SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number 1-5721
LEUCADIA NATIONAL CORPORATION
(Exact name of registrant as specified in its Charter)
New York 13-2615557
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
315 Park Avenue South, New York, New York 10010-3607
(Address of principal executive offices) (Zip Code)
(212) 460-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
----------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
------- ------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer X Accelerated filer Non-accelerated filer
----- ---- ----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
YES NO X
------- ------
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding
of each of the issuer's classes of common stock, at August 1, 2006: 216,287,442.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, 2006 and December 31, 2005
(Dollars in thousands, except par value)
June 30, December 31,
2006 2005
------------- -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 356,942 $ 386,957
Investments 1,306,672 1,323,562
Trade, notes and other receivables, net 272,334 377,216
Prepaids and other current assets 154,420 140,880
------------ -----------
Total current assets 2,090,368 2,228,615
Restricted cash 133,388 27,018
Non-current investments 1,064,040 977,327
Notes and other receivables, net 33,854 22,747
Intangible assets, net and goodwill 94,649 85,083
Deferred tax assets, net 1,009,645 1,094,017
Other assets 157,656 213,583
Property, equipment and leasehold improvements, net 405,928 237,021
Investments in associated companies 554,293 375,473
------------ -----------
Total $ 5,543,821 $ 5,260,884
============ ===========
LIABILITIES
Current liabilities:
Trade payables and expense accruals $ 156,741 $ 259,778
Other current liabilities 14,645 23,783
Debt due within one year 410,668 175,664
Income taxes payable 16,348 15,171
------------ -----------
Total current liabilities 598,402 474,396
Other non-current liabilities 110,424 121,893
Long-term debt 1,026,579 986,718
------------ -----------
Total liabilities 1,735,405 1,583,007
------------ -----------
Commitments and contingencies
Minority interest 16,653 15,963
------------ -----------
SHAREHOLDERS' EQUITY
Common shares, par value $1 per share, authorized 300,000,000 shares;
216,225,442 and 216,058,016 shares issued and outstanding, after deducting
56,875,963 and 56,874,929 shares held in treasury 216,225 216,058
Additional paid-in capital 512,797 501,914
Accumulated other comprehensive loss (80,416) (81,502)
Retained earnings 3,143,157 3,025,444
------------ -----------
Total shareholders' equity 3,791,763 3,661,914
------------ -----------
Total $ 5,543,821 $ 5,260,884
============ ===========
See notes to interim consolidated financial statements.
2
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the periods ended June 30, 2006 and 2005
(In thousands, except per share amounts)
(Unaudited)
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
Revenues and Other Income:
Manufacturing $ 118,414 $ 88,051 $ 237,805 $ 108,925
Telecommunications 40,145 30,593 79,610 30,593
Investment and other income 63,303 31,992 197,490 64,458
Net securities gains 44,418 46,949 83,132 47,026
----------- ---------- ----------- -----------
266,280 197,585 598,037 251,002
----------- ---------- ----------- -----------
Expenses:
Cost of sales:
Manufacturing 100,276 76,412 198,789 91,121
Telecommunications 23,411 18,851 47,224 18,851
Interest 21,601 16,429 38,786 33,066
Salaries and incentive compensation 34,033 16,924 55,057 25,043
Depreciation and amortization 9,356 7,159 17,419 11,146
Selling, general and other expenses 36,578 32,198 88,290 60,736
----------- ---------- ----------- -----------
225,255 167,973 445,565 239,963
----------- ---------- ----------- -----------
Income from continuing operations before income taxes
and equity in income of associated companies 41,025 29,612 152,472 11,039
Income taxes 14,952 (1,107,452) 58,058 (1,106,828)
------------ ---------- ----------- -----------
Income from continuing operations before equity in
income of associated companies 26,073 1,137,064 94,414 1,117,867
Equity in income of associated companies, net of taxes 9,534 67,345 23,263 78,493
----------- ---------- ----------- -----------
Income from continuing operations 35,607 1,204,409 117,677 1,196,360
Income from discontinued operations, net of taxes 1,048 12,124 134 22,786
Gain (loss) on disposal of discontinued operations, net of taxes 365 54,578 (98) 54,578
----------- ---------- ----------- -----------
Net income $ 37,020 $1,271,111 $ 117,713 $ 1,273,724
=========== ========== =========== ===========
Basic earnings (loss) per common share:
Income from continuing operations $ .16 $ 5.59 $ .54 $5.56
Income from discontinued operations .01 .06 -- .11
Gain (loss) on disposal of discontinued operations -- .25 -- .25
----- ------ ----- -----
Net income $ .17 $ 5.90 $ .54 $5.92
===== ====== ===== =====
Diluted earnings (loss) per common share:
Income from continuing operations $ .16 $ 5.23 $ .53 $5.21
Income from discontinued operations .01 .05 -- .10
Gain (loss) on disposal of discontinued operations -- .24 -- .23
----- ------ ----- -----
Net income $ .17 $ 5.52 $ .53 $5.54
===== ====== ===== =====
See notes to interim consolidated financial statements.
3
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the six months ended June 30, 2006 and 2005
(In thousands)
(Unaudited)
2006 2005
---- ----
Net cash flows from operating activities:
Net income $ 117,713 $ 1,273,724
Adjustments to reconcile net income to net cash provided by operations:
Deferred income tax provision (benefit) 66,665 (1,110,000)
Depreciation and amortization of property, equipment and leasehold improvements 19,422 97,416
Other amortization (8,155) 1,392
Share-based compensation 9,363 --
Excess tax benefit from exercise of stock options (197) --
Provision for doubtful accounts 1,029 3,605
Net securities gains (83,132) (47,004)
Equity in income of associated companies (37,567) (79,223)
Distributions from associated companies 24,849 89,245
Net gains related to real estate, property and equipment, and other assets (100,460) (21,614)
(Gain) loss on disposal of discontinued operations 158 (56,578)
Investments classified as trading, net (2,541) 18,537
Net change in:
Restricted cash 8,574 (15,422)
Trade, notes and other receivables 199,614 77,463
Prepaids and other assets 2,519 (16,968)
Trade payables and expense accruals (139,163) (11,882)
Other liabilities (9,401) (19,321)
Income taxes payable 1,188 674
Other 15,701 (2,011)
----------- -----------
Net cash provided by operating activities 86,179 182,033
----------- -----------
Net cash flows from investing activities:
Acquisition of property, equipment and leasehold improvements (39,754) (65,596)
Acquisitions of and capital expenditures for real estate investments (28,051) (6,855)
Proceeds from disposals of real estate, property and equipment, and other assets 177,020 29,079
Proceeds from sale of discontinued operations 558 95,160
Acquisitions, net of cash acquired (105,059) (177,947)
Net change in restricted cash (56,515) --
Advances on notes receivables (251) (100)
Collections on notes and loan receivables 4,211 2,483
Investments in associated companies (226,709) (4,180)
Distributions from associated companies 20,480 130
Purchases of investments (other than short-term) (2,172,760) (1,587,206)
Proceeds from maturities of investments 689,494 607,759
Proceeds from sales of investments 1,517,961 994,387
----------- -----------
Net cash used for investing activities (219,375) (112,886)
----------- -----------
Net cash flows from financing activities:
Net change in customer banking deposits -- (8,658)
Issuance of long-term debt 133,524 21,612
Reduction of long-term debt (33,360) (51,814)
Issuance of common shares 1,523 1,387
Purchase of common shares for treasury (33) --
Excess tax benefit from exercise of stock options 197 --
Other 1,277 1,914
----------- -----------
Net cash provided by (used for) financing activities 103,128 (35,559)
----------- -----------
Effect of foreign exchange rate changes on cash 53 (3,007)
----------- -----------
Net increase (decrease) in cash and cash equivalents (30,015) 30,581
Cash and cash equivalents at January 1, 386,957 486,948
----------- -----------
Cash and cash equivalents at June 30, $ 356,942 $ 517,529
=========== ===========
See notes to interim consolidated financial statements.
4
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity
For the six months ended June 30, 2006 and 2005
(In thousands, except par value)
(Unaudited)
Common Accumulated
Shares Additional Other
$1 Par Paid-In Comprehensive Retained
Value Capital Income (Loss) Earnings Total
----- ------- ------------- -------- -----
Balance, January 1, 2005 $ 215,201 $490,903 $ 136,138 $ 1,416,411 $2,258,653
----------
Comprehensive income:
Net change in unrealized gain (loss) on
investments, net of taxes of $0 (29,639) (29,639)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $0 (13,136) (13,136)
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $0 2,127 2,127
Net income 1,273,724 1,273,724
----------
Comprehensive income 1,233,076
----------
Exercise of options to purchase common shares 170 1,217 1,387
--------- -------- ---------- ----------- ----------
Balance, June 30, 2005 $ 215,371 $492,120 $ 95,490 $ 2,690,135 $3,493,116
========= ======== ========== =========== ==========
Balance, January 1, 2006 $ 216,058 $501,914 $ (81,502) $ 3,025,444 $3,661,914
----------
Comprehensive income:
Net change in unrealized gain (loss) on
investments, net of taxes $1,455 (2,564) (2,564)
Net change in unrealized foreign exchange
gain (loss), net of taxes of $2,268 3,999 3,999
Net change in unrealized gain (loss) on
derivative instruments, net of taxes of $198 (349) (349)
Net income 117,713 117,713
----------
Comprehensive income 118,799
----------
Share-based compensation expense 9,363 9,363
Exercise of options to purchase common shares,
including excess tax benefit 168 1,552 1,720
Purchase of common shares for treasury (1) (32) (33)
--------- -------- ---------- ----------- ----------
Balance, June 30, 2006 $ 216,225 $512,797 $ (80,416) $ 3,143,157 $3,791,763
========= ======== ========== =========== ==========
See notes to interim consolidated financial statements.
5
LEUCADIA NATIONAL CORPORATION AND SUBSIDIARIES
Notes to Interim Consolidated Financial Statements
1. The unaudited interim consolidated financial statements, which reflect all
adjustments (consisting of normal recurring items or items discussed
herein) that management believes necessary to present fairly results of
interim operations, should be read in conjunction with the Notes to
Consolidated Financial Statements (including the Summary of Significant
Accounting Policies) included in the Company's audited consolidated
financial statements for the year ended December 31, 2005, which are
included in the Company's Annual Report filed on Form 10-K, as amended by
Form 10-K/A, for such year (the "2005 10-K"). Results of operations for
interim periods are not necessarily indicative of annual results of
operations. The consolidated balance sheet at December 31, 2005 was
extracted from the audited annual financial statements and does not include
all disclosures required by accounting principles generally accepted in the
United States of America ("GAAP") for annual financial statements.
On June 14, 2006, a two-for-one stock split was effected in the form of a
100% stock dividend that was paid to shareholders of record on May 30,
2006. The financial statements (and notes thereto) give retroactive effect
to the stock split for all periods presented.
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" ("FIN 48"), which prescribes the
accounting for and disclosure of uncertainty in tax positions. FIN 48
defines the criteria that must be met for the benefits of a tax position to
be recognized in the financial statements and the measurement of tax
benefits recognized. FIN 48 is effective for fiscal years beginning after
December 15, 2006, with the cumulative effect of the change in accounting
principle recorded as an adjustment to opening retained earnings. The
Company is currently evaluating the impact of adopting FIN 48 on its
consolidated financial statements.
In July 2006 the Company completed the sale of Symphony Health Services,
LLC ("Symphony") and has reclassified Symphony as a discontinued operation
in the Company's consolidated financial statements. For more information
concerning the sale, see Note 9.
Certain amounts for prior periods have also been reclassified to be
consistent with the 2006 presentation, and to reflect as discontinued
operations WilTel Communications Group, LLC ("WilTel"), which was sold
during the fourth quarter of 2005.
2. Results of operations for the Company's segments are reflected from the
date of acquisition. The primary measure of segment operating results and
profitability used by the Company is income (loss) from continuing
operations before income taxes and equity in income (losses) of associated
companies. As a result of the classification of Symphony as a discontinued
operation, the Company no longer has a Healthcare Services segment; for
information about the Company's new Gaming Entertainment segment, see Note
17.
Certain information concerning the Company's segments for the three and six
month periods ended June 30, 2006 and 2005 is presented in the following
table.
6
Notes to Interim Consolidated Financial Statements, continued
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
(In thousands)
Revenues and other income (a):
Manufacturing:
Idaho Timber $ 91,743 $ 63,532 $ 184,281 $ 63,532
Plastics 27,069 24,624 54,231 45,443
Telecommunications 41,032 30,655 80,713 30,655
Gaming Entertainment 842 -- 842 --
Domestic Real Estate 9,748 7,838 71,796 17,292
Other Operations 9,536 10,095 19,056 18,193
Corporate 86,310 60,841 187,118 75,887
--------- --------- --------- ---------
Total consolidated revenues and other income $ 266,280 $ 197,585 $ 598,037 $ 251,002
========= ========= ========= =========
Income (loss) from continuing operations before income taxes
and equity in income of associated companies:
Manufacturing:
Idaho Timber $ 4,309 $ (351) $ 11,536 $ (351)
Plastics 4,997 4,677 10,224 7,945
Telecommunications 2,097 (719) 2,021 (719)
Gaming Entertainment 613 -- 613 --
Domestic Real Estate 3,162 1,130 50,983 542
Other Operations (10,078) (931) (16,816) (4,571)
Corporate 35,925 25,316 93,911 7,703
Elimination (b) -- 490 -- 490
--------- --------- --------- ---------
Total consolidated income from continuing
operations before income taxes and equity in income
of associated companies $ 41,025 $ 29,612 $ 152,472 $ 11,039
========= ========= ========= =========
(a) Revenues and other income for each segment include amounts for services
rendered and products sold, as well as segment reported amounts classified
as investment and other income and net securities gains on the Company's
consolidated statements of operations.
(b) Eliminates services purchased by ATX Communications, Inc. ("ATX") from
WilTel and recorded as a cost of sales by ATX.
For the three month periods ended June 30, 2006 and 2005, income from continuing
operations has been reduced by depreciation and amortization expenses of
$13,900,000 and $10,800,000, respectively; such amounts are primarily comprised
of Corporate ($3,000,000 and $2,700,000, respectively), manufacturing
($4,400,000 and $4,200,000, respectively), other operations ($3,100,000 and
$1,500,000, respectively) and telecommunications ($2,300,000 and $1,800,000,
respectively). For the six month periods ended June 30, 2006 and 2005, income
from continuing operations has been reduced by depreciation and amortization
expenses of $25,900,000 and $17,500,000, respectively; such amounts are
primarily comprised of Corporate ($5,900,000 and $5,300,000, respectively),
manufacturing ($8,600,000 and $5,900,000, respectively), other operations
($4,500,000 and $3,000,000, respectively) and telecommunications ($5,100,000 and
$1,800,000, respectively). Depreciation and amortization expenses for other
segments are not material.
For the three month periods ended June 30, 2006 and 2005, income from continuing
operations has been reduced by interest expense of $21,600,000 and $16,400,000,
respectively; such amounts are primarily comprised of Corporate ($18,100,000 and
$15,600,000, respectively), gaming entertainment ($3,400,000 in 2006), and other
operations ($400,000 in 2005). For the six month periods ended June 30, 2006 and
2005, income from continuing operations has been reduced by interest expense of
$38,800,000 and $33,100,000, respectively; such amounts are primarily comprised
of Corporate ($35,100,000 and $31,200,000, respectively), gaming entertainment
($3,400,000 in 2006) and other operations ($1,000,000 in 2005). Interest expense
for other segments is not material.
7
Notes to Interim Consolidated Financial Statements, continued
3. The following tables provide summarized data with respect to significant
investments in associated companies accounted for under the equity method
of accounting for the periods the investments were owned by the Company.
The information is provided for those investments whose relative
significance to the Company could result in the Company including separate
audited financial statements for such investments in its Annual Report on
Form 10-K for the year ended December 31, 2006 (in thousands).
June 30, June 30,
2006 2005
------------ ---------
EagleRock Capital Partners (QP), LP ("EagleRock"):
Total revenues $ 17,100 $ (25,300)
Income (loss) from continuing operations before extraordinary items 16,600 (26,100)
Net income (loss) 16,600 (26,100)
The Company's equity in net income (loss) 12,000 (19,500)
Jefferies Partners Opportunity Fund II, LLC ("JPOF II"):
Total revenues $ 31,400 $ 17,600
Income from continuing operations before extraordinary items 30,200 16,400
Net income 30,200 16,400
The Company's equity in net income 19,700 11,100
4. A summary of investments at June 30, 2006 and December 31, 2005 is as
follows (in thousands):
June 30, 2006 December 31, 2005
------------------------------ -----------------------------
Carrying Value Carrying Value
Amortized and Estimated Amortized and Estimated
Cost Fair Value Cost Fair Value
---- ---------- ---- ----------
Current Investments:
Investments available for sale $1,192,167 $1,189,507 $1,206,973 $1,206,195
Trading securities 103,858 103,395 103,978 105,541
Other investments, including accrued interest income 13,770 13,770 11,826 11,826
---------- ---------- ---------- ----------
Total current investments $1,309,795 $1,306,672 $1,322,777 $1,323,562
========== ========== ========== ==========
Non-current Investments:
Investments available for sale $ 840,967 $ 905,713 $ 762,178 $ 825,716
Other investments 158,327 158,327 151,611 151,611
---------- ---------- ---------- ----------
Total non-current investments $ 999,294 $1,064,040 $ 913,789 $ 977,327
========== ========== ========== ==========
During the first quarter of 2006, the Company sold all of its 115,000,000 shares
of Level 3 Communications, Inc. common stock that it had received in connection
with the sale of WilTel for total proceeds of $376,600,000 and recorded a
pre-tax gain of $37,400,000.
8
Notes to Interim Consolidated Financial Statements, continued
5. A summary of intangible assets, net and goodwill at June 30, 2006 and
December 31, 2005 is as follows (in thousands):
June 30, December 31,
2006 2005
----------- ----------
Intangibles:
Customer relationships, net of accumulated amortization of $11,216 and $6,686 $ 57,827 $ 58,911
Licenses, net of accumulated amortization of $5 and $0 11,867 --
Trademarks and tradename, net of accumulated amortization of $466 and $268 3,983 4,140
Software, net of accumulated amortization of $1,211 and $701 3,889 4,399
Patents, net of accumulated amortization of $220 and $142 2,110 2,188
Other, net of accumulated amortization of $1,960 and $1,488 974 1,446
Goodwill 13,999 13,999
-------- --------
$ 94,649 $ 85,083
======== ========
As a result of the acquisition of Premier Entertainment Biloxi, LLC
("Premier") during the second quarter of 2006, the net carrying amount of
intangible assets increased by $11,900,000; see Note 17 for further
information. In addition, the net carrying amount of intangible assets,
principally customer relationships, increased by $3,500,000 due to
acquisitions by the plastics manufacturing segment and within the other
operations segment.
Amortization expense on intangible assets was $3,000,000 and $2,700,000,
respectively, for the three month periods ended June 30, 2006 and 2005, and
$5,800,000 and $3,000,000, respectively, for the six month periods ended
June 30, 2006 and 2005. The estimated aggregate future amortization expense
for the intangible assets for each of the next five years is as follows:
2006 (for the remaining six months) - $6,000,000; 2007 - $10,800,000; 2008
- $10,300,000; 2009 - $9,200,000; and 2010 - $7,600,000.
At June 30, 2006 and December 31, 2005, goodwill was comprised of
$5,800,000 within the telecommunications segment and $8,200,000 within the
plastics manufacturing segment.
6. A summary of accumulated other comprehensive income (loss), net of taxes at
June 30, 2006 and December 31, 2005 is as follows (in thousands):
June 30, December 31,
2006 2005
----------- -----------
Net unrealized losses on investments $ (24,945) $ (22,381)
Net unrealized foreign exchange gains (losses) 1,109 (2,890)
Net unrealized losses on derivative instruments (1,357) (1,008)
Net minimum pension liability (55,223) (55,223)
---------- ----------
$ (80,416) $ (81,502)
========== ==========
7. Investment and other income includes changes in the fair values of
derivative financial instruments of $800,000 and $(1,300,000) for the three
month periods ended June 30, 2006 and 2005, respectively, and $1,800,000
and $(200,000), for the six month periods ended June 30, 2006 and 2005,
respectively.
8. In February 2006, 711 Developer, LLC ("Square 711"), a 90% owned subsidiary
of the Company, completed the sale of 8 acres of unimproved land in
Washington, D.C. for aggregate cash consideration of $121,900,000. The land
was acquired by Square 711 in September 2003 for cash consideration of
$53,800,000. After satisfaction of mortgage indebtedness on the property of
$32,000,000 and other closing payments, the Company received net cash
proceeds of approximately $75,700,000, and recorded a pre-tax gain of
$48,900,000.
9
Notes to Interim Consolidated Financial Statements, continued
9. In July 2006, the Company sold Symphony to RehabCare Group, Inc., for
aggregate cash consideration of approximately $101,500,000, subject to
working capital adjustments. Including estimated working capital
adjustments and after satisfaction of Symphony's outstanding credit
agreement ($31,700,000 at June 30, 2006) and other sale related
obligations, the Company expects to realize net cash proceeds of
approximately $62,300,000 and expects to record a pre-tax gain on sale of
discontinued operations of approximately $53,300,000. Results of operations
for Symphony for the three and six month periods ended June 30, 2006 and
2005 are as follows:
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
(In thousands)
Revenues and other income:
Healthcare revenues $ 55,650 $ 60,977 $ 110,370 $ 128,415
Investment and other income 206 103 225 543
--------- --------- --------- ----------
55,856 61,080 110,595 128,958
--------- --------- --------- ----------
Expenses:
Healthcare cost of sales 46,978 51,328 95,628 107,792
Interest 590 741 1,195 1,469
Salaries 2,974 3,125 5,835 6,485
Depreciation and amortization 356 314 708 615
Selling, general and other expenses 3,237 4,723 7,013 10,394
--------- --------- --------- ----------
54,135 60,231 110,379 126,755
--------- --------- --------- ----------
Income from discontinued operations before income taxes 1,721 849 216 2,203
Income taxes 21 (8) 31 (8)
--------- --------- --------- ----------
Income from discontinued operations $ 1,700 857 $ 185 $ 2,211
========= ========= ========= ==========
The Company has not classified Symphony's assets and liabilities as
discontinued operations because the balances are not material. Summarized
information for Symphony's assets and liabilities is as follows (in
thousands):
June 30, December 31,
2006 2005
--------- -----------
Current assets $ 54,219 $ 52,470
Non-current assets 3,839 3,165
--------- ---------
Total assets $ 58,058 $ 55,635
========= =========
Current liabilities $ 17,014 $ 45,262
Non-current liabilities 32,057 280
--------- ---------
Total liabilities $ 49,071 $ 45,542
========= =========
Gain (loss) on disposal of discontinued operations principally reflects
working capital adjustments and the resolution of certain sale-related
obligations and contingencies related to WilTel, which was sold in the
fourth quarter of 2005.
10
Notes to Interim Consolidated Financial Statements, continued
10. Pension expense charged to operations for the three and six month periods
ended June 30, 2006 and 2005 related to the defined benefit pension plan
(other than WilTel's plan) included the following components (in
thousands):
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
Interest cost $ 483 $ 512 $ 967 $ 1,023
Expected return on plan assets (266) (229) (532) (457)
Actuarial loss 236 208 471 416
Amortization of prior service cost 1 1 1 2
------- ------ --------- -------
Net pension expense $ 454 $ 492 $ 907 $ 984
======= ====== ========= =======
WilTel's defined benefit pension plan expense charged to operations
(classified as discontinued operations in 2005) for the three and six month
periods ended June 30, 2006 and 2005 included the following components (in
thousands):
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
--------------------- ---------------------
2006 2005 2006 2005
---- ---- ---- ----
Interest cost $ 2,487 $ 2,052 $ 4,975 $ 4,103
Service cost -- 966 -- 1,931
Expected return on plan assets (1,766) (1,327) (3,532) (2,653)
Actuarial loss 397 11 793 23
--------- -------- -------- -------
Net pension expense $ 1,118 $ 1,702 $ 2,236 $ 3,404
========= ======== ======== =======
Employer contributions to WilTel's defined benefit pension plan were
$42,800,000 during the first six months of 2006; as disclosed in the
Company's 2005 10-K such contributions were estimated to aggregate
$29,100,000 for all of 2006. The Company is currently evaluating whether it
will make additional contributions during the remainder of 2006.
Several subsidiaries provide certain healthcare and other benefits to
certain retired employees under plans which are currently unfunded. The
Company pays the cost of postretirement benefits as they are incurred.
Amounts charged to expense were not material in each of the three and six
month periods ended June 30, 2006 and 2005.
11. Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), using
the modified prospective method. SFAS 123R requires that the cost of all
share-based payments to employees, including grants of employee stock
options and warrants, be recognized in the financial statements based on
their fair values. The cost is recognized as an expense over the vesting
period of the award. Prior to adoption of SFAS 123R, no compensation cost
was recognized in the statements of operations for the Company's
share-based compensation plans; the Company disclosed certain pro forma
amounts as required.
11
Notes to Interim Consolidated Financial Statements, continued
The fair value of each award is estimated at the date of grant using the
Black-Scholes option pricing model. As a result of the adoption of SFAS
123R, compensation cost increased by $9,000,000 and $9,400,000,
respectively, for the three and six month 2006 periods and net income
decreased by $5,800,000 and $6,100,000, respectively, for the three and six
month 2006 periods. Had the Company used the fair value based accounting
method for the three and six month 2005 periods, compensation cost would
have been higher by $500,000 and $1,000,000, respectively, and primary and
diluted earnings per share would not have changed. As of June 30, 2006,
total unrecognized compensation cost related to nonvested share-based
compensation plans was $32,400,000; this cost is expected to be recognized
over a weighted-average period of 3.5 years.
As of June 30, 2006, the Company has two share-based plans: a fixed stock
option plan and a senior executive warrant plan. The fixed stock option
plan provides for grants of options or rights to non-employee directors and
certain employees up to a maximum grant of 450,000 shares to any individual
in a given taxable year. The maximum number of common shares that may be
acquired through the exercise of options or rights under this plan cannot
exceed 2,519,150. The plan provides for the issuance of stock options and
stock appreciation rights at not less than the fair market value of the
underlying stock at the date of grant. Options granted to employees under
this plan are intended to qualify as incentive stock options to the extent
permitted under the Internal Revenue Code and become exercisable in five
equal annual instalments starting one year from date of grant. Options
granted to non-employee directors become exercisable in four equal annual
instalments starting one year from date of grant. No stock appreciation
rights have been granted. As of June 30, 2006, 2,495,150 shares were
available for grant under the plan. During the three and six month 2006
periods, 24,000 options at $30.78 per share were granted; during the three
and six month 2005 periods, 12,000 options at $18.03 per share were
granted.
The senior executive warrant plan provides for the issuance, subject to
shareholder approval, of warrants to purchase up to 2,000,000 common shares
to each of the Company's Chairman and President at an exercise price equal
to 105% of the closing price per share of a common share on the date of
grant. On March 6, 2006, the Company's Board of Directors approved, subject
to shareholder approval, the grant of warrants to purchase 2,000,000 common
shares to each of the Company's Chairman and President at an exercise price
equal to $28.515 per share (105% of the closing price per share of a common
share on that date). In May 2006, shareholder approval was received and the
warrants were issued. The warrants expire in 2011 and vest in five equal
tranches with 20% vesting on the date shareholder approval was received and
an additional 20% vesting in each subsequent year.
The following summary presents the weighted-average assumptions used for
grants made during the 2006 and 2005 periods:
2006 2005
-------------------------------- --------
Options Warrants Options
------- -------- -------
Risk free interest rate 4.92% 4.95% 3.77%
Expected volatility 22.78% 23.05% 23.58%
Expected dividend yield .81% .41% .69%
Expected life 4.3 years 4.3 years 4.3 years
Weighted average fair value per grant $7.75 $9.39 $4.29
The expected life assumptions were based on historical behavior and
incorporated post-vesting forfeitures for each type of award and population
identified.
12
Notes to Interim Consolidated Financial Statements, continued
The following table summarizes information about outstanding stock options
at June 30, 2006 and changes during the six months then ended:
Weighted-Average
Remaining
Weighted-Average Contractual Term Aggregate Intrinsic
Shares Exercise Price (in years) Value
------ -------------- ---------- -------------------
Outstanding at January 1, 2006 1,955,260 $17.60
Granted 24,000 $30.78
Exercised (168,460) $ 9.04 $ 3,100,000
============
Forfeited -- $ --
---------
Outstanding at June 30, 2006 1,810,800 $18.57 3.8 $ 19,200,000
========= ====== ========== ============
Exercisable at June 30, 2006 459,600 $16.51 3.3 $ 5,800,000
========= ====== ========== ============
At June 30, 2006, 4,000,000 warrants were outstanding and 800,000 were
exercisable; outstanding warrants had an aggregate intrinsic value of
$2,700,000 and exercisable warrants had an aggregate intrinsic value of
$500,000. Both the outstanding and exercisable warrants had a
weighted-average remaining contractual term of 4.7 years. No warrants were
exercised or forfeited during the six month 2006 period.
12. For the 2006 periods, the Company's effective income tax rate is higher
than the federal statutory rate due to state income taxes. The income tax
provision for the 2005 periods reflects a credit of $1,110,000,000 as a
result of the reversal of a portion of the valuation allowance for the
deferred tax asset. The Company adjusted the valuation allowance since it
believed it was more likely than not that it will have future taxable
income sufficient to realize that portion of the net deferred tax asset.
13. Basic earnings (loss) per share amounts are calculated by dividing net
income (loss) by the sum of the weighted average number of common shares
outstanding. To determine diluted earnings (loss) per share, the weighted
average number of common shares is adjusted for the incremental weighted
average number of shares issuable upon exercise of outstanding options and
warrants, unless the effect is antidilutive. In addition, the calculations
of diluted earnings (loss) per share assume the 3 3/4% Convertible Notes
are converted into common shares and earnings increased for the interest on
such notes, net of the income tax effect, unless the effect is
antidilutive. The number of shares used to calculate basic earnings (loss)
per share amounts was 216,201,000 and 215,303,000 for the three month
periods ended June 30, 2006 and 2005, respectively, and 216,154,000 and
215,265,000 for the six month periods ended June 30, 2006 and 2005,
respectively. The number of shares used to calculate diluted earnings
(loss) per share amounts was 231,777,000 and 231,026,000 for the three
month periods ended June 30, 2006 and 2005, respectively, and 231,482,000
and 231,017,000 for the six month periods ended June 30, 2006 and 2005,
respectively.
14. Cash paid for interest and income taxes (net of refunds) was $34,600,000
and $4,500,000, respectively, for the six month period ended June 30, 2006
and $52,000,000 and $1,400,000, respectively, for the six month period
ended June 30, 2005.
15. Debt due within one year includes $221,400,000 and $92,100,000 as of June
30, 2006 and December 31, 2005, respectively, relating to repurchase
agreements. These fixed rate repurchase agreements have a weighted average
interest rate of approximately 5%, mature at various dates through November
2006 and are secured by investments with a carrying value of $229,900,000.
13
Notes to Interim Consolidated Financial Statements, continued
16. In April 2006, the Company acquired a 30% limited liability company
interest in Goober Drilling, LLC, ("Goober Drilling") for aggregate
consideration of $60,000,000, excluding expenses, and agreed to lend to
Goober Drilling, on a secured basis, up to $80,000,000 to finance new
equipment purchases and construction costs, and to repay existing debt. In
June 2006, the Company agreed to increase the secured loan amount to an
aggregate of $126,000,000 to finance additional equipment purchases and
construction costs. As of June 30, 2006, the outstanding loan amount was
$53,100,000. Goober Drilling is an on-shore contract oil and gas drilling
company based in Stillwater, Oklahoma that provides drilling services to
exploration and production companies. The Company's investment in Goober
Drilling is classified as an investment in an associated company.
17. During the second quarter of 2006, the Company indirectly acquired a
controlling voting interest in Premier for an aggregate purchase price of
$90,800,000, excluding expenses. The Company effectively owns approximately
46% of the fully diluted common units of Premier and all of Premier's
preferred units, which accrue an annual preferred return of 17%. The
Company also acquired Premier's junior subordinated note due August 2012,
with an outstanding balance at acquisition of $13,400,000, and has made an
$8,000,000 12% loan to Premier that matures in May 2007. Premier is the
owner of the Hard Rock Hotel & Casino Biloxi ("Hard Rock Biloxi"), located
in Biloxi, Mississippi, which was severely damaged prior to opening by
Hurricane Katrina and which, pending receipt of insurance proceeds, is to
be rebuilt. All of Premier's equity interests are pledged to secure
repayment of Premier's outstanding $160,000,000 principal amount of 10 3/4%
First Mortgage Notes due February 1, 2012 (the "Premier Notes"). In
addition, the Company agreed to provide up to $40,000,000 of construction
financing to Premier's general contractor by purchasing the contractor's
receivables from Premier if the receivables are more than ten days past
due.
The Company has consolidated Premier from the date of acquisition. Based
upon the Company's preliminary allocation of the purchase price, it has
recorded intangible assets of $11,900,000, principally related to the
license to use the Hard Rock name. The license will be amortized on a
straight-line basis over its initial term of 20 years, which term commences
upon the opening of the Hard Rock Biloxi. The Company has not completed all
of the analyses and studies to finalize its allocation of the purchase
price for Premier; it expects to complete its allocation of the purchase
price by the end of 2006, and any changes from its initial allocation could
affect the values assigned to property and equipment and intangible assets.
However, the Company does not expect that the impact of these changes will
be material. Unaudited pro forma data is not included for Premier as the
amounts were not material.
Prior to Hurricane Katrina, Premier purchased a comprehensive blanket
insurance policy providing up to $181,100,000 in coverage for damage to
real and personal property, including business interruption coverage.
Premier has reached settlements with various insurance carriers aggregating
$159,800,000 with respect to $167,100,000 face amount of coverage; the
remaining $14,000,000 face amount of coverage has not been settled and is
currently in litigation. As of June 30, 2006, paid insurance settlements
aggregating $111,900,000 ($121,500,000 as of August 7, 2006) have been
placed on deposit into restricted accounts held by the indenture trustee of
the Premier Notes; proceeds from the remaining insurance policies that have
been settled are expected to be received before the end of August. The
restricted accounts held by the trustee are classified as restricted cash
in the Company's consolidated balance sheet.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino, which
was a facility built on floating barges, and caused significant damage to
the hotel and related structures. The threat of hurricanes remains a
significant risk to the existing facilities and to the new casino, which
will be constructed over water on concrete pilings that are expected to
greatly improve the structural integrity of the facility. In July 2006,
Premier purchased a new insurance policy providing up to $149,300,000 in
coverage for damage to real and personal property and up to the lesser of
six months or $30,000,000 of business interruption and delayed opening
coverage. The coverage is syndicated through several insurance carriers,
each with an A.M. Best Rating of A- (Excellent) or better. The policy
provides coverage for the existing structures, as well as for the repair
and rebuild of the hotel, low rise building and parking garage and the
construction of the new
14
Notes to Interim Consolidated Financial Statements, continued
casino. Although the insurance policy is an "all risk" policy, weather
catastrophe occurrence ("WCO"), which is defined to include damage caused
by a named storm, is limited to $50,000,000 with a deductible equal to the
greater of $7,000,000 or 5% of total insured values at risk. WCO coverage
is subject to mandatory reinstatement of coverage for an additional
pre-determined premium.
Since the WCO coverage purchased by Premier is substantially less than the
coverage in place prior to Hurricane Katrina, Premier has more exposure to
property damage resulting from similar catastrophic storms. However,
Premier's assessment of the probability of a similar type of loss occurring
during the remainder of this year's hurricane season is remote, an
assessment based in large part on the less severe damage sustained to the
non-casino facilities from Hurricane Katrina last year, and the amount of
new construction that will be at risk during the balance of this hurricane
season. Premiums for WCO policies have increased dramatically as a result
of Hurricane Katrina, and the amount of coverage that can be purchased has
also been reduced as insurance companies seek to reduce their exposure to
such events.
On May 5, 2006, a subsidiary of the Company commenced a tender offer for
all of the Premier Notes at a price equal to 101% of par value, plus
accrued and unpaid interest to the date of purchase. The tender offer
satisfied Premier's obligation under the indenture to make such an offer
upon a change of control; the offer expired on June 9, 2006 without any
Premier Notes being tendered. On June 30, 2006, Premier commenced a tender
offer to purchase up to $94,000,000 aggregate principal amount of the
Premier Notes at a price equal to 100% of par value, plus accrued and
unpaid interest to the date of purchase, as required under the indenture
for the Premier Notes as a result of the payment of a specified amount of
insurance proceeds. Contemporaneous with the commencement of Premier's
offer, the Company commenced a tender offer for all of the Premier Notes at
a price equal to 101% of the par value of the Premier Notes, plus accrued
and unpaid interest to the date of purchase. The Company's offer was
intended to enable Premier to have the maximum amount of insurance proceeds
available to it to finance the opening of the Hard Rock Biloxi while still
providing the holders of the Premier Notes with the opportunity to sell all
of their Premier Notes without commission or expense associated with any
such sale. Both tender offers expired on August 2, 2006 without any Premier
Notes being tendered. Upon the payment of certain additional insurance
proceeds expected during the third quarter of 2006, Premier may be required
to make another tender offer for the Premier Notes up to the aggregate
amount of additional insurance proceeds paid. In the event Premier is
required to make another tender offer, the Company has also agreed, under
certain conditions, to make a tender offer for all of the Premier Notes at
a price equal to 101% of par value. The Company has classified the Premier
Notes as a current payable as of June 30, 2006.
Premier has made a proposal to the trustee of the Premier Notes to exercise
its discretion, subject to court approval, to allow Premier to use the
insurance proceeds held by the trustee to repair, rebuild and open the Hard
Rock Biloxi and to pay certain claims. The proposal assumes that funds
would not be needed to purchase the Premier Notes pursuant to Premier's
tender offer described above, and included a revised plan and budget for
the reconstruction and repair of the Hard Rock Biloxi, along with financial
and other information to assist the trustee in its evaluation of Premier's
proposal, and certain other information as required under the indenture and
related documents governing the Premier Notes. On June 30, 2006, the
trustee filed a petition with the State of Minnesota District Court, Second
Judicial District, Ramsey County, seeking to authorize the trustee to take
all actions reasonable or necessary to consummate Premier's proposal. A
hearing on this matter is expected to take place in August 2006.
15
Notes to Interim Consolidated Financial Statements, continued
18. In June 2006, the Company entered into an agreement to sell ATX to
Broadview Networks Holdings, Inc. Closing of the transaction is subject to
receipt of required regulatory approvals, purchaser financing and
satisfaction of certain closing conditions. After payment of estimated
closing costs, amounts due to minority interests and estimated net working
capital adjustments, at closing the Company would receive net cash proceeds
of approximately $85,000,000, and would record a pre-tax gain on sale of
discontinued operations of approximately $30,000,000.
19. In June 2006, the Company entered into a new credit agreement with various
bank lenders for a $100,000,000 unsecured credit facility that matures in
five years and bears interest based on the Eurocurrency rate or the prime
rate. The Company's existing credit agreement was terminated. At June 30,
2006, no amounts were outstanding under this bank credit facility.
20. In July 2006, the Company entered into a subscription agreement with
Fortescue Metals Group Ltd ("Fortescue") and its subsidiary, FMG Chichester
Pty Ltd ("FMG"), pursuant to which the Company agreed to invest an
aggregate of $400,000,000 in Fortescue and its Pilbara iron ore
infrastructure project in Western Australia. Pursuant to the subscription
agreement, the Company will acquire 26,400,000 common shares of Fortescue,
representing approximately 9.99% of the common stock of Fortescue to then
be outstanding, and a 13 year, $100,000,000 note of FMG. Interest on the
note is calculated as 4% of the revenue, net of government royalties,
invoiced from the iron ore produced from the project. The note will be
unsecured and will be subordinate to the secured debt to be issued in
respect of the project. The Company's obligation to consummate the
investment is subject to Fortescue obtaining approximately $2,000,000,000
of additional financing for the project, including senior secured
financing, on terms acceptable to the Company. If this condition is not
satisfied or waived by December 31, 2006, either party will be able to
terminate the subscription agreement.
21. Restricted cash as of June 30, 2006 includes $117,500,000 relating to
Premier's restricted accounts held by the trustee; see Note 17 for further
information. The remaining balance of $15,900,000 principally represents
cash collateral requirements for letters of credit to secure various
obligations; substantially all of these obligations expire before 2008.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations.
The following should be read in conjunction with the Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the 2005
10-K.
Liquidity and Capital Resources
For the six month period ended June 30, 2006, net cash was provided by operating
activities principally as a result of the collection of certain receivables from
AT&T Inc. (formerly SBC Communications, Inc.), distributions and collection of a
receivable from associated companies, and receipt of proceeds from short-term
investments, partially offset by payment of incentive compensation and pension
plan contributions. For the six month period ended June 30, 2005, net cash was
provided by operating activities principally as a result of the collection of a
receivable related to a former partnership interest, distributions from
associated companies and a decrease in the Company's investment in the trading
portfolio.
As of June 30, 2006, the Company's readily available cash, cash equivalents and
marketable securities, excluding amounts held by subsidiaries that are parties
to agreements which restrict the payment of dividends, totaled $2,295,400,000.
This amount is comprised of cash and short-term bonds and notes of the United
States Government and its agencies of $1,259,700,000 (54.9%), U.S.
Government-Sponsored Enterprises of $247,100,000 (10.8%) and other publicly
traded debt and equity securities aggregating $788,600,000 (34.3%). This amount
does not include 5,600,000 shares of Inmet Mining Corporation, which is
restricted and carried at cost of $78,000,000 as of June 30, 2006 (market value
of $209,600,000).
As of June 30, 2006, the Company had outstanding $221,400,000 of fixed rate
repurchase agreements (an increase of $129,300,000 from December 31, 2005).
These repurchase agreements, which are reflected in debt due within one year,
have a weighted average interest rate of approximately 5%, mature at various
dates through November 2006 and are secured by investments with a carrying value
of $229,900,000.
In January, April and July 2006, the Company received $16,600,000, $20,100,000
and $11,500,000, respectively, as distributions from its investment in
EagleRock. The amount received in January was included in current trade, notes
and other receivables, net in the Company's December 31, 2005 consolidated
balance sheet. As more fully described in the 2005 10-K, the Company's entire
interest in EagleRock is in the process of being redeemed.
In January 2006, the Company invested $50,000,000 in Safe Harbor Domestic
Partners L.P. ("Safe Harbor"), a limited partnership which will principally
invest in the securities of Japanese public companies. Although the general
partner is permitted to invest directly in securities, the general partner
expects that substantially all funds will be invested in a master fund managed
by the general partner.
In February 2006, Square 711 completed the sale of 8 acres of unimproved land in
Washington, D.C. for aggregate cash consideration of $121,900,000. The land was
acquired by Square 711 in September 2003 for cash consideration of $53,800,000.
After satisfaction of mortgage indebtedness on the property of $32,000,000 and
other closing payments, the Company received net cash proceeds of approximately
$75,700,000.
During the first quarter of 2006, the Company received aggregate cash proceeds
of $56,400,000 from the sale of its equity interest in and loan repayment by two
associated companies and recorded a pre-tax gain totaling $27,500,000, which is
reflected in investment and other income for the six month period ended June 30,
2006.
In the second quarter of 2006, the Company acquired a 30% limited liability
company interest in Goober Drilling for aggregate consideration of $60,000,000,
excluding expenses, and agreed to lend to Goober Drilling, on a secured basis,
up to $126,000,000 to finance new equipment purchases and construction costs,
and to repay existing debt. As of June 30, 2006, the outstanding loan amount was
$53,100,000. Goober Drilling is an on-shore contract oil and gas drilling
company based in Stillwater, Oklahoma that provides drilling services to
exploration and production companies.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
As discussed above, during the second quarter of 2006, the Company indirectly
acquired a controlling voting interest in Premier for an aggregate purchase
price of $90,800,000, excluding expenses. The Company effectively owns
approximately 46% of the fully diluted common units of Premier and all of
Premier's preferred units, which accrue an annual preferred return of 17%. The
Company also acquired Premier's junior subordinated note due August 2012, with
an outstanding balance at acquisition of $13,400,000, and has made an $8,000,000
12% loan to Premier that matures in May 2007. All of Premier's equity interests
are pledged to secure repayment of Premier's outstanding $160,000,000 principal
amount of 10 3/4% First Mortgage Notes due February 1, 2012 (the "Premier
Notes"). In addition, the Company agreed to provide up to $40,000,000 of
construction financing to Premier's general contractor by purchasing the
contractor's receivables from Premier if the receivables are more than ten days
past due.
Prior to Hurricane Katrina, Premier purchased a comprehensive blanket insurance
policy providing up to $181,100,000 in coverage for damage to real and personal
property, including business interruption coverage. Premier has reached
settlements with various insurance carriers aggregating $159,800,000 with
respect to $167,100,000 face amount of coverage; the remaining $14,000,000 face
amount of coverage has not been settled and is currently in litigation. As of
June 30, 2006, paid insurance settlements aggregating $111,900,000 ($121,500,000
as of August 7, 2006) have been placed on deposit into restricted accounts held
by the indenture trustee of the Notes; proceeds from the remaining insurance
policies that have been settled are expected to be received before the end of
August. The restricted accounts held by the trustee are classified as restricted
cash in the Company's consolidated balance sheet.
Hurricane Katrina completely destroyed the Hard Rock Biloxi's casino, which was
a facility built on floating barges, and caused significant damage to the hotel
and related structures. The threat of hurricanes remains a significant risk to
the existing facilities and to the new casino, which will be constructed over
water on concrete pilings that are expected to greatly improve the structural
integrity of the facility. In July 2006, Premier purchased a new insurance
policy providing up to $149,300,000 in coverage for damage to real and personal
property and up to the lesser of six months or $30,000,000 of business
interruption and delayed opening coverage. The coverage is syndicated through
several insurance carriers, each with an A.M. Best Rating of A- (Excellent) or
better. The policy provides coverage for the existing structures, as well as for
the repair and rebuild of the hotel, low rise building and parking garage and
the construction of the new casino. Although the insurance policy is an "all
risk" policy, weather catastrophe occurrence ("WCO"), which is defined to
include damage caused by a named storm, is limited to $50,000,000 with a
deductible equal to the greater of $7,000,000 or 5% of total insured values at
risk. WCO coverage is subject to mandatory reinstatement of coverage for an
additional pre-determined premium.
Since the WCO coverage purchased by Premier is substantially less than the
coverage in place prior to Hurricane Katrina, Premier has more exposure to
property damage resulting from similar catastrophic storms. However, Premier's
assessment of the probability of a similar type of loss occurring during the
remainder of this year's hurricane season is remote, an assessment based in
large part on the less severe damage sustained to the non-casino facilities from
Hurricane Katrina last year, and the amount of new construction that will be at
risk during the balance of this hurricane season. Premiums for WCO policies have
increased dramatically as a result of Hurricane Katrina, and the amount of
coverage that can be purchased has also been reduced as insurance companies seek
to reduce their exposure to such events.
On May 5, 2006, a subsidiary of the Company commenced a tender offer for all of
the Premier Notes at a price equal to 101% of par value, plus accrued and unpaid
interest to the date of purchase. The tender offer satisfied Premier's
obligation under the indenture to make such an offer upon a change of control;
the offer expired on June 9, 2006 without any Premier Notes being tendered. On
June 30, 2006, Premier commenced a tender offer to purchase up to $94,000,000
aggregate principal amount of the Premier Notes at a price equal to 100% of par
value, plus accrued and unpaid interest to the date of purchase, as required
under the indenture for the Premier Notes as a result of the payment of a
specified amount of insurance proceeds. Contemporaneous with the commencement of
Premier's offer, the Company commenced a tender offer for all of the Premier
Notes at a price
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
equal to 101% of the par value of the Premier Notes, plus accrued and unpaid
interest to the date of purchase. The Company's offer was intended to enable
Premier to have the maximum amount of insurance proceeds available to it to
finance the opening of the Hard Rock Biloxi while still providing the holders of
the Premier Notes with the opportunity to sell all of their Premier Notes
without commission or expense associated with any such sale. Both tender offers
expired on August 2, 2006 without any Premier Notes being tendered. Upon the
payment of certain additional insurance proceeds expected during the third
quarter of 2006, Premier may be required to make another tender offer for the
Premier Notes up to the aggregate amount of additional insurance proceeds paid.
In the event Premier is required to make another tender offer, the Company has
also agreed, under certain conditions, to make a tender offer for all of the
Premier Notes at a price equal to 101% of par value. The Company has classified
the Premier Notes as a current payable as of June 30, 2006.
Premier believes that its insurance recoveries and permitted equipment financing
is adequate to reconstruct the Hard Rock Biloxi similar to its condition
immediately preceding Hurricane Katrina, and is also sufficient to cover
interest and expenses through the reconstruction period and settle all
outstanding payables arising both prior to and subsequent to Hurricane Katrina,
assuming the insurance proceeds are received in a favorable and timely manner.
However, due to Premier's current inability to access the insurance proceeds,
together with the litigation with the remaining insurance carrier, both the
amount and timing of receipt of the insurance proceeds is uncertain. Premier has
estimated that the cost of debris removal and replacing the property and
equipment destroyed by Hurricane Katrina will be approximately $123,000,000 and
will take approximately twelve months to complete. Interest payments under the
Notes during this reconstruction period are estimated to be approximately
$20,100,000 and preopening expenses are estimated to be approximately
$17,000,000.
Premier has made a proposal to the trustee of the Premier Notes to exercise its
discretion, subject to court approval, to allow Premier to use the insurance
proceeds held by the trustee to repair, rebuild and open the Hard Rock Biloxi
and to pay certain claims. The proposal assumes that funds would not be needed
to purchase the Premier Notes pursuant to Premier's tender offer described
above, and included a revised plan and budget for the reconstruction and repair
of the Hard Rock Biloxi, along with financial and other information to assist
the trustee in its evaluation of Premier's proposal, and certain other
information as required under the indenture and related documents governing the
Premier Notes. On June 30, 2006, the trustee filed a petition with the State of
Minnesota District Court, Second Judicial District, Ramsey County, seeking to
authorize the trustee to take all actions reasonable or necessary to consummate
Premier's proposal. A hearing on this matter is expected to take place in August
2006.
In June 2006, the Company entered into a new credit agreement with various bank
lenders for a $100,000,000 unsecured credit facility that matures in five years
and bears interest based on the Eurocurrency rate or the prime rate. The
Company's existing credit agreement was terminated. At June 30, 2006, no amounts
were outstanding under this bank credit facility.
In July 2006, the Company sold Symphony to RehabCare Group, Inc., for aggregate
cash consideration of approximately $101,500,000, subject to working capital
adjustments. Including estimated working capital adjustments and after
satisfaction of Symphony's outstanding credit agreement ($31,700,000 at June 30,
2006) and other sale related obligations, the Company expects to realize net
cash proceeds of approximately $62,300,000 and expects to record a pre-tax gain
on sale of discontinued operations of approximately $53,300,000.
In July 2006, the Company entered into a subscription agreement with Fortescue
and its subsidiary, FMG, pursuant to which the Company agreed to invest an
aggregate of $400,000,000 in Fortescue and its Pilbara iron ore infrastructure
project in Western Australia. Pursuant to the subscription agreement, the
Company will acquire 26,400,000 common shares of Fortescue, representing
approximately 9.99% of the common stock of Fortescue to then be outstanding, and
a 13 year, $100,000,000 note of FMG. Interest on the note is calculated as 4% of
the revenue, net of government royalties, invoiced from the iron ore produced
from the project. The note will be
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
unsecured and will be subordinate to the secured debt to be issued in respect of
the project. The Company's obligation to consummate the investment is subject to
Fortescue obtaining approximately $2,000,000,000 of additional financing for the
project, including senior secured financing, on terms acceptable to the Company.
If this condition is not satisfied or waived by December 31, 2006, either party
will be able to terminate the subscription agreement.
Critical Accounting Estimates
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with GAAP. The preparation of these financial statements
requires the Company to make estimates and assumptions that affect the reported
amounts in the financial statements and disclosures of contingent assets and
liabilities. On an on-going basis, the Company evaluates all of these estimates
and assumptions. The following areas have been identified as critical accounting
estimates because they have the potential to have a material impact on the
Company's financial statements, and because they are based on assumptions which
are used in the accounting records to reflect, at a specific point in time,
events whose ultimate outcome won't be known until a later date. Actual results
could differ from these estimates.
Income Taxes - The Company records a valuation allowance to reduce its deferred
tax asset to the amount that is more likely than not to be realized. If in the
future the Company were to determine that it would be able to realize its
deferred tax asset in excess of its net recorded amount, an adjustment would
increase income in such period. Similarly, if in the future the Company were to
determine that it would not be able to realize all or part of its deferred tax
asset, an adjustment would be charged to income in such period. The
determination of the amount of the valuation allowance required is based, in
significant part, upon the Company's projection of future taxable income at any
point in time. The Company also records reserves for contingent tax liabilities
based on the Company's assessment of the probability of successfully sustaining
its tax filing positions.
During 2005, the Company's projections of future taxable income enabled it to
conclude that it is more likely than not that it will have future taxable income
sufficient to realize a portion of the Company's net deferred tax asset;
accordingly, $1,135,100,000 of the deferred tax valuation allowance was reversed
as a credit to income tax expense (principally during the second quarter of
2005). The Company's conclusion that a portion of the deferred tax asset was
more likely than not to be realizable is strongly influenced by its historical
ability to generate significant amounts of taxable income. The Company's
estimate of future taxable income considers all available evidence, both
positive and negative, about its current operations and investments, includes an
aggregation of individual projections for each material operation and
investment, and includes all future years that the Company estimated it would
have available net operating losses. Over the projection period, the Company
assumed that its readily available cash, cash equivalents and marketable
securities would provide returns generally equivalent to the returns expected to
be provided by the Company's existing operations and investments, except for
certain amounts assumed to be invested on a short-term basis to meet the
Company's liquidity needs. The Company believes that its estimate of future
taxable income is reasonable but inherently uncertain, and if its current or
future operations and investments generate taxable income greater than the
projected amounts, further adjustments to reduce the valuation allowance are
possible. Conversely, if the Company realizes unforeseen material losses in the
future, or its ability to generate future taxable income necessary to realize a
portion of the deferred tax asset is materially reduced, additions to the
valuation allowance could be recorded. At June 30, 2006, the balance of the
deferred valuation allowance was approximately $800,000,000.
Impairment of Securities - Investments with an impairment in value considered to
be other than temporary are written down to estimated fair value. The
write-downs are included in net securities gains in the consolidated statements
of operations. The Company evaluates its investments for impairment on a
quarterly basis.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
The Company's determination of whether a security is other than temporarily
impaired incorporates both quantitative and qualitative information; GAAP
requires the exercise of judgment in making this assessment, rather than the
application of fixed mathematical criteria. The Company considers a number of
factors including, but not limited to, the length of time and the extent to
which the fair value has been less than cost, the financial condition and near
term prospects of the issuer, the reason for the decline in fair value, changes
in fair value subsequent to the balance sheet date, and other factors specific
to the individual investment. The Company's assessment involves a high degree of
judgment and accordingly, actual results may differ materially from the
Company's estimates and judgments. The Company recorded impairment charges for
securities of $1,700,000 and $1,000,000 for the three month periods ended June
30, 2006 and 2005, respectively, and $2,600,000 and $3,300,000 for the six month
periods ended June 30, 2006 and 2005, respectively.
Business Combinations - At acquisition, the Company allocates the cost of a
business acquisition to the specific tangible and intangible assets acquired and
liabilities assumed based upon their relative fair values. Significant judgments
and estimates are often made to determine these allocated values, and may
include the use of independent appraisals, consider market quotes for similar
transactions, employ discounted cash flow techniques or consider other
information the Company believes relevant. The finalization of the purchase
price allocation will typically take a number of months to complete, and if
final values are materially different from initially recorded amounts
adjustments are recorded. Any excess of the cost of a business acquisition over
the fair values of the net assets and liabilities acquired is recorded as
goodwill which is not amortized to expense. Recorded goodwill of a reporting
unit is required to be tested for impairment on an annual basis, and between
annual testing dates if events or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its net book value.
Subsequent to the finalization of the purchase price allocation, any adjustments
to the recorded values of acquired assets and liabilities would be reflected in
the Company's consolidated statement of operations. Once final, the Company is
not permitted to revise the allocation of the original purchase price, even if
subsequent events or circumstances prove the Company's original judgments and
estimates to be incorrect. In addition, long-lived assets like property and
equipment, amortizable intangibles and goodwill may be deemed to be impaired in
the future resulting in the recognition of an impairment loss; however, under
GAAP the methods, assumptions and results of an impairment review are not the
same for all long-lived assets. The assumptions and judgments made by the
Company when recording business combinations will have an impact on reported
results of operations for many years into the future.
Results of Operations
The 2006 Periods Compared to the 2005 Periods
Manufacturing - Idaho Timber
Revenues and other income for Idaho Timber (which was acquired in May 2005) were
$91,700,000 and $184,300,000 for the three and six month periods ended June 30,
2006, respectively, and $63,500,000 for the 2005 periods; gross profit was
$9,400,000 and $21,200,000 for the three and six month periods ended June 30,
2006, respectively, and $3,400,000 for the 2005 periods; and pre-tax income
(loss) was $4,300,000 and $11,500,000 for the three and six month periods ended
June 30, 2006, respectively, and $(400,000) for the 2005 periods. Results of
operations include salaries and incentive compensation expenses of $2,600,000
and $5,200,000 for the three and six month periods ended June 30, 2006,
respectively, and $1,100,000 for the 2005 periods, and depreciation and
amortization expenses of $1,200,000 and $2,500,000 for the three and six month
periods ended June 30, 2006, respectively, and $1,800,000 for the 2005 periods.
While Idaho Timber's revenues and shipment volume for the second quarter of 2006
were largely unchanged as compared to the first quarter of 2006, the average
selling price
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
declined significantly during June. This decline was principally due to
weakening demand resulting from the abundant supply of high-grade inventory in
the marketplace combined with expected decreased demand due to reductions in new
housing starts. Raw material costs (the largest component of its cost of sales),
which generally lag behind reductions in selling prices, increased during the
second quarter of 2006 as compared to the first quarter of 2006 reflecting
uncertainty concerning Canadian low-grade softwood imports. Gross profit and
pre-tax results reflect this compression during the second quarter, and
particularly during the month of June.
Manufacturing - Plastics
Pre-tax income for the plastics division was $5,000,000 and $4,700,000 for the
three month periods ended June 30, 2006 and 2005, respectively, and $10,200,000
and $7,900,000 for the six month periods ended June 30, 2006 and 2005,
respectively. The plastics division's revenues and other income were $27,100,000
and $24,600,000 for the three month periods ended June 30, 2006 and 2005,
respectively, and $54,200,000 and $45,400,000 for the six month periods ended
June 30, 2006 and 2005, respectively. Gross profits were $8,700,000 and
$8,100,000 for the three month periods ended June 30, 2006 and 2005,
respectively, and $17,800,000 and $14,400,000 for the six month periods ended
June 30, 2006 and 2005, respectively. The increase in revenues in 2006 reflects
an increase in NSW's revenues (which was acquired in February 2005) of $800,000
and $3,400,000, respectively, for the three and six month periods, and increases
primarily in the carpet cushion and erosion control markets, partially reduced
by a decline in the consumer products market due to lower demand for certain
products. The sales increases result from a variety of factors including the
strong housing market, increased road construction and the impact of price
increases implemented in 2005. Gross margin for the second quarter of 2006 also
reflects an increase in the cost of polypropylene, the principal raw material
used and a byproduct of the oil refining process whose price tends to fluctuate
with the price of oil. In addition, gross margins for the three and six month
2006 periods reflect $400,000 and $800,000, respectively, of greater
amortization expense on intangible assets resulting from acquisitions and
depreciation expense as compared to the same periods in 2005. Pre-tax results
for the three and six month 2006 periods also reflect $500,000 and $1,000,000 of
higher salaries and incentive compensation expense than for the comparable
periods in 2005.
Telecommunications - ATX
ATX has been consolidated by the Company since April 22, 2005, the effective
date of its bankruptcy plan. ATX telecommunications revenues and other income
were $41,000,000 and $80,700,000, respectively, for the three and six month
periods ended June 30, 2006 and $30,700,000 for the 2005 periods.
Telecommunications cost of sales were $23,400,000 and $47,200,000, respectively,
for the three and six month periods ended June 30, 2006 and $19,400,000 for the
2005 periods. Salaries and incentive compensation expense was $6,300,000 and
$12,500,000, respectively, for the three and six month periods ended June 30,
2006 and $5,100,000 for the 2005 periods; depreciation and amortization expenses
were $2,300,000 and $5,100,000, respectively, for the three and six month
periods ended June 30, 2006 and $1,800,000 for the 2005 periods; and selling,
general and other expenses were $6,800,000 and $13,800,000, respectively, for
the three and six month periods ended June 30, 2006 and $5,200,000 for the 2005
periods. ATX had pre-tax income (loss) of $2,100,000 and $2,000,000,
respectively, for the three and six month periods ended June 30, 2006 and
$(700,000) for the 2005 periods. Other income for the 2006 periods includes
$500,000 from the recovery of certain pre-bankruptcy payments that had no book
value. Revenues and cost of sales for the second quarter of 2006 were largely
unchanged as compared to the first quarter of 2006.
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
In June 2006, the Company entered into an agreement to sell ATX to Broadview
Networks Holdings, Inc. Closing of the transaction is subject to receipt of
required regulatory approvals, purchaser financing and satisfaction of certain
closing conditions. After payment of estimated closing costs, amounts due to
minority interests and estimated net working capital adjustments, at closing the
Company would receive net cash proceeds of approximately $85,000,000, and would
record a pre-tax gain on sale of discontinued operations of approximately
$30,000,000.
Gaming Entertainment
For the period from date of acquisition to June 30, 2006, Premier had pre-tax
income of $600,000. Such amount reflects Premier's interest expense of
$3,400,000, all other expenses of $2,300,000, insurance recoveries and charges
for minority interests. As more fully discussed above, Premier is currently
awaiting the release of insurance proceeds held by the trustee under the Premier
Notes; however, reconstruction activities have begun and are expected to take
twelve months to complete. Until such time as the Hard Rock Biloxi reopens,
Premier's operating results will consist primarily of overhead costs, interest
expense, charges or credits for minority interests and remaining insurance
recoveries.
Domestic Real Estate
Pre-tax income for the domestic real estate segment was $3,200,000 and
$1,100,000 for the three month periods ended June 30, 2006 and 2005,
respectively, and $51,000,000 and $500,000 for the six month periods ended June
30, 2006 and 2005, respectively. Pre-tax income for this segment for the six
month period ended June 30, 2006 principally reflects the sale by Square 711,
which resulted in a pre-tax gain of $48,900,000. In addition, the Company
recognized pre-tax profit related to its 95-lot development project in South
Walton County, Florida of $3,000,000 and $1,500,000 for the three month periods
ended June 30, 2006 and 2005, respectively, and $3,500,000 and $2,400,000 for
the six month periods ended June 30, 2006 and 2005, respectively. Such amounts
principally result from the completion of certain required improvements.
Corporate and Other Operations
Investment and other income increased in the three and six month periods ended
June 30, 2006 as compared to the same periods in 2005 primarily due to greater
interest income of $19,600,000 and $38,100,000, respectively, reflecting a
larger amount of invested assets and higher interest rates, and for the six
month period, $27,500,000 of gain from the sales of two associated companies. In
addition, investment and other income for the 2006 periods include $7,100,000
from the recovery of a bankruptcy claim. Investment and other income also
reflects income (charges) of $800,000 and $(1,300,000) for the three month
periods ended June 30, 2006 and 2005, respectively, and $1,800,000 and
$(200,000) for the six month periods ended June 30, 2006 and 2005, respectively,
related to the accounting for mark-to-market values of Corporate derivatives.
Net securities gains for Corporate and Other Operations aggregated $44,400,000
and $46,900,000 for the three month periods ended June 30, 2006 and 2005,
respectively, and $83,100,000 and $47,000,000 for the six month periods ended
June 30, 2006 and 2005, respectively. Included in net securities gains for the
six month 2006 period is a gain of $37,400,000 from the sale of 115,000,000
shares of Level 3 common stock for $376,600,000. Net securities gains include
provisions of $1,700,000 and $1,000,000 for the three month periods ended June
30, 2006 and 2005, respectively, and $2,600,000 and $3,300,000 for the six month
periods ended June 30, 2006 and 2005, respectively, to write down the Company's
investments in certain available for sale securities. The write-down of the
securities resulted from a decline in market value determined to be other than
temporary.
The increase in interest expense during the 2006 periods as compared to the same
periods in 2005 primarily reflects interest expense relating to fixed rate
repurchase agreements.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
Salaries and incentive compensation expense increased by $13,100,000 and
$16,700,000, respectively, in the three and six month periods ended June 30,
2006 as compared to the same periods in 2005 principally due to share-based
compensation expense recorded as a result of the adoption of SFAS 123R. For the
three and six month 2006 periods, salaries and incentive compensation expense
included $9,000,000 and $9,400,000, respectively, relating to grants made under
the Company's senior executive warrant plan and the fixed stock option plan.
Salaries and incentive compensation also increased due to greater Corporate
bonus expense, compensation expense of a subsidiary that was acquired in the
fourth quarter of 2005 that is engaged in the development of a new medical
product, and greater compensation expense for the winery operations.
The increase in selling, general and other expenses of $6,500,000 and
$16,400,000 in the three and six month periods ended June 30, 2006 as compared
to the same periods in 2005 primarily reflects research and development costs
and operating expenses of the medical product development subsidiary, greater
employee benefit costs including pension costs relating to WilTel's retained
plan (which were classified with discontinued operations in 2005), the write
down of certain gas properties, and higher professional fees, which largely
relate to potential and existing investments. The 2006 periods also reflect
increased corporate aircraft expenses. In addition, selling, general and
administrative expenses for the three and six month 2005 periods include
$1,300,000 and $2,100,000, respectively, related to Indular, an Argentine shoe
manufacturing company that was sold in the fourth quarter of 2005.
For the three and six month periods ended June 30, 2006, the Company's effective
income tax rate is higher than the federal statutory rate primarily due to state
income taxes. The income tax provisions for the 2005 periods reflect a credit of
$1,110,000,000 as a result of the reversal of a portion of the valuation
allowance for the deferred tax asset. The Company adjusted the valuation
allowance since it believes it is more likely than not that it will have future
taxable income sufficient to realize that portion of the net deferred tax asset.
Associated Companies
Equity in income (losses) of associated companies for the three and six month
periods ended June 30, 2006 and 2005 includes the following (in thousands):
For the Three Month For the Six Month
Period Ended June 30, Period Ended June 30,
-------------------- --------------------------
2006 2005 2006 2005
-------- ------- -------- --------
Olympus Re Holdings, Ltd. $ -- $ 4,900 $ -- $ 12,000
EagleRock 2,500 (14,700) 12,000 (19,500)
JPOF II 14,100 4,700 19,700 11,100
HomeFed Corporation 200 500 900 500
Union Square -- 72,000 -- 72,300
Safe Harbor (4,600) -- (3,500) --
Other 2,900 600 8,500 2,800
-------- -------- -------- --------
Equity in income before income taxes 15,100 68,000 37,600 79,200
Income tax expense 5,600 700 14,300 700
-------- -------- -------- --------
Equity in income, net of taxes $ 9,500 $ 67,300 $ 23,300 $ 78,500
======== ======== ======== ========
In early 2006, Olympus Re Holdings, Ltd. raised a significant amount of new
equity to replace some, but not all of the capital that was lost as a result of
the 2005 hurricanes. Since the Company did not invest additional capital in
Olympus, its equity interest was diluted (to less than 4%) such that it no
longer applies the equity method of accounting for this investment subsequent to
December 31, 2005. The Company wrote down the book value of its remaining
investment in Olympus to zero in 2005.
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
In May 2005, Union Square sold its interest in an office complex located on
Capitol Hill in Washington, D.C. During the second quarter of 2005, the Company
received its share of the net proceeds totaling $71,800,000 and received an
additional $1,000,000 in the fourth quarter for its share of escrowed proceeds.
The Company recognized a pre-tax gain on the sale, including the escrowed
proceeds, of $71,900,000.
Discontinued Operations
Healthcare Services
As discussed above, in July 2006 the Company sold Symphony and classified its
historical operating results as a discontinued operation during the second
quarter. Pre-tax income of the healthcare services segment was $1,700,000 and
$800,000 for the three month periods ended June 30, 2006 and 2005, respectively,
and $200,000 and $2,200,000 for the six month periods ended June 30, 2006 and
2005, respectively.
Real Estate
In May 2005, the Company sold its 716-room Waikiki Beach hotel and related
assets for an aggregate purchase price of $107,000,000, before closing costs and
other required payments. The Company recorded a pre-tax gain of $56,600,000,
which is reflected in gain on disposal of discontinued operations for the three
and six month periods ended June 30, 2005.
WilTel
Gain (loss) on disposal of discontinued operations for the 2006 periods
principally reflects working capital adjustments and the resolution of certain
sale-related obligations and contingencies related to WilTel, which was sold in
the fourth quarter of 2005. WilTel's pre-tax income classified as a discontinued
operation was $11,300,000 and $20,600,000 for the three and six month periods
ended June 30, 2005, respectively.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking statements. Such
statements may relate, but are not limited, to projections of revenues, income
or loss, development expenditures, plans for growth and future operations,
competition and regulation, as well as assumptions relating to the foregoing.
Such forward-looking statements are made pursuant to the safe-harbor provisions
of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are inherently subject to risks and uncertainties,
many of which cannot be predicted or quantified. When used in this Report, the
words "estimates," "expects," "anticipates," "believes," "plans," "intends" and
variations of such words and similar expressions are intended to identify
forward-looking statements that involve risks and uncertainties. Future events
and actual results could differ materially from those set forth in, contemplated
by or underlying the forward-looking statements.
Factors that could cause actual results to differ materially from any results
projected, forecasted, estimated or budgeted or may materially and adversely
affect the Company's actual results include but are not limited to the
following: potential acquisitions and dispositions of our operations and
investments could change our risk profile; dependence on certain key personnel;
economic downturns; changes in the U.S. housing market; changes in
telecommunications laws and regulations; risks associated with the increased
volatility in raw material prices and the availability of key raw materials;
compliance with government laws and regulations; changes in mortgage interest
rate levels or changes in consumer lending practices; a decrease in consumer
spending or general increases in the cost of living; proper functioning of our
information systems; intense competition in the operation
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Interim Operations, continued.
of our businesses; our ability to generate sufficient taxable income to fully
realize our deferred tax asset; weather related conditions and significant
natural disasters, including hurricanes, tornadoes, windstorms, earthquakes and
hailstorms; our ability to insure certain risks economically; reduction or
cessation of dividend payments on our common shares. For additional information
see Part I, Item 1A. Risk Factors in the 2005 10-K and Part II, Item 1A. Risk
Factors contained herein.
Undue reliance should not be placed on these forward-looking statements, which
are applicable only as of the date hereof. The Company undertakes no obligation
to revise or update these forward-looking statements to reflect events or
circumstances that arise after the date of this Report or to reflect the
occurrence of unanticipated events.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information required under this Item is contained in Item 7A of the Company's
Annual Report on Form 10-K for the year ended December 31, 2005, and is
incorporated by reference herein.
Item 4. Controls and Procedures.
Evaluation of disclosure controls and procedures
(a) The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of
the Company's disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of June 30, 2006. Based on their
evaluation, the Company's principal executive and principal financial
officers concluded that the Company's disclosure controls and procedures
were effective as of June 30, 2006.
Changes in internal control over financial reporting
(b) There has been no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act) that occurred during the Company's fiscal quarter ended June 30, 2006,
that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On June 8, 2006, approximately 1,590 individual purchasers of subordinated notes
issued by Thaxton Group, Inc. ("Thaxton") filed, in one consolidated case, a
lawsuit in the United States District Court for the District of South Carolina,
Anderson Division, against Leucadia National Corporation; FINOVA Capital
Corporation, Inc.; FINOVA Group, Inc.; Berkshire Hathaway, Inc.; Thomas Mara;
Berkadia, LLC; Berkadia II LLC; Berkadia Equity Holdings LLC; and Berkadia
Management LLC. Plaintiffs in the aggregate claim to have purchased
approximately $84,000,000 (including interest) of Thaxton Notes (as defined
below). The plaintiffs' claims are brought under various statutory and common
law theories and substantially rely upon a control theory of lender liability,
assert civil conspiracy, securities fraud, unfair trade practices act, and civil
racketeering claims against the defendants and seek civil, punitive and treble
damages. The Company believes that the claims against it are without merit and
intends to vigorously defend against this litigation.
This lawsuit arises out of the same facts underlying litigation between The
FINOVA Group Inc. and its subsidiaries (collectively, "Finova") and Thaxton and
its affiliates (and their respective chapter 11 estates) and holders of Thaxton
Notes following the bankruptcy of Thaxton in October 2003 and its subsequent
default on subordinated debt that Thaxton and certain related parties had issued
(the "Thaxton Notes"). The claims in the prior litigations against Finova relate
to Finova's attempts to collect on its $108,000,000 senior secured loan to
Thaxton. These actions were either brought by holders of the Thaxton Notes
(which actions were certified as a class action by the United States District
Court for the District of South Carolina, Anderson Division, but which ruling
was subsequently reversed by the United States Court of Appeals for the Fourth
Circuit) or by the unsecured creditors of Thaxton in the Thaxton bankruptcy
proceedings. All of these actions were consolidated for pre-trial discovery in
the United States District Court for the District of South Carolina, Anderson
Division. In March 2006, the South Carolina District Court granted a partial
summary judgment motion on the Thaxton creditors' claim for equitable
subordination, finding that FINOVA Capital Corporation had engaged in fraudulent
conduct by purposefully structuring its loan agreement in a way that allowed
Thaxton to report to all its creditors, and particularly prospective purchasers
of Thaxton Notes, that an $8,000,000 equity investment had been made in 1998,
when in fact, that $8,000,000 continued to be debt, and that this enabled
Thaxton to violate federal banking law. Finova has filed an appeal of this
decision to the Fourth Circuit. Finova has stated in its filings with the
Securities and Exchange Commission that it believes that all of the claims
against it in these actions are without merit.
For additional information concerning Finova and Thaxton-related litigation,
reference is made to the Form 10-K for the year ended December 31, 2005 filed by
The FINOVA Group Inc. and its Form 10-Q for the quarter ended June 30, 2006.
For additional information concerning the Company's relationship with Berkadia
and Finova, see the Company's 2005 10-K.
Item 1A. Risk Factors.
As a result of the Company's acquisition of Premier during the second quarter of
2006, the Company is adding to its risk factors the items listed below that are
specific to the Premier investment.
Premier could be unsuccessful in its attempt to fully collect on its remaining
insurance claim related to Hurricane Katrina. Premier is currently engaged in
litigation with one insurance carrier that provided $14,000,000 of insurance
coverage. If Premier is not successful in recovering its insurance claim, it may
not have sufficient funds to repair and rebuild the Hard Rock Biloxi and fund
its pre-opening expenses without additional assistance.
27
Premier may not be successful in obtaining access to the insurance proceeds held
in restricted accounts by the trustee under the Notes. If the trustee under the
Notes does not approve Premier's proposal and release the funds to repair and
rebuild the Hard Rock Biloxi, Premier will not be able to carry out its business
plan in a timely manner without access to alternative capital.
Premier could encounter problems during reconstruction that could substantially
increase the construction costs or delay the opening of the Hard Rock Biloxi.
Reconstruction projects like the Hard Rock Biloxi are subject to significant
development and construction risks, any of which could cause unanticipated cost
increases and delays. These include, among others, the following:
o shortages of materials and skilled labor;
o adverse weather which damages the project or causes delays;
o delays in obtaining or inability to obtain necessary permits, licenses and
approvals, including alcoholic beverage licensing and gaming commission
approval;
o changes in statutes, regulations, policies and agency interpretations of
laws applicable to gaming projects;
o changes to the plans or specifications;
o engineering problems;
o labor disputes and work stoppages;
o environmental issues;
o fire, flooding and other natural disasters; and
o geological, construction, excavation, regulatory and equipment problems.
Premier has no operating history or history of earnings and does not have any
experience developing or operating a gaming facility. Following reconstruction,
the Hard Rock Biloxi will be a new business and, accordingly, will be subject to
all of the risks inherent in the establishment of a new business enterprise. If
Premier is unable to manage these risks successfully, or fail to attract a
sufficient number of guests, gaming customers and other visitors to the Hard
Rock Biloxi, it would negatively impact its operations.
The right to operate the Hard Rock Biloxi is contingent upon governmental
approval. A revocation, suspension, limit or condition of Premier's gaming
licenses or registrations would result in a material adverse effect on its
business. If Premier's gaming licenses and/or registrations are revoked for any
reason, the Mississippi Gaming Commission could require us to close the Hard
Rock Biloxi. Failure to maintain such approvals could prevent or delay the
completion of reconstruction or opening of the Hard Rock Biloxi, or otherwise
affect the design and features of the operation of the Hard Rock Biloxi, all of
which could materially and adversely affect financial position and results of
operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The Company's purchases of its common shares during the second quarter of 2006
were as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
Total Number of
Shares Purchased Approximate
as Part of Dollar Value of
Publicly Shares that May
Total Number Average Announced Plans Yet Be Purchased
of Shares Price Paid or under the Plans
Purchased (1) Per Share Programs or Programs
------------- --------- ---------------- -------------
June 1 to June 30 1,034 $32.02 -- $ --
------------- ------ ---------
Total 1,034 --
============= =========
(1) Consists of common shares received from a director to exercise stock
options in accordance with the terms of the stock option plan. Shares were
valued at the market price at the time of the option exercise.
28
Item 4. Submission of Matters to a Vote of Security Holders.
The following matters were submitted to a vote of shareholders at the
Company's 2006 Annual Meeting of Shareholders held on May 16, 2006.
a) Election of directors.
Number of Shares
----------------
For Withheld
--- --------
Ian M. Cumming 194,563,118 1,484,466
Paul M. Dougan 194,565,600 1,481,984
Lawrence D. Glaubinger 194,526,426 1,521,158
Alan J. Hirschfield 194,096,136 1,951,448
James E. Jordan 193,977,302 2,070,282
Jeffrey C. Keil 195,458,462 589,122
Jesse Clyde Nichols, III 194,540,806 1,506,778
Joseph S. Steinberg 194,558,996 1,488,588
b) Approval of an amendment to the Company's 2003 Senior Executive
Annual Incentive Bonus Plan increasing the maximum annual
incentive bonus that may be paid to each of Ian M. Cumming and
Joseph S. Steinberg under the plan from 1% to 1.35% of the
audited pre-tax earnings of the Company and its consolidated
subsidiaries for each year of the plan through and including
fiscal year 2014.
For 150,358,868
Against 2,383,850
Abstentions 1,460,404
Broker non-votes 41,844,462
c) Approval of the 2006 Senior Executive Warrant Plan and the grant
of warrants to each of Ian M. Cumming and Joseph S. Steinberg
under the plan to purchase 2,000,000 Leucadia National
Corporation common shares at a per share exercise price equal to
$28.515 per share, representing 105% of the closing price of our
common shares as quoted on the New York Stock Exchange on March
6, 2006, the date on which the warrants were granted, subject to
shareholder approval.
For 147,119,728
Against 5,314,134
Abstentions 1,549,258
Broker non-votes 42,064,464
d) Approval of an amendment to the 1999 Stock Option Plan increasing
the number of Leucadia National Corporation common shares
reserved for issuance under the 1999 Stock Option Plan by
2,000,000 common shares so that an aggregate of 2,519,150 common
shares would be reserved for issuance under the plan.
For 146,616,522
Against 6,064,970
Abstentions 1,521,626
Broker non-votes 41,844,466
29
e) Ratification of PricewaterhouseCoopers LLP, as independent
auditors for the year ended December 31, 2006.
For 195,678,248
Against 253,646
Abstentions 115,690
Broker non-votes --
Item 6. Exhibits.
10.1 Form of Unit Purchase Agreement, dated as of April 6, 2006,
by and among GAR, LLC, the Company, AA Capital Equity Fund,
L.P., AA Capital Biloxi Co-Investment Fund, L.P. and HRHC
Holdings, LLC.
10.2 Form of Loan Agreement, dated as of April 6, 2006, by and
among Goober Drilling, LLC, the Subsidiaries of Goober
Drilling, LLC from time to time signatory thereto and the
Company.
10.3 Form of First Amendment to Loan Agreement, dated as of June
15, 2006, between Goober Drilling, LLC, the Subsidiaries of
Goober Drilling, LLC from time to time signatory thereto and
the Company.
10.4 Form of First Amended and Restated Limited Liability Company
Agreement of Goober Drilling, LLC, dated as of June 15,
2006, by and among Goober Holdings, LLC, Baldwin
Enterprises, Inc., the Persons that become Members from time
to time, John Special, Chris McCutchen, Jim Eden, Mike Brown
and Goober Drilling Corporation.
10.5 Form of Purchase and Sale Agreement, dated as of May 3,
2006, by and among LUK-Symphony Management, LLC, Symphony
Health Services, LLC and RehabCare Group, Inc.
10.6 Form of Amendment No. 1, dated as of May 16, 2006, to the
Amended and Restated Shareholders Agreement dated as of June
30, 2003, by and among Ian M. Cumming, Joseph S. Steinberg
and the Company.
10.7 Form of Credit Agreement, dated as of June 28, 2006, by and
among the Company, the various financial institutions and
other Persons from time to time party thereto and JPMorgan
Chase Bank, National Association.
31.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.3 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEUCADIA NATIONAL CORPORATION
(Registrant)
Date: August 9, 2006 By: /s/ Barbara L. Lowenthal
-----------------------
Barbara L. Lowenthal
Vice President and Comptroller
(Chief Accounting Officer)
31
Exhibit Index
10.1 Form of Unit Purchase Agreement, dated as of April 6, 2006,
by and among GAR, LLC, the Company, AA Capital Equity Fund,
L.P., AA Capital Biloxi Co-Investment Fund, L.P. and HRHC
Holdings, LLC.
10.2 Form of Loan Agreement, dated as of April 6, 2006, by and
among Goober Drilling, LLC, the Subsidiaries of Goober
Drilling, LLC from time to time signatory thereto and the
Company.
10.3 Form of First Amendment to Loan Agreement, dated as of June
15, 2006, between Goober Drilling, LLC, the Subsidiaries of
Goober Drilling, LLC from time to time signatory thereto and
the Company.
10.4 Form of First Amended and Restated Limited Liability Company
Agreement of Goober Drilling, LLC, dated as of June 15,
2006, by and among Goober Holdings, LLC, Baldwin
Enterprises, Inc., the Persons that become Members from time
to time, John Special, Chris McCutchen, Jim Eden, Mike Brown
and Goober Drilling Corporation.
10.5 Form of Purchase and Sale Agreement, dated as of May 3,
2006, by and among LUK-Symphony Management, LLC, Symphony
Health Services, LLC and RehabCare Group, Inc.
10.6 Form of Amendment No. 1, dated as of May 16, 2006, to the
Amended and Restated Shareholders Agreement dated as of June
30, 2003, by and among Ian M. Cumming, Joseph S. Steinberg
and the Company.
10.7 Form of Credit Agreement, dated as of June 28, 2006, by and
among the Company, the various financial institutions and
other Persons from time to time party thereto and JPMorgan
Chase Bank, National Association.
31.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification of President pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.3 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman of the Board and Chief Executive
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 Certification of President pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.3 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32