 4.35% in 1991. The decrease in the margin for 1993 was due primarily to securitization sales of loans and the expansion of investments in security resell agreements during the second half of 1993. Securitization sales of loans converts high margin income from loans to other operating income. The security resell agreements are primarily in U.S. government and U.S. government agency securities which offer low yields but represent virtually no risk to the Company and require low or no consolidated "risk-based" capital. The Company has been entering into the security resell arrangements through the new division in its lead banking subsidiary, Discount Corporation of New York. The Company has chosen this method of investing in very short-term arrangements to increase its net interest income while maintaining its liquidity.
The spread on average interest-bearing funds is the difference between the yield on earning assets and the cost of interest-bearing funds. The Company's spread on average interest-bearing funds was 3.62% for 1993 as compared to 3.89% in 1992 and 3.56% in 1991. The spread on average interest-bearing funds for 1993 has also been affected by securitization sales of loans and investments in security resell arrangements.
Consolidated average balances, the amount of interest earned or paid, the applicable interest rate for the various categories of earning assets and interest-bearing funds which represent the components of net interest income and interest differentials on a taxable-equivalent basis, and the effect on net interest income of changes due to volume and rates for the years 1993, 1992, and 1991 are shown in tables on pages 17 through 19. Income computed on a taxable-equivalent basis is income as reported in the consolidated statements of income adjusted to make income and earning yields on assets exempt from income taxes comparable to other taxable income. Applied to yields on the obligations of states and political subdivisions thereof and on industrial revenue bonds, this adjustment facilitates analysis. The incremental tax rate used for calculating the taxable-equivalent adjustment was approximately 32% in each of 1993, 1992, and 1991.
In the tables for the three years, the principal amounts of nonaccrual and renegotiated loans have been included in the average loan balances used to determine the rate earned on loans. Interest income on nonaccrual loans is included in income only to the extent that cash payments have been received and not applied to principal and is accrued on restructured loans at the reduced rates. Certain restructured loan agreements call for additional interest to be paid on a deferred or contingent basis. Such interest is taken into income only as collected.
The analysis in the tables of the effect on net interest income of volume and rate changes, the change due to the volume/rate variance in this analysis has been allocated to volume, except when volume and rate have both increased then this variance has been allocated proportionately to both volume and rate and when rate has increased and volume has decreased then this variance has been allocated to rate.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL AND CHANGES DUE TO VOLUME AND RATES
- --------------------
1 Taxable-equivalent rates used where applicable. 2 Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL AND CHANGES DUE TO VOLUME AND RATES
- ---------------------
1 Taxable-equivalent rates used where applicable. 2 Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY, INTEREST RATES AND INTEREST DIFFERENTIAL AND CHANGES DUE TO VOLUME AND RATES
- --------------------
1 Taxable-equivalent rates used where applicable. 2 Net of unearned income and fees, net of related costs. Loans include nonaccrual and restructured loans.
PROVISION FOR LOAN LOSSES
The provision for loan losses in 1993 decreased 77.6% to $2,298,000 from $10,251,000 in 1992, and $23,549,000 in 1991. The decrease in loan loss provisions resulted from improved credit risk management and an improved economy which have produced decreases in nonperforming assets and charge offs and an increase in recoveries.
OTHER OPERATING INCOME
The Company's other operating income increased by 26.3% to $78,127,000 in 1993 as compared to $61,861,000 in 1992, and $51,488,000 in 1991. Service charges on deposits increased by 17.0% in 1993 to $22,216,000, primarily as a result of price increases and higher volumes in 1993. Other service charges, commissions, and fees increased by 10.6% in 1993 to $20,450,000 primarily as a result of increased fees relating to mortgage and other loan originations. Trading account income decreased by 47.0% to $2,350,000 in 1993 as compared to $4,437,000 in 1992 primarily as a result of a gain on the sale of SBA-IO strips in 1992. Loan sales and servicing income increased 226.7% to $21,471,000 in 1993 primarily as a result of an increased volume of consumer and real estate loans sold at the end of 1992 and during 1993. The Company has not recognized an initial gain on the sale of loans but recognizes the income over the servicing life of the sale. Other income decreased by 17.0% in 1993 to $7,035,000 primarily as a result of interest received on federal income tax refunds in 1992.
The following table presents the components of other operating income for the years indicated and a year-to-year comparison expressed in terms of percent changes.
OTHER OPERATING INCOME
OTHER OPERATING EXPENSES
Operating expenses increased by 19.5% in 1993 to $156,548,000 as compared to $131,040,000 in 1992, and $117,307,000 in 1991. Employee salary and benefits costs increased by 20.0% in 1993 to $79,245,000, primarily as a result of increased staffing in retail and investment activities, general salary increases and bonuses, commissions, and profit sharing costs related to increased profitability.
The Company benefited by a decrease of 85.5% in other real estate expense to $366,000 in 1993 as holding costs declined through the continued sales of other real estate owned properties during 1993. Also, values received in the sales of other real estate owned continued to improve in 1993. F.D.I.C. premiums increased by 13.7% in 1993 to $6,541,000 as compared to $5,752,000 in 1992 due primarily to higher assessment rates. The Company recognized a loss on early extinguishment of debt in the amount of $6,022,000 during 1993. All other expenses increased 12.0% to $24,279,000 in 1993 as compared to $21,781,000 in 1992 primarily due to increases in travel expenses and other miscellaneous expenses.
The following table presents the components of other operating expenses for the years indicated and a year-to-year comparison expressed in terms of percent changes.
OTHER OPERATING EXPENSES
The following table presents full-time equivalent employees and banking offices at December 31, for the years indicated:
FULL-TIME EQUIVALENT EMPLOYEES
INCOME TAXES
The Company's income taxes increased 17.0% to $24,718,000 compared to $21,200,000 in 1992, and $12,975,000 in 1991, primarily due to the increase in before tax income. The Company's effective tax rate decreased slightly to 32.5% in 1993 from 32.8% in 1992 as the increase in tax-exempt income and other lesser factors offset the 1993 increase in the statutory federal rate.
QUARTERLY SUMMARY
The following table presents a summary of earnings and end-of-period balances by quarter for the years ended December 31, 1993, 1992, and 1991:
SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
ANALYSIS OF FINANCIAL CONDITION
LIQUIDITY
Liquidity represents the Company's ability to provide adequate funds to meet its financial obligations, including withdrawals by depositors, debt service requirements, and operating needs. Liquidity is primarily provided by the regularly scheduled maturities of the Company's investment and loan portfolios. In addition, the Company's liquidity is enhanced by the fact that cash, money market securities, and liquid investments, net of "short-term purchased" liabilities and wholesale deposits, totaled $1,605.8 million or 55.2% of core deposits at December 31, 1993, as compared to $1,067.6 million or 40.1% of core deposits at December 31, 1992.
The Company's core deposits, consisting of demand, savings, and money market deposits, and small certificates of deposit, constituted 96.2% of total deposits at December 31, 1993, as compared to 96.3% at December 31, 1992.
Maturing balances in loan portfolios provide flexibility in managing cash flows. Maturity management of those funds is an important source of medium-to long-term liquidity. The Company's ability to raise funds in the capital markets through the "securitization" process and by debt issuances allows the Company to take advantage of market opportunities to meet funding needs at reasonable cost.
The Company manages its liquidity position in order to assure its ability to meet maturing obligations. Through an ongoing review of the Company's levels of interest-sensitive assets and liabilities, efforts are made to structure portfolios in such a way as to minimize the effects of fluctuating interest rate levels on net interest income.
The parent company's cash requirements consist primarily of principal and interest payments on its borrowings, dividend payments to shareholders, cash operating expenses, and payments for income taxes. The parent company's cash needs are routinely satisfied through payments by subsidiaries of dividends, proportionate shares of current income taxes, management and other fees, and principal and interest payments on subsidiary borrowings from the parent company.
INTEREST RATE SENSITIVITY
Interest rate sensitivity measures the Company's financial exposure to changes in interest rates. Interest rate sensitivity is, like liquidity, affected by maturities of assets and liabilities. Unlike liquidity, however, interest rate sensitivity is measured in terms of "gaps," defined as the difference between volumes of assets and liabilities whose interest rates are subject to reset within specified periods of time.
The Company, through the management of interest rate "maturities" and the use of off-balance sheet arrangements such as "interest rate caps, floors, and interest rate exchange contract agreements," attempts to be reasonably close to neutral.
The following table presents information as to the Company's interest rate sensitivity at December 31, 1993:
MATURITIES AND INTEREST RATE SENSITIVITY AT DECEMBER 31, 1993
EARNING ASSETS
Average earning assets of $3,891.8 million in 1993 increased 18.9% from the 1992 level of $3,272.1 million and the 1991 level of $3,079.4 million. Earning assets comprised 91.3% of total average assets in 1993 compared with 92.3% in 1992, with average loans representing 51.5% of earning assets in 1993 compared to 59.7% in 1992.
The volume of liquid money market investments, consisting of interest-bearing deposits, federal funds sold and security resell agreements and other money market investments, increased 68.9% to $770.2 million in 1993 from $456.0 million in 1992. Investment and trading securities increased 29.7% to $1,118.0 million in 1993 from $862.0 million in 1992. The increase was reflected primarily in the taxable securities category. Average loan volume increased 2.5% to $2,003.6 million in 1993 as compared to $1,954.1 million in 1992.
The following table sets forth the composition of average earning assets for the years indicated:
AVERAGE EARNING ASSETS
INVESTMENT SECURITIES PORTFOLIO
Investment securities prior to December 31, 1993 were held to maturity and carried at amortized cost. At December 31, 1993 the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" and segregated the portfolio for securities held to maturity, carried at amortized cost, and securities available for sale, carried at market. The following table presents the Company's year-end investment securities portfolio.
MATURITIES AND AVERAGE YIELDS OF INVESTMENT SECURITIES
The following table presents by maturity range and type of security, the average yield of the investment portfolio at December 31, 1993. The average yield is based on effective rates on book balances at the end of the year.
* An effective tax rate of 30% was used to adjust tax-exempt securities yields to rates comparable to those on fully taxable securities.
At December 31, 1993, the value of the Accessor Funds Inc. and the Federal Home Loan Bank of Seattle stock each exceeded ten percent of shareholders' equity.
LOAN PORTFOLIO
During 1993, the Company consummated a revolving consumer loan securitization totaling approximately $190 million and a home refinance loan securitization totaling approximately $159 million. After these sales, loans and leases at December 31, 1993 totaled $2,250,491,000, an increase of 15.7% compared to $1,945,223,000 at December 31, 1992, and $1,890,058,000 at December 31,1991. Loans held for sale, real estate loans, and lease financing increased 3.8%, 63.2%, and 4.8%, respectively, at December 31, 1993 compared to December 31, 1992, while commercial, financial, and agricultural loans decreased 11.3% and consumer loans decreased 17.0%. In the real estate portfolio, construction loans increased $66,649,000 or 74.7%, home equity credit line loans increased $12,224,000 or 8.5%, and 1-4 family residential loans, which include home refinance loans, increased $207,885,000 or 147.8%, and all other real estate secured loans increased $129,894,000 or 45.6%.
The table below sets forth the amount of loans outstanding by type at December 31 for the years indicated:
LOAN PORTFOLIO
The Company has no foreign loans in its loan portfolio.
ASSETS MANAGED
In recent years, banks and other financial institutions have had an increasing tendency to "securitize" loans by pooling and selling them to investors, with the servicing responsibilities and residual income in excess of financing costs, servicing expenses, and loan losses accruing to the originating institution. The "securitization" of receivables can assist an institution in maximizing its ability to originate loans without large increases in capital, thereby enhancing the return on shareholders' equity. The Company's participation in the "securitization" process, as well as its participation in originating and selling mortgage loans, has increased in recent years. At December 31, 1993, real estate loans serviced for others amounted to $1,466.5 million compared to $1,252.8 million at December 31, 1992, and $1,224.3 million at December 31, 1991. Other loans serviced for investors at December 31, 1993 totaled $373.4 million, compared to $267.9 million at December 31, 1992, and $158.2 million at December 31, 1991.
LOAN MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST RATES
The following table shows maturity distribution and sensitivity to changes in interest rates of the loan portfolio at December 31, 1993.
CREDIT RISK MANAGEMENT
Management of credit risk is a primary objective in maintaining a safe and sound institution. To accomplish this task, the Company has written and placed in effect loan policies to govern each of its loan portfolios. Loan policies assist the Company in providing a framework for consistency in the acceptance of credit and a basis for sound credit decisions. Generally, the Company makes its credit decisions based upon debtor cash flow and available collateral. The Company has structured its organization to separate the lending function from the credit administration function to strengthen the control and independent evaluation of credit activities. In addition, the Company has well-defined standards for grading its loan portfolio, and maintains an internal Credit Examination Department which periodically conducts examinations of the quality, documentation, and administration of the Company's lending departments, and submits reports thereon to a committee of the Board of Directors. Emphasis is placed on early detection of potential problem credits so that action plans can be developed on a timely basis to mitigate losses.
LOAN RISK ELEMENTS
The following table shows the principal amounts of nonaccrual, past due 90 days or more, restructured loans, and potential problem loans at December 31 for each year indicated.
Includes loans held for sale.
Impact of Nonperforming Loans on Interest Income
The following table presents the gross interest income on nonaccrual and restructured loans that would have been recorded if these loans had been current in accordance with their original terms (interest at original rates), and the amount of interest income on these loans that was included in income for each year indicated.
Potential problem loans consist primarily of commercial loans and commercial real estate loans of $1 million. Management reviews loans graded "special mention" and monitors the status of such loans for becoming potential problem loans and their likelihood of becoming nonperforming loans. At December 31, 1993, management identified as potential problem loans two loans totaling $1,114,000 compared to three loans totaling $6,263,000, at December 31, 1992, and three loans totaling $5,042,000 at December 31, 1991. Management believes that for the near future, potential problem loans should remain at about the current level.
Another aspect of the Company's credit risk management strategy is the diversification of the loan portfolio. At year-end, the Company had 19% of its portfolio in commercial loans, 48% in real estate loans, 16% in consumer loans, 11% in loans held for sale, and 6% in lease financing. In addition, the Company attempts to avoid the risk of an undue concentration of credits in a particular industry or trade group, as indicated by the commercial loan and lease portfolio being allocated over more than 17 major industry classifications. At year end, the largest concentration in the commercial loan and leasing portfolio was in the retail industry group which comprised approximately 17% of the portfolio. The retail group is also well diversified in eight subcategories. Agricultural and mining loans comprise less than 7% of total commercial loans. Segments of the real estate portfolio as a percentage of total loans included 7% constructions loans, 7% home equity credit line loans, 16% 1-4 family residential loans and 18% other real estate-secured loans. The Company has no significant exposure to highly leveraged transactions and has no foreign credits in its loan portfolio.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, restructured loans, and other real estate owned. Loans are generally placed on nonaccrual status when the loan is 90 days or more past due as to principal or interest, unless the loan is in the process of collection and well-secured. Consumer loans are not placed on a nonaccrual status inasmuch as they are generally charged off when they become 120 days past due. Loans are restructured to provide a reduction or deferral of interest or principal payments when the financial condition of the borrower deteriorates and requires that the borrower be given temporary or permanent relief from the contractual terms of the credit. Other real estate owned is acquired through or in lieu of foreclosure on credits that are secured by real estate.
Nonperforming assets totaled $29,425,000 as of December 31, 1993, an increase of 1.6% from $28,975,000 as of December 31, 1992, but a decrease of 32.7% from the $43,692,000 at December 31, 1991. Nonperforming assets represented 1.32% of net loans and other real estate owned at December 31, 1993, as compared to 1.50% and 2.34% at December 31, 1992 and 1991, respectively. Nonperforming assets as a percentage of net loans and other real estate owned at December 31, 1993 are at their lowest levels since at least 1985, the period where records have been maintained using the present definitions.
Accruing loans past due 90 days or more totaled $9,955,000 as of December 31, 1993, as compared to $6,219,000 at December 31, 1992 and $5,131,000 of December 31, 1991. These loans equal .45% of net loans and leases at December 31, 1993, as compared to .32% and .28% at December 31, 1992 and 1991, respectively.
Continuous efforts have been made to reduce nonperforming loans and to liquidate real estate owned properties in such a manner as to recover the greatest value possible. Significant steps have been taken during the last few years to strengthen the Company's credit culture by implementing a number of initiatives designed to increase internal controls and improve early detection and resolution of problem loans.
The following table sets forth the composition of nonperforming assets at December 31 for the years indicated:
*Includes loans held for sale.
ALLOWANCE FOR LOAN LOSSES
The Company's allowance for loan losses was 2.93% of net loans and leases at December 31, 1993, as compared to 2.97% as of December 31, 1992 and 3.02% as of December 31, 1991. Loan charge-offs decreased 53.7% and recoveries increased 57.2% in 1993 as compared to 1992, which resulted in a ratio of net charge-offs to average loans and leases of (.27)% in 1993, compared to .48% in 1992 and 1.49% in 1991. The allowance for loan and lease losses relative to problem loans continued to strengthen in 1993. The allowance, as a percentage of nonperforming loans, at December 31, 1993 was 247.19%, as compared to 236.37% and 159.88% at December 31, 1992 and 1991, respectively. Nonperforming loans are defined as loans on which interest is not accrued and restructured loans. The allowance, as a percentage of noncurrent loans, was 201.73% at December 31, 1993 as compared to 216.51% and 151.66% at December 31, 1992 and 1991, respectively. Noncurrent loans are defined as loans on which interest is not accrued, plus loans 90 days or more past due on which interest continues to accrue.
In analyzing the adequacy of the allowance for loan and lease losses, management utilizes a comprehensive loan grading system to determine risk potential in the portfolio, and considers the results of independent internal and external credit reviews, historical charge-off experience, and changes in the composition and volume of the portfolio. Other factors, such as general economic conditions and collateral values, are also considered. Larger problem credits are individually evaluated to determine appropriate reserve allocations. Additions to the allowance are based upon the resulting risk profile of the portfolio developed through the evaluation of the above factors.
SUMMARY OF LOAN LOSS EXPERIENCE
The following table shows the changes in the allowance for losses for each year indicated.
Review of nonperforming loans and evaluation of the quality of the loan portfolio, as previously mentioned, results in the identification of certain loans with risk characteristics which warrant specific reserve allocations in the determination of the amount of the allowance for loan losses. The allowance is not allocated among all loan categories, and amounts allocated to specific categories are not necessarily indicative of future charge-offs. An amount in the allowance not specifically allocated by loan category is necessary in view of the fact that, while no loans were made with the expectation of loss, some loan losses inevitably occur. The following is a categorization of the allowance for loan losses for each year indicated.
DEPOSITS
Total average deposits increased 5.8% to $2,820.8 million in 1993 from $2,666.7 million in 1992 and $2,531.8 million in 1992. Total deposits increased 9.3% to $3,024,111,000 at December 31, 1993 compared to $2,764,824,000 at December 31, 1992. The Company's base of core deposits, consisting of demand, savings and money market accounts, increased 21.9% and 12.5%, respectively, comparing December 31, 1993 to December 31, 1992, while certificates of deposit under $100,000 decreased 12.6%. Domestic deposits over $100,000 decreased 6.8% and foreign deposits increased 29.9% respectively, comparing December 31, 1993 to December 31, 1992.
The following table presents the average amount and the average rate paid on each of the following categories for each year indicated:
AVERAGE DEPOSIT AMOUNTS AND AVERAGE RATES
Substantially all foreign deposits are in denominations of $100,000 or more.
SHORT-TERM BORROWINGS
The following table sets forth data pertaining to the Company's short-term borrowings for each year indicated:
(a) Federal funds purchased and security repurchase agreements are primarily on an overnight or demand basis. Rates on overnight funds reflect current market rates. Rates on fixed-maturity borrowings are set at the time of the borrowings.
(b) Federal Home Loan Bank advances less than one year are overnight and reflect current market rates or reprice monthly based on a one-month LIBOR as set by the Federal Home Loan Bank of Seattle. Other borrowings are primarily variable rate and reprice based on changes in the prime rate which reflect current market.
RETURN ON EQUITY AND ASSETS
CAPITAL RESOURCES
In recent years, regulations with respect to capital and capital adequacy for commercial banks and bank holding companies have been evolving. At year end, there were two measures of capital adequacy in use as follows:
1. Risk-based Capital
Risk-based capital guidelines require varying amounts of capital to be maintained against different categories of assets, depending on the general level of risk inherent in the assets. A capital allocation is also required for off-balance sheet exposures such as letters of credit, loan commitment and interest rate contracts. The risk-based capital guidelines are in full effect in 1993 and 1992. As reflected in the following table, the Company's total risk-based capital ratio was 14.34% at December 31, 1993 and 15.53% at December 31, 1992. The minimum regulatory requirement is an 8% total risk-based capital ratio for a bank to be considered "well-capitalized" under the regulatory definition is 10%.
2. Tier I Leverage
Under the risk-based capital guidelines, a bank holding company could, in theory, significantly leverage its capital through the investment in assets with little or no credit risk. The guidelines place a limit on such leverage through the establishment of a minimum level of tangible equity as a percentage of average total assets. The Company's Tier I leverage ratio was 5.47% at December 31, 1993 and 6.24% at December 31, 1992, compared to the minimum regulatory requirement of 4% to be considered adequately capitalized.
The following table presents the regulatory risk-based capital at December 31 for the years indicated:
* Limited to 1.25% of risk-weighted assets. ** Limited to 50% of core capital and reduced by 20% per year during an instrument's last five years before maturity.
DIVIDENDS
The Company's quarterly dividend rate was $.28 per share for the third and fourth quarters of 1993, $.21 per share for the first and second quarters of 1993 and the fourth quarter of 1992, and $.18 per share for all other quarterly periods during 1992 and 1991. The annual dividend rate was $.98 for 1993, $.75 for 1992 and $.72 for 1991. During the years 1989 through 1993 there was no preferred stock outstanding.
The following table sets forth dividends paid by the Company of each year indicated:
FOREIGN OPERATIONS
Zions First National Bank opened a foreign office located in Grand Cayman, Grand Cayman Islands, B.W.I. in 1980. This office has no foreign loans outstanding. The office accepts Eurodollar deposits from qualified customers of the Bank and places deposits with foreign banks and foreign branches of other U.S. banks. Foreign deposits at December 31 totaled $68,563,000 in 1993, $52,777,000 in 1992 and $52,993,000 in 1991; and averaged $55,823,000 for 1993, $86,479,000 for 1992 and $62,729,000 for 1991.
ITEM 8. | 109380 | 1993 |
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Each of the Grantor Trusts, listed in the table as shown below, was formed by GMAC Auto Receivables Corporation (the "Seller") pursuant to a Pooling and Servicing Agreement between the Seller and The First National Bank of Chicago, as trustee. Each Trust acquired retail finance receivables from the Seller in the aggregate amount as shown below in exchange for certificates representing undivided ownership interests in each Trust. Each Trust's property includes a pool of retail instalment sale contracts secured by new, and in some Trust's used, automobiles and light trucks, certain monies due thereunder and security interests in the vehicles financed thereby.
The certificates for each of the following Trusts consist of two classes, entitled Asset Backed certificates, Class A and Asset Backed certificates, Class B. The Class A certificates represent in the aggregate an undivided ownership interest that ranges between approximately 91% and 94.5% of the Trusts and the Class B certificates represent in the aggregate an undivided ownership interest that ranges between approximately 5.5% and 9% of the Trusts. Only the Class A certificates have been remarketed to the public. The Class B certificates have not been offered to the public and initially are being held by the Seller. The rights of the Class B certificateholder to receive monthly distributions with respect to the receivables are subordinated to the rights of the Class A certificateholders.
Original Aggregate Amount ----------------------------------- Date of Pooling Retail Asset Backed Certificates Grantor and Servicing Finance ------------------------- Trust Agreement Receivables Class A Class B - ------- ----------------- --------- -------- ------- (In millions of dollars)
GMAC 1990-A December 20, 1990 $1,162.6 $1,057.9 $104.7
GMAC 1991-A March 14, 1991 891.7 811.4 80.3
GMAC 1991-B September 17, 1991 1,007.4 916.7 90.7
GMAC 1991-C December 16, 1991 1,326.4 1,207.0 119.4
GMAC 1992-A January 30, 1992 2,001.4 1,851.3 150.1
GMAC 1992-C March 26, 1992 1,100.3 1,012.3 88.0
GMAC 1992-D June 4, 1992 1,647.6 1,499.3 148.3
GMAC 1992-E August 20, 1992 1,578.0 1,436.0 142.0
GMAC 1992-F September 29, 1992 1,644.6 1,496.6 148.0
GMAC 1992-G November 19, 1992 1,379.4 1,303.5 75.9
GMAC 1993-A March 24, 1993 1,403.0 1,297.8 105.2
GMAC 1993-B September 16, 1993 1,450.6 1,341.8 108.8
II-1
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (concluded)
General Motors Acceptance Corporation, the originator of the retail receivables, continues to service the receivables for each of the aforementioned Grantor Trusts and receives compensation and fees for such services. Investors receive monthly payments of the pro rata portion of principal and interest for each Trust as the receivables are liquidated.
------------------------
II-2
ITEM 8. | 872553 | 1993 |
|
ITEM 6. SELECTED FINANCIAL DATA
The information appearing in the section captioned 'Summary of Selected Financial Data' from the portions of the Company's 1993 Annual Report to shareholders filed as Exhibit 13 to this Form 10-K Report is incorporated by reference herein.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information appearing in the section captioned 'Management's Discussion and Analysis' from the portions of the Company's 1993 Annual Report to shareholders filed as Exhibit 13 to this Form 10-K Report is incorporated by reference herein.
ITEM 8. | 78128 | 1993 |
ITEM 6. SELECTED FINANCIAL DATA.
Selected Financial Data including net sales, earnings from continuing operations, earnings from continuing operations per common share, total assets, long-term debt, and cash dividends paid are reported in the Eleven Year Summary in the Company's 1993 Annual Report to Shareholders and are incorporated herein by reference.
ITEM 7. | ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Financial Condition and Results of Operations
Management's discussion and analysis of financial condition and results of operations which is included in the sections titled "Management's Discussion and Analysis--Results of Operations" and "Management's Discussion and Analysis--Financial Condition" in the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
Liquidity and Capital Resources
Management's discussion of liquidity and capital resources which is included in the section titled "Management's Discussion and Analysis--Cash Flows" in the Company's 1993 Annual Report to Shareholders is incorporated herein by reference.
ITEM 8. | 69598 | 1993 |